We’ve locked our heads to the Ukraine-Russia conflict and we’re on our toes for any new advancements, but however terrorising that may be, it hasn’t stopped the rest of the world from functioning. Or would “Crumbling” be a more fitting word?
Picture this: You’re walking down a busy street. You notice a pot hole at a distance and your brain immediately alerts you to be careful. As you walk further, you see every person that reaches the pothole, fall right in. Logically I’m sure we can all agree that it only makes sense to walk around it. But if that is the case, why is Sri Lanka currently facing what is said to be its worst ever economic crisis since its independence- when its characteristics all seem to be an imitation of something we’ve seen before?
The economy is at war with its own people. Its downfall has left the country’s mere 22 million rationing their food and baby formulas. Mopeds and vehicles form never-ending lines at the gas pumps where troops have been deployed to distribute petrol. People parade the streets protesting the current government for the absurd situation they’ve put their citizens in- because that is all this is. A classic case of slowly built up mis-governance finally blowing up in the leadership’s face, and the common Sri Lankan man is made a casualty because of it.
As of March of this year, the country’s inflation rate climbed up to 18.7%. Teamed up with a hideous drop in foreign currency reserves- a 70% fall in the span of 2 years- Sri Lanka has found itself in a major debt crisis. Even with $4 billion of debt repayments due this year, the country has to first worry about its ability to pay for more than just a month’s requirement of essential imports with the measly $2.3 billion left as foreign currency reserves. The shortage of these goods has never had a greater impact on its people. Electricity availability is limited to a couple hours in a day and newsprint is shutting down for the same reason school examinations are postponed- there is no paper. The Sri Lankan rupee now stands at 315 for 1 USD, which can hardly be good for their debt to GDP ratio which is currently at 119%.
Tracing the Roots and How We Arrived Here
The coronavirus pandemic left many economies in distress, but the current tumultuous state of Sri Lanka cannot be entirely attributed to the effects of covid-19. There is no denying that its impact on Sri Lanka’s tourism, which its economy relies heavily on, was negative. However, that was only an addition to an economy that’d already started crumbling pre-pandemic, years in advance. After almost 30 years of ethnic conflict, 2009 marked the beginning of high growth rates in Sri Lanka as an emerging economy. Both public and private investments was directed towards infrastructure development in Colombo which was largely made possible by taking loans from Chinese banks. However, the results of its construction were non tradable and their returns were limited to the country’s population and their purchasing power- so the growth that lit hope in everyones eyes, was short lived.
The problem with absolute values, is that they paint a picture that is more often than not, inaccurate. They can be easily manipulated and conveniently used. Inferably, all Rajapaksa governments in power must have taken advantage of this, because in absolute terms, the country’s export performance was on a steady incline. The real underdog and always the one to look out for, is relative performance. The share of exports in the country’s GDP stood at 39% in the 2000s and only seemed to decline from then on. By solely focusing on exporting traditional goods like textile and rubber, their export competitiveness dropped when neighbouring lower-income countries were able to do the same for cheaper. That loss was grave for their foreign currency stock as it accounted for more than half of their foreign currency earnings.
As we course through the timeline of economic highs and lows in Sri Lanka, we’ll find that an issue they failed to grow out of, was the lack of diversification in their export and import portfolios. In hindsight what we can say with assurance is that had the government chosen to spread out their tangible and intangible resource allocation into various sectors, they wouldn’t be in nearly as bad of a state as they’re currently in.
With barely any foreign inflows into the country, Sri Lanka began its journey into a debt spiral by borrowing money from international sources and issuing sovereign bonds. That money coming in with the construction of infrastructure, gave the illusion that the economy was still doing well, carpeting the poor export performance and the tower of debt obligations Sri Lanka was quickly amassing.
Come 2019, debt stock expanded by nearly 50% and the government had no sufficient means to pay for it apart from taking more loans. This however did not stop the new Rajapaksa government from making poll promises to come into power. A reduction of individual tax obligations by 40% and the VAT by 80% may have politically made the party more appealing, but that strategy flew right in the face of textbook economic knowledge. This step alone created a loss in government revenue worth 2% of their entire GDP.
With no money to pay off their monster foreign debt, how were measures that shrunk their tax revenue given the green light? Sure, one can argue that this was done to increase consumer expenditure and boost economic activity, but in which markets? When the government’s investments were streamlined right into infrastructure and real estate, neglecting the development of tradable sectors, any consumer expenditure in the latter would obtain unsatisfactory monetary value, and not be able to offset the aforementioned debt pressures.
