• World
  • Apr 04
  • N. Sathiya Moorthy

Understanding the causes of economic crisis in Sri Lanka

Decades ago, Lee Kwan Yew who made Singapore what it is today wanted the city-state to become like Sri Lanka. The nation then used to be called Ceylon. “When I went to Colombo for the first time in 1956,” Lee wrote in 1998, “it was a better city than Singapore… It ought to have flourished. But it didn’t…Changing names, sometimes maybe you deceive the gods, but I don’t think you are deceiving the people.” 

Over a decade ago, the ruling Rajapaksa family in Sri Lanka was considered to be the right people at the right place at the right time. They won the war against the LTTE, after three long decades. Today, they are seen as the wrong people at the wrong place at the wrong time. The economic mess that they inherited, and to which they added their own in two stints totalling 13 years since first coming to elected power in 2005 has starved the nation. 

Today, the country is grappling with what is said to be its worst economic crisis since independence from the UK in 1948. It is caused in part by a lack of foreign currency, which is used to pay for fuel imports.

Though COVID-19 is accepted as the main contributor, the foreign exchange stopped flowing in, and the reserves melted away without the government and the Central Bank (CB) doing enough.

The island nation has seen widespread public anger against the government for its mishandling of the worst economic crisis. People are languishing in long queues for fuel, cooking gas and endure power cuts lasting multiple hours. The public came out onto the streets independently of political parties. The mass agitation prompted the government to impose a state of emergency which gives security forces sweeping powers to arrest people. Later, a curfew was imposed to curb public protests which the public defied.

The economic distress has triggered an unprecedented political crisis, targeting President Gotabaya Rajapaksa and the government led by Prime Minister Mahinda Rajapaksa, his brother and two-term President.

It was under President Mahinda’s regime (2005-2015), and guided by Gotabaya as defence secretary, that the Sri Lankan armed forces defeated the LTTE in May 2009.

Today, the Rajapaksas are on the defensive, with street-protests seeking to take an anarchist form, as if orchestrated, in the form of ‘Arab Spring’ and ‘Orange Revolution’. This could lead to political instability. 

Tourists, who shore up the forex reserves in this post-pandemic period on a daily basis, and investors, who are expected to boost employment, family incomes and government revenues, could well stay away – for a longer time than the nation could afford.

Legacy issue

Sri Lanka’s economic crisis is not the making of a single government, President or even a generation. It’s a legacy issue, which each elected government passed on to the next, with its own share or contribution. When past governments talked about approaching the IMF for assistance, it was not to give a big boost to the economy but to find money, to pay for past sins, either in the form of clearing existing debts or to supposedly fund capital expenditure of the exchequer – but did not do much in that regard. 

The government was not at all prepared for dealing with the COVID-19 pandemic. The situation exposed an open secret that each generation of elected political leadership, with the connivance of the permanent bureaucracy, had passed on to the next, and so on. Today, a new generation of population is paying for the past sins of their political masters, who remain more or less the same, for decades now.

The Sri Lankan economy was meandering along, swinging violently between market capitalism of the United National Party (UNP), which was at the helm at Independence in 1948, and the socialist model of the breakaway Sri Lanka Freedom Party (SLFP), founded in 1952 and which came to power in 1956 elections, heading a heterogenous left-leaning parties and ideologies.

These confusing and contradictory measures came to an end in the late 70s, when J.R. Jayawardene (JRJ) became the nation’s Executive President, after authoring the Second Republican Constitution with a four-fifths majority in Parliament. At least some of the nation’s political, constitutional and economic woes are since attributed to the Executive Presidency.

JRJ introduced economic reforms, based on the western, capitalist, market-oriented model. He was encouraged in this by the very same Lee of Singapore, who had once praised Sri Lanka, when it was still Ceylon, and yet would go on to ridiculing the nation. Reading Lee’s self-help book for Singapore wrongly, JRJ amassed all Constitutional and executive powers in the President.

JRJ also introduced economic reforms without understanding that Singapore’s growth owed not to market capitalism, per se, but the readiness with which the US and other western nations and their investors pumped in big money, to make the city-state into a financial and trading hub. It was the same with Dubai, later. Both Singapore and Dubai continue to serve as hubs for transit trade in huge volumes and money-worth, but not much of it is consumed by either. 

Having started off with the wrong end of the stick, the JRJ regime damaged the nation’s mainstay agrarian economy by freeloading the import of even dairy products and condiments for the dining table. 

In the midst of the pandemic and the engulfing forex crisis, President Gotabaya Rajapaksa sought to reset the clock. He did it too fast and also without preparing the nation and the farming community to shift to organic farming, where he only replaced imported chemical fertilizers with organic fertilizer, coming from China. 

This dented whatever farming activity that was possible over the past one-plus year under testing circumstances. The crisis worsened when the government’s agri-scientists certified that the Chinese organic fertilizer was unfit for local use. 

Tea production, which was a major export and hence forex earner, already lacking external markets owing to the COVID lockdown across the globe, suffered the worst. 

The China factor

Looking back, some Sri Lankan analysts agree that instead of aping the Singapore/Dubai model, the nation should have followed the post-World War II Japanese model, which, despite being an archipelago-nation went into sector-specific manufacturing like automobiles and engineering, and knowledge-based service industries like transistor and other miniature gadgets. Of course, Japan did not have any ideological hang-ups and opposition from within. The US that encouraged Japan to come out of the War-time isolation, especially owing to Hiroshima and Nagasaki, also provided a ready and expanding market in the post-War era. 

