Sri Lanka and Pakistan, brothers in crisis

Author: Editorial Board, ANU

A Sri Lankan debt crisis — the prospect of which has for many months hung over the country like a storm about to break — has arrived. Observers of the Sri Lankan economy have been warning of a reckoning for some time. In its regular reviews the IMF warned in 2016 of ‘unbalanced macroeconomic policies’; in 2018 of vulnerability to ‘adverse shocks’.

Major tax cuts in Sri Lanka in 2019 represented a significant loosening of fiscal policy that contributed to enormous deficits as the COVID-19 pandemic hit and Sri Lanka’s tourist industry collapsed. The country is now staggering under the weight of its accumulated foreign debt. Persistent current account deficits also set the stage for a balance-of-payments crisis which has — and likely will — continue to hurt the most vulnerable citizens, as foreign exchange reserves dwindle and the supply of vital imports runs dry.

With twin deficits comes twin crises for the brothers who rule Sri Lanka. President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa have to confront the most challenging economic circumstances in the country’s recent history while facing down the enormous protests that threaten their rule.

Those who have taken to the streets in Colombo and across the nation have not been and cannot easily be appeased by the resignations of cabinet ministers, even if some are relatives of the president and prime minister: they want an end to the Rajapaksas’ rule tout court.  The opposition bloc Samagi Jana Balawegaya has also demanded an end to the executive presidency that was reintroduced by constitutional amendment in 2020. This would help restore some checks and balances to Sri Lanka’s system of government, in serious decay since the constitutional crisis of 2018.

In our first lead article this week, Chulanee Attanayake argues that what the Sri Lankan economy needs is breathing space: for reforms to take shape, and for their results to solidify. ‘Even if the government is making an effort to achieve economic stability by tightening monetary policies, restructuring debt and seeking an IMF bailout, the economy needs time to recover’.

‘The country needs to regain international credibility, which can only be achieved through economic reform. Reforms should include adjusting fuel and electricity prices, tax reforms, restructuring of state-owned enterprises and privatisation of services’. This is a massive agenda that will require two elements in short supply: time and political will. Even if it were implemented, the economic cost will be severe, and without help, it will be Sri Lanka’s poorest who bear the brunt.

The IMF suggested recently that an effort to strengthen social safety nets needs to accompany macroeconomic stabilisation and structural reform. Some pain is inevitable, but alleviating the burden on the worst-off can help Sri Lanka to avoid a descent into the ‘macroeconomics of populism’. As diagnosed by Rudi Dornbusch in Latin America, when fiscal ill-discipline provokes a severe crisis, it risks leading to excruciating austerity, which in turn leads to the election of populists who promise to loosen the purse strings. This is a cycle Sri Lanka literally cannot, with debt over 100 per cent of GDP, afford.

If in Sri Lanka an economic crisis has precipitated a political one, elsewhere in South Asia, a political crisis threatens to destabilise Pakistan at precisely the moment when stability is needed to stave off an economic crisis. The ejection earlier this month of Pakistan’s Prime Minister Imran Khan and the installation of a new government under the leadership of Shehbaz Sharif — brother of former Prime Minister Nawaz Sharif — comes at a difficult time for the country.

Many of the elements of the Sri Lankan crisis find echoes in Pakistan. Inflation is galloping, the Pakistani rupee, like its Sri Lankan counterpart, is struggling, and both fiscal and current account deficits have ballooned beyond control. The prospect of a balance of payments crisis cannot be discounted.

Though Prime Minister Sharif has a reputation for competence from his time as chief minister of Punjub, he will struggle to shake the suspicion of some that he is the marionette of his powerful brother. Another major headache will be manoeuvring any difficult economic measures through his unwieldy cabinet, stuffed not just with politicians from his own Pakistan Muslim League (Nawaz), but also with rivals from across the political spectrum — from the centre-left People’s Party to the hardline Jamiat Ulema-e-Islam.

As Shuja Nawaz explains in our second lead article this week, ‘​​If the new government manages to keep its head above the choppy economic waters, it faces many domestic political issues. Khan had failed to unify the fractured polity of Pakistan. Sharif will need to bring the centre and the periphery together’. Pakistan, Nawaz argues, is at real risk of falling into a cycle of unrest, military coups and instability, an ‘Egypt-on-the-Indus situation’.

If anything, Pakistan’s tribulations show that doing away with ruling families and the executive presidency are, however advisable, no panacea for Sri Lanka. Pakistan has a ceremonial president and suffered a deterioration in its macroeconomic conditions under Khan, a celebrity to be sure, but not a dynasty.

Meanwhile in Bangladesh — despite democratic backsliding and politics which have been dominated for three decades by the daughter of a prime minister and the daughter of a president — the IMF is projecting a growth rate of 6.5 per cent in 2022, considerably higher than for either Pakistan or Sri Lanka. Bangladesh is also poised to apply for membership in the Regional Comprehensive Economic Partnership mega trade deal, which will help enmesh it in the dynamic East Asian economy.

The Bangladesh economic model, with prudent macroeconomic management and policies oriented towards the development of export-led manufacturing growth, is the only long-term solution to South Asia’s economic disarray — if only the politics will allow it.

The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.

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