Their Creditors and Why Not the IMF?
Sri Lanka’s persistent refusal to seek assistance from the international monetary fund could very likely be due to their resistance in following the IMF’s guidelines and code of conduct. The structure of their taxation system, not keeping their central bank and government independent nor their exchange rate fixed, are all against what the IMF recommends. This meant that Sri Lanka seeking help from the organisation could follow only after they reformed a majority of their macroeconomic policies in accordance with the international body- something they were clearly unwilling to do.
Before they finally did get into talks with the IMF, their first avenues of new revenue were its superpower neighbours; India and China. The latter has risen to be one of Sri Lankas most consistent lenders partly because of the country’s agreement into the belt and road initiative to boost their infrastructure development, post war. While it may be Indian and western media’s gumption to paint this economic demise as a product of the Chinese debt trap, we have to note that China accounts for only 10% of Sri Lanka’s total debt. This not only means that the latter has greater dues to other creditors like the ADB, the world bank and Japan, but also that a restructuring of the Chinese debt repayment plan would do very little to reduce Sri Lankas total burden.
What Now?
As spectators, we can only comment on Sri Lankas situation. It can be tempting to give the benefit of the doubt and blame the “uncertainty of the future” for the missteps the Sri Lankan government took, it would also be naive. The crisis was not sudden. It gradually grew before of all of the Rajapaksa governments’ eyes and they knowingly added onto it. By shielding the world from what was actually going on, that government was the only body entirely in the know of the real pressures the economy was under. Their miscreant governance put their people right under the bus and it is now of prime most importance that they backseat their egos, to lift the country out of this mess.
Fortunately, the preventative measures the country could have employed at various points in the last few decades are still viable and quite frankly, the best solutions for them now. Sri Lanka continues to put an unnecessary pressure on itself to pay back their loans and interests compiled, when the rest of the world has opted to help them out through debt easing, relief, restructuring, and reform. The easiest step they must take would be to improve their tax revenue through an increase in their tax rates back to at least their original level and expand their tax base. However, Sri Lanka has a history of not amending the regressive effects of policy on the lower income population. Just as the IMF suggests, the government needs to do so only after creating bulletproof insulation for them to insure no negative impact on the labour class. Through their investments in real estate, the rich in Sri Lanka were able to get richer creating a bigger income gap. That additional wealth remained inadequately taxed and doing so would improve the government’s tax revenue by a substantial amount.
With a lager public budget, the government can then actively spread out their efforts and resources into various sectors to develop them simultaneously. They must do so with a stronger focus on improving tradable goods and service production such that their export portfolio can be devised with diversity rather than weights on traditional goods and tourism. On that note, as the pandemic conditions improve, there is hope in increased returns from tourism once again.
As they do this, they need to keep a tenacious eye on their reformed tax regime such that it continues to yield revenue for their public budget without discouraging economic activity. Fortunately for them, their pre 2019 tax rates were more than adequate for this goal. Even so, it may be better for them to increase their rates higher than those and gradually come back down that level. With the yielded tax revenues, the government can become less reliant on foreign reserves for development in their country. When they invest internally, they aid in the private sector creating an environment suitable for foreign direct investment which would not only boost their international economic status but help them rebuild their stock of foreign currency.
All of these measures unquestionably accrue very long term results and it would take quite some time before things start looking up again for Sri Lanka. At the same time the suggested plan does not sound like anything new and it certainly isn’t.
The gravity of the Sri Lankan economic collapse is unique only to its own economy for the very reason that the world has seen much worse and arrived at the same solutions for numerous countries, already.
The Rajapaksa government is confronted with a threat more menacing than their economic repercussions- their people. Just for the sheer number of years, or rather decades, that the Sri Lankan people were deceived and taken advantage of, their trust- at least for this dynastic government- could very well be shattered. President Gotabaya Rajapaksa needs the people’s cooperation to help him lift the country out of its trenches. But he comes off entirely out of tune when asking the citizens to look past their rightful distrust, and still have faith in his administration’s caliber.
After elevating the economy with a more solid foundation building in progress-
the current government owes both Sri Lanka’s present and future, the bare minimum of graciously stepping down and passing its responsibilities onto a more competent and dependable administration.
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