Where Will Sri Lanka Head for in the Current Crisis? - 2022-08-05
Sri Lanka is suffering its worst economic crisis since it gained independence in 1948.
Soaring prices, worsening food and fuel shortages, and gradual depletion of foreign exchange reserves...... the continued economic woes have led to protests and strikes in multiple places across Sri Lanka, and the domestic situation in the country is tense. On July 5, 2022, Sri Lankan Prime Minister Wickremasinghe said in Parliament that Sri Lanka had "gone bankrupt". On July 9, large crowds of protesters occupied the presidential residence, the presidential office, and the prime minister's office. In the early morning of July 13, Sri Lankan President Gotabaya Rajapaksa left the country by military aircraft. A few hours later, Sri Lanka entered a state of national emergency, and a curfew was imposed in the western province where Colombo, the capital of the country, is located.
For a long time, Sri Lanka's foreign exchange reserves have been exhausted, while its outstanding debts are rising and its currency are depreciating significantly. The Sri Lankan government has been forced to turn to the International Monetary Fund (IMF) for help. However, due to its over-reliance on international assistance and policies, Sri Lanka has failed to offer an effective alternative development plan, which makes it unable to respond to the crisis.
The long-standing economic problems
The long-standing drawbacks of economic development are the deep root cause of the current crisis. Structurally, Sri Lanka's economy is dominated by agriculture (fishery), primary processing and general service industries, and heavily dependent on external markets. The tourism industry is an important source of foreign exchange revenue for the country. Sri Lanka has a relatively weak industrial base, mainly consisting of the labor-intensive light industry, while capital- and technology-intensive industries are underdeveloped.
Among South Asian countries, Sri Lanka was the first to implement an economic liberalization policy. It became the first country in South Asia to carry out restructuring and embark on the neoliberalist track. In 1978, the government began to implement the economic opening-up policy. It proactively attracted foreign investments, while setting up free trade zones domestically. It lifted state control over import trade, promoted privatization, and accelerated the enterprise privatization process, all geared to create a free economic environment and gradually form a market economic landscape. In the process of implementing liberalization and financialization policies, the gap between the rich and the poor widened. To a certain extent, it also made the national economy more vulnerable.
Because of the 26-year civil war in the country, the more radical neoliberalist economic policy could not continue, and global investors also lost interest in Sri Lanka. After the civil war, the country began to pursue a radical deficit fiscal policy in an effort to recover and develop its economy. However, this only increased the national debt burden. Altogether, Sri Lanka has accumulated a total external debt of about US$51 billion. As for import and export trade, Sri Lanka has run a trade deficit for many years, and its revenues cannot make ends meet. In April this year, the Sri Lankan government announced that due to the foreign exchange shortage, it had to suspend the repayment of its foreign debts.
Improper policies accelerated the economic collapse
Over the past four years, domestic policy failures have also expedited Sri Lanka’s economic collapse. In 2019, the Rajapaksa government implemented a substantial tax reduction policy after it took office, resulting in an annual loss of more than US$1.4 billion in revenue. By the end of 2019, Sri Lanka's foreign exchange reserves only stood at US$7.6 billion.
At the beginning of 2021, Sri Lanka experienced a shortage of foreign exchange. To stem the rapid outflow of foreign exchange, in April 2021, the government suddenly announced a ban on the import of chemical fertilizers, pesticides, herbicides and fungicides. The measure was designed to reduce the flight of foreign exchange from the country and boost organic agriculture. But, the policy of banning the import of chemical fertilizers has led to a sharp failure in agriculture and seriously weakened Sri Lanka's ability to be self-sufficient in rice. As a result, the government has to import grain from abroad at high prices to supplement its grain reserves, which has in turn exacerbated the foreign exchange shortage. Although the ban on chemical fertilizers was subsequently lifted in November, it had nevertheless caused irreparable damage to the production of grain, tea and rubber, resulting in huge losses to these products that could have been exported.
With the end of the civil war and the stabilization of the Rajapaksa government, a large amount of global capital began to flow into Sri Lanka, creating a "false economic prosperity" of the country. With the help of foreign capital, huge real estate investments were made in the country, damaging small-scale agriculture and food self-sufficiency. At the same time, Sri Lanka’s national investment in agriculture has also continued to decline, while the growth of agricultural production has been falling.
The superimposition of multiple external crises
The global COVID-19 pandemic has seriously impacted Sri Lanka’s already fragile national economy. Tourism is one of the pillars of Sri Lanka's economy. Before the pandemic, tourism accounted for more than 12% of Sri Lanka's GDP and 14% of its foreign exchange revenue. However, affected by the pandemic, overseas tourists decreased sharply, striking a heavy blow to Sri Lanka's tourism industry. In addition, due to the pandemic, the home-bound remittances of 2 million Sri Lankan nationals working overseas have fallen substantially, further exacerbating Sri Lanka’s foreign exchange crisis.
