How Did the Government Fall?
Gotabaya Rajapaksa, a Sri Lankan politician and former military officer who served as the 8th president of Sri Lanka from 2019 to 2022, initiated a self-imposed exile on 13 July 2022, following widespread protests led by civilians demanding his resignation, triggered by extensive discontent over his handling of the country’s economic crisis. On 13 July 2022, following a string of mammoth protests that eventually culminated into a civilian takeover of his official residence and workplace by protestors, Rajapaksa fled the country, accompanied by his spouse and a personal security detail, to the Maldives, before further retreating to Singapore on 14 July. On 14 July, whilst in exile, Rajapaksa resigned the presidency, becoming the first Sri Lankan president to relinquish the office mid-term. Rajapaksa’s resignation triggered widespread celebrations amongst the Sri Lankan people, many of whom had long demanded the removal of the Rajapaksa family from power. Ranil Wickremesinghe, a veteran politician whom Rajapaksa had earlier appointed as the country’s prime minister, succeeded Rajapaksa as interim president on 15 July and was officially elected to the presidency five days later, on 20 July.
Genesis of the Economic Crisis
Sri Lanka fell into deep economic crisis in mid- 2022 when it defaulted on its external loans while its foreign exchange reserves declined to less than $ 2 billion, not sufficient enough even for import of essential goods which led to shortage of food, fuel and medicine and pushed rate of inflation high. This made cost of living unaffordable for Sri Lankan people and they came in streets to protest against the ruling government.
Why did Sri Lanka fell into economic crisis? The government blamed the Covid pandemic, which badly affected Sri Lanka’s tourist trade – one of its biggest foreign currency earners. It also says tourists were frightened off by a series of deadly bomb attacks in 2019. However, many experts blame President Rajapaksa’s poor economic management for the country’s economic crisis. Rampant corruption and cronyism is also blamed for the current crisis in the country. Rajapaksa was also blamed for his divisive and anti minority policies, which impinged on business environment, investment and growth.
The growth model of Sri Lanka since the end of its civil war in 2009, focused on providing goods to its domestic market, instead of trying to boost foreign trade. This led to a fall in its exports earnings while while the bill for imports kept growing. Sri Lanka now imports $ 3 billion more than it exports every year, and that is why it has run out of foreign currency. At the end of 2019, Sri Lanka had $7.6billion in foreign currency reserves, which have dropped to around $ 250 million. The fiscal policy of Mr Rajapaksa was also criticised for big tax cuts he introduced in 2019, which lost the government income of more than $1.4 billion a year.
The Present Economic Challenge
Sri Lanka faces an unsustainable debt and severe balance of payments crisis, which is having a negative impact on growth and poverty. According to the World Bank’s latest South Asia Economic Focus and the Sri Lanka Development Update, Sri Lanka’s real GDP is expected to fall by 9.2 percent in 2022 and a further 4.2 percent in 2023.
The country owes more than $51bn (£39bn) to foreign lenders, including $6.5bn to China, which has begun discussions about restructuring its loans.
The G7 group of countries – Canada, France, Germany, Italy, Japan, UK and the US – had said it supports Sri Lanka’s attempts to reduce its debt repayments. The World Bank has agreed to lend Sri Lanka $600m, and India has offered at least $1.9 billion. The International Monetary Fund (IMF) is discussing a possible $ 2.9 billion loan. But it would require a stable government that could raise interest rates and taxes to help fund the deal, so any bailout may be delayed until a new administration is in place.
Mr Wickremesinghe had already said the government would print money to pay employees’ salaries, but warned this would be likely to boost inflation and lead to further price hikes. He also said state-owned Sri Lankan Airlines could be privatised. The country has asked Russia and Qatar to supply it with oil at low prices to help reduce the cost of petrol.
World Bank said in its country report update on Sri Lanka last October that the fluid political situation and heightened fiscal, external and financial sector imbalances pose significant uncertainty for Sri Lanka’s economic outlook. The growth outlook is subject to high uncertainty and will depend on the progress in fiscal consolidation, debt restructuring, and growth enhancing structural reforms. Despite tightened monetary policy, inflation will likely stay elevated. The fiscal deficit is expected to gradually fall over the medium-term due to consolidation efforts. The current account deficit is expected to decline due to import compression. Additional resources will be needed in 2023 and beyond to close the external financing gap. Poverty is projected to remain above 25 percent in the next few years.
The report added that the key downside risks for the country include a slow debt restructuring process, limited external financing support, and a prolonged recovery from the scarring effects of the crisis. Fiscal consolidation needs to be accompanied by tighter monetary policy to contain inflationary pressures. Significant debt restructuring is essential to restore a sustainable debt level. The financial sector has to be managed carefully given high exposures to the public sector. The necessary macroeconomic adjustments may initially adversely affect growth and poverty, but will correct the macroeconomic imbalances.
India’s Assistance to Sri Lanka in Economic Crisis
In total India provided about $4 billion in rapid assistance between January and July, including credit lines, a currency swap arrangement and deferred import payments, and sent a warship carrying essential drugs to Sri Lanka. The crisis proved that India is the most reliable partner of Sri Lanka. There is an age old relation between the people of India and e Sri Lanka’s 22 million people. The two countries are bound by shared history, geography, culture and strategic complementarities.
Sri Lanka has concluded debt restructuring talks with India, an essential condition for availing the IMF bailout package, but the same remains inconclusive with China which is one the biggest creditors of the country.
Now, as Sri Lanka closes in on a $2.9 billion loan deal from the International Monetary Fund (IMF) and its economy stabilises, India is seeking long-term investment cooperation with Sri Lanka for the benefit of both the countries. The Chinese investments in Sri Lanka have landed the country into a debt trap so it wants to go ahead with Indian investment in future while India is very concerned on increasing dependence of Sri Lanka on China that could create strategic hassles for India and other Indian Ocean Rim countries.
Given the lack of economic feasibility of the Chinese projects in the country and potential debt trap theft Sri Lanka is now interested to enhance investment from India. “What we are looking at right now is investment from them,” Sri Lankan Foreign Minister Ali Sabry said in an interview this month, referring to a range of projects worth over $1 billion currently under discussion that would help bolster India’s presence in Sri Lanka. “They’re willing to invest as much as it takes.”
IMF Bailout for Sri Lanka
The economic crisis in Sri Lanka has brought the country on the brink of default. It has already defaulted on some of its external debt servicing obligations. The country desperately needs a bailout from the International Monetary Fund (IMF).
Sri Lanka and the IMF have reached a preliminary agreement on a $2.9 billion bailout plan over four years, but final approval depends on assurances given by creditors on the debt restructuring.
The Prudent Measures to Rise from Crisis
Sri Lanka has initiated some measures to tