Years of policy failure and COVID throw Sri Lanka into deep crisis

Author: Chulanee Attanayake, NUS

Sri Lanka is collapsing. Its economy is at a tipping point. The country is witnessing one of the worst economic and political crises in its history, with massive protests demanding President Gotabaya Rajapaksa’s resignation. The protests were sparked by a marked decline in living standards as Sri Lankans have been battling long and frequent power cuts and a 25 per cent increase in food prices.

In the weeks preceding the protests, many had to queue for hours to obtain fuel and gas, which caused four elderly people to die of heat exhaustion. Frustrated and disappointed Sri Lankans, who have been experiencing this situation for too long, began protesting in March 2022.

The situation is a culmination of multiple economic and political factors which have cumulated over time. Sri Lanka has experienced macroeconomic instability, economic stagnation and a volatile business environment for decades . It has also been suffering from a twin deficit problem — a balance of payments, foreign exchange and fiscal deficit — due to years of economic mismanagement and corruption.

The ratio of government revenue to gross domestic product (GDP) has been unbalanced for years. Economic policy since the 1990s has seen a combination of tax exemptions and reductions for the wealthy and multinational corporations. These policy decisions have resulted in a steady decline in government revenue collection. In 2021, Sri Lanka’s tax revenue amounted to only 9.6 per cent of GDP against government expenditure at close to 20 per cent of GDP .

Adding to this is the external deficit problem, created by high imports, low exports and increasing debt. The debt-to-GDP ratio, which declined in 2009, has been steadily increasing since 2014. After graduating to middle income country status in 1997, concessional loans from multilateral agencies and bilateral donors became inaccessible, and Sri Lanka turned to international capital markets for commercial borrowings. Sri Lanka’s foreign debt composition is now heavily tilted toward commercial loans, with a growing reliance on international sovereign bonds.

Despite being one of the earliest economies in South Asia to open up, Sri Lanka still has limited sources of foreign exchange. The COVID-19 pandemic disrupted two primary sources of foreign exchange earnings— remittances from unskilled migrant workers and tourism. With limited foreign exchange earnings, coupled with a high import dependency and commercial debt burden, Sri Lanka’s foreign exchange began to decline rapidly.

Government policies have aggravated these problems. The sudden decision in April 2021 to ban chemical fertiliser imports, in an effort to limit foreign exchange outflows, led to a shortage in essential commodities and affected food security. The government also ignored repeated calls from experts to seek bailout from the International Monetary Fund.

In late March, street protests culminated in a massive demonstration demanding President Rajapaksa’s resignation. The protests, which quickly spread across the country, are unprecedented in Sri Lanka’s history. While a number of cabinet ministers resigned in response, Rajapaksa and his brother Mahinda, the Prime Minister, continue to hold onto power.

In what some have described as Sri Lanka’s Arab Spring, protesters have occupied Galle Face, a park in front of the Presidential Secretariat, and established a tent city named ‘Gotagogama,’ meaning ‘Gota Go Village’. The protest slogans of #GoGotaHome and #GoRajapaksasHome are calls for the government to renounce power.

Historical allegations of corruption and nepotism against the Rajapaksa family have resurfaced. With Rajapaksa showing no intention of stepping down, Sri Lanka’s political stability and national security are at risk. Rajapaksa seems determined to prove that he can turn things around.

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.

Reforms will place financial burden on Sri Lankans, and result in likely layoffs in the public sector. So even if Rajapaksa and his government manage to resolve the economic problems, this is unlikely to resolve the civil unrest.

If Rajapaksa and his brother decide to resign, the protests will temporarily subside. But their successors will need time to restore economic order and stability. They will have to implement a painful reform and restructuring process, putting the general public through more economic hardship. Sri Lankans’ tolerance of political incompetence has run out and their thirst for basic rights now seems unquenchable.

Chulanee Attanayake is a Research Fellow at the Institute of South Asian Studies, National University of Singapore.

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