The lack of foreign exchange for imports has become a "catalyst" for Sri Lanka's worsening problems such as fuel shortage, power outage, lack of drugs, and rising food prices this year.
The conflict between Russia and Ukraine and the sanction policy pursued by Western countries have led to soaring international oil and gas prices, which has seriously impacted Sri Lanka's economy and people's lives. Russia and Ukraine are both important trading partners of Sri Lanka. They are also important markets for Sri Lanka's tea exports, as well as important sources of international tourists for the country. The conflict between Russia and Ukraine has not only hindered the normal trade between Sri Lanka and the two countries of Russia and Ukraine, but also led to soaring food and energy prices in the international market. As a result, Sri Lanka's food and energy imports have been damaged, its tourism industry has been hit hard, and a shortage of foreign exchange has arisen, plunging the country into an unsustainable situation of desperation.
Should the Belt and Road Initiative bear the blame?
The outbreak of the current crisis in Sri Lanka is the result of the joint action of a series of factors, which not only reflects the country's long-standing and accumulated deep-seated problems in the course of its economic development, but also exposes the risks and difficulties faced by small and medium-sized countries in social and economic development under a complex and volatile international economic and political environment.
Sri Lanka is an important participant in the Belt and Road Initiative. China's massive aid has directly helped Sri Lanka to improve its infrastructure and boost its social and economic development. Although Sri Lanka has a large debt deficit, its debt to China is not the cause of the current crisis as accused by Western media. In fact, China's Belt and Road-related projects in Sri Lanka and the debts resulting from them account for only about 10% of Sri Lanka's total external debt. In fact, China is also a potential victim of Sri Lanka's debt crisis.
In a media interview held on July 15, 2022, Sri Lanka's ambassador to China Palitha Kohona said that Sri Lanka's largest creditors include the Asian Development Bank, the World Bank, and institutional investors. "We owe a lot of money to Western institutional investors, including the Wall Street," Kohona said. Sri Lanka hopes that the World Bank and the Asian Development Bank can put forward package plans to help the country to solve its debt problem. "We also encourage our bilateral partners, including India, Japan and China, to provide more assistance. We need the help of our friends to get out of the current difficulties."
China hopes that Sri Lanka can end its current turmoil, solve its accumulated problems and return to the right track as soon as possible. According to information released by the Chinese Ministry of Foreign Affairs, from April to May this year, the Chinese government announced emergency humanitarian assistance totaling RMB500 million to Sri Lanka, which is the largest amount of free aid that the country has received since the outbreak of its current economic and livelihood crisis. On July 14, the second batch of grain supplies from China's emergency humanitarian assistance to Sri Lanka was successfully delivered.
On July 12, 2011, Chinese Foreign Ministry spokesman Wang Wenbin said that China will continue to provide assistance to the best of its ability for Sri Lanka's economic and social development, and support Sri Lanka in restoring its economy and improving its people's livelihood." As for Sri Lanka's China-related debt, China supports relevant financial institutions to negotiate with Sri Lanka to seek a proper solution. We are willing to work with relevant countries and international financial institutions to continue to play an active role in helping Sri Lanka to cope with its current difficulties, alleviate its debt burden and achieve sustainable development."
Dealing with the crisis
How should Sri Lanka cope with this crisis?
Firstly, it should stabilize the situation as soon as possible. Sri Lanka needs to take the current crisis as an opportunity to establish a united multi-party government, put aside mutual prejudices, improve its governance capacity, restore the normal social and economic order as soon as possible, overcome difficulties, and get out of the quagmire of the crisis at the earliest time possible.
Secondly, fundamentally, Sri Lanka needs to carry out institutional and structural reforms to change its over-reliance on tourism and exports, and reduce or get rid of its excessive dependence on a single market.
Thirdly, Sri Lanka should seek support and assistance from other countries or international financial organizations in various ways, speed up debt restructuring and proactively apply for short-term loans, so as to alleviate its debt payment pressure.
In addition, the Sri Lankan government may also consider selling assets. At the same time, it should get rid of extravagance and waste, scale down the government budget and expenditure, and use its limited financial resources to develop the national economy, people's livelihood and the most urgently needed projects.
How the situation in Sri Lanka evolves in the future will depend on how the new government is formed and operates. However, due to the long-standing problems, there is still considerable uncertainty about the new government and the effect of its policy in the future.
The author is Hu Zhiyong, research professor at the Institute of International Relations of Shanghai Academy of Social Sciences, talks about the origin of Sri Lanka's dilemma and the measures that the country may take to cope with it.
Source: China Report ASEAN
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