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How Sri Lanka’s economic crisis has been decades in the making

Years of debt accumulation, policy missteps – including a failed experiment in organic farming – and ill-conceived infrastructure projects built with Chinese funds have led the nation to the edge of catastrophe

 

Sri Lanka has flirted with economic crises for decades, but it is now on the verge of an unmitigated catastrophe that could quickly turn into a humanitarian disaster. Sri Lankans are already suffering from oil shortages as well as power cuts, and there is growing concern that the country – recovering from recently enacted disastrous agricultural policies – might not be able to feed its people.

Facing nationwide protests, the government declared a temporary state of emergency from April 2-4. But even after the emergency period is lifted, the underlying issues that resulted in such economic calamity will persist.

As the richest country per capita in South Asia, it is worth considering what has gone so wrong in Sri Lanka.

There are a number of macro factors that have exacerbated the situation – from the effect of the pandemic on the country’s tourism industry and on foreign remittances to higher oil prices caused by the Russia-Ukraine war. But the underlying reasons for Sri Lanka’s suffering are poor economic policymaking and decades of debt mismanagement.

The culprits in this situation are easy to identify. Over the past several decades, the Rajapaksa family has been behind many of the decisions that have produced the current crisis. Family members currently serve as prime minister (Mahinda), president and defence minister (Gotabaya), and finance minister (Basil), in addition to holding a number of prominent roles in the private sector.

Upon returning to power in 2019, the Rajapaksa government introduced massive tax cuts and controversially pushed an order to immediately convert Sri Lanka’s entire agricultural sector to organic farming without providing any training to farmers. The 2021 rice harvest failed, requiring Sri Lanka to pay huge sums to import food.

These recent miscues have worsened what was already a precarious situation. Sri Lanka has long pursued growth through international borrowing. Until the early 2000s, much of Sri Lanka’s debt came in the form of concessionary loans provided by multilateral agencies and bilateral donors.

These concessionary loans were favourable to Sri Lanka: they had low-interest rates, long payback periods, and could be restructured in a pinch. As Sri Lanka graduated to middle-income status and concessionary loans dried up, the country turned to international sovereign bond issuances, typically carrying higher interest rates and requiring more immediate payback periods.

In the 2000s, Mahinda Rajapaksa embraced China as an alternative to Western and Indian donors. China was willing to finance large infrastructure projects where these other lenders balked.

Many of these projects made little sense for Sri Lanka, including the Mattala Rajapaksa International Airport, which was designed to receive 1 million passengers a year and was financed by high-interest development loans from the Exim Bank of China. Built near Mahinda Rajapaksa’s home village, the airport received just over 1,000 travellers in 2019.

Observers have long debated why the Chinese would be willing to fund projects that projected such low rates of return. For its part, Chinese leaders emphasised that establishing friendly relations with Sri Lanka was in China’s best interests.

Furthermore, by providing funding and infrastructure development, China was enabling countries like Sri Lanka to chart their own future courses. These claims aside, Beijing was also engaged in an effort to undermine India’s influence in Sri Lanka.

In recent years, however, smaller nations like Sri Lanka have become far more sceptical of China’s intentions. Sri Lanka’s new lenders have been hesitant to restructure their debt obligations, seizing a port in Colombo a few years ago and only offering minimal relief in present negotiations.

Earlier, in 2017, the country was forced to lease the port of Hambantota for 99 years to China after failing to make payments on debts that it had incurred in the construction of the facility.

It is doubtful that the Rajapaksas can extricate themselves or their country from the present situation. The government has approached India, a friendly neighbour that has been eager to re-engage with Sri Lanka as it attempts to check China’s growing power in the region.

In response to Sri Lanka’s crisis, India has already extended some financial support – and would be likely to step in if a true humanitarian disaster emerges – but is unlikely to have an interest in providing a fully-fledged bailout. The Rajapaksa government is also engaging in conversations with the International Monetary Fund.

After years of badmouthing the IMF in favour of sovereign and Chinese debt, however, the Rajapaksas are likely to be given a short leash in negotiations. The IMF could demand a series of politically unpopular reforms that will not bode well for the administration.

The only other option is for the country to default on its debt obligations, a decision that would probably doom the incumbent government.

Protesters are not only demonstrating against the current predicament but are demanding that the Rajapaksas be removed from power. The hope is that a new government would be better positioned to negotiate with creditors and restructure debt obligations.

But even with most of the cabinet resigning, the Rajapaksas may continue to hold out. Either way, Sri Lanka’s situation is likely to get far worse before it gets better.

06 Apr 22/Wednesday                                                                                Source: scmp

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