At the end of the Civil War in 2009, Sri Lanka, under President Mahinda Rajpaaksa also attempted such a turn, though not fully or whole-heartedly. It invited some Indian IT giants for a personal tour of the nation, and promised infrastructure facilities, as a part of Mahinda’s poll manifestos of 2005 and 2010. Owing to domestic protests in Tamil Nadu, the IT majors, who had a strong presence in the south Indian state, withdrew.

Likewise, Chennai-based, world-renowned agro-economist, Dr. M.S. Swaminathan also cancelled a scheduled visit to Colombo to help revive the post-war agrarian economy, after pan-Tamil protests outside the Foundation named after him. 

After a while, agriculture research institutes of the government of India, based outside Tamil Nadu, stepped in. India also provided farm implements, housing, assistance in setting up women self-help groups, for Tamil war widows, officially adding up to 90,000, to live a honourable life and fend for themselves. 

The Mahinda government turned to China, first to develop the southern-most Hambantota Port, originally offered to India, which reportedly found it uneconomical, over the short, medium and long terms. 

Following this, it came under China’s care, leading to Sri Lanka surrendering the nation’s territory to the Chinese construction firms on a 99-year-lease. The debt-equity swap-deal has done more harm to Sri Lanka’s economy over the medium and long terms than good.

It did not stop there. With no working plans to help retrieve the cost over whatever term was fixed, Sri Lanka went in for massive expressways, funded and executed by China. In the past 15 years, the China-funded projects brought in expressways but did not create jobs or help boost the local economy directly. 

The Chinese firms brought in all their material without procuring them locally, and also the labour force, thus draining the domestic market of opportunities and jobs that would have helped boost family incomes at every level. 

In the years following the end of war, the nation recorded high growth-rates, which were unnatural and artificial. Even then, economists cautioned that the ‘jobless growth’ would hit the economy hard before long. 

How has the crisis worsened?

The country was struck badly by the 2019 Easter serial bomb blasts, followed by months of lockdown due to the pandemic. Both drained the nation of forex earnings from tourism, which was a major component. The lockdown also denied, as elsewhere, markets for Sri Lanka’s agricultural products like tea and also ready-to-wear dress, made out of imported cotton.

For at least two decades preceding the pandemic, the nation had become a major source for trained technicians for factory-floors, housemaids and chauffeurs for the the Gulf-Arab region, Western Europe and elsewhere. The lockdown meant that they were all sent back home, and the substantial amount of foreign exchange too dried up. 

Even without the pandemic-driven forex crisis, the predecessor government had decided to approach the International Monetary Fund (IMF), anticipating fiscal trouble. Independent of whichever party was in power, governance issues like delayed sanctions and corruption also put off foreign investors, to whom the nation had nothing exceptional to offer otherwise. 

How India is helping its neighbour?

The promised Indian investments, both in the public and private sectors, could help revive the local supplies market and also the labour market. Public Sector Undertakings (PSUs) have signed agreements to refurbish the oil tanks farms in eastern Trincomalee of Second World War, costing millions of dollars. Both countries are likely to use the oil tanks as joint ‘strategic storage’ facilities, more in economic terms. The public sector National Thermal Power Corporation (NTPC) has also signed to set up a solar power plant in Sampur. 

India’s Adani Group is developing the Colombo Port’s Western Container Terminal (WCT) in joint-sector mode. The Adani Group has also been contracted to set up renewable energy farms in Mannar and Ponneryn, both in the Tamil-dominated Northern Province, and also on three islands off Jaffna peninsula, namely, Nainativu, Neduntheevu and Analaitivu. 

After several high-level meetings, New Delhi has been pumping in assistance in the form of cash-swaps, credit lines for fuel and commodities supplies, to meet the daily needs. 

In March, India announced a $1 billion line of credit to Sri Lanka as part of its financial assistance to help the island nation deal with its economic crisis. Earlier, in February, India extended a $500 million line of credit to help Sri Lanka purchase petroleum products.

Political crisis

Sporadic public protests have been held across the country, demanding food and fuel, as long queues outside shops and fuel stations produced no results. Though the government claimed to have stocks stacked up in containers in Colombo Port, the forex crisis meant that it could not release dollars for local wholesalers and public sector oil agencies to clear those consignments. This has since led to a piquant situation, where pent-up frustrations over the ‘ruling family’, which has numerous Rajapaksas in positions of power.

The Opposition parties, which were stymied by low numbers in the 225-member Parliament, are leading many protests. After a protest outside President Rajapaksa’s house turned violent, he declared a state of emergency. 

With a section of the ruling alliance turning against particular members of the Rajapaksa clan in government, particularly Finance Minister Basil Rajapaksa, more for his ‘haughty ways’ from the past, Gotabaya has got his entire team of ministers, other than Prime Minister Mahinda Rajapaksa, to submit their resignations. 

Multiple ginger groups and rebel groups within the ruling party might join hands, especially the parliamentary group, ensuring the continued stability of the government inside Parliament, and also outside, to a greater or lesser extent. 

The ministry-making is expected to boost the confidence of the people in the government leadership, and also overcome the political pressure from the opposition Samagi Jana Balavegaya (SJB), whose leader Sajith Premadasa hopes to replace President Gotabaya. 

The way ahead

The assistance from neighbouring India, and even China have proved inadequate to save the situation. The nation needs short, medium and long-term remedies, including generosity from debtors, who should agree to restructure the pending loans, say, by three years and beyond.

The nation also needs to do a lot of belt-tightening, which in time could have saved the day, but was ignored in favour of populist measures in what still remains a conformist electoral democracy. 

Sri Lanka has approached the International Monetary Fund (IMF) as a last resort, fearing that infamous IMF conditionalities would make the government leadership unpopular with the rural poor in the Sinhala-Buddhist South, which is also the traditional constituency of the Rajapaksas.

(The writer is a policy analyst and commentator. The views expressed here are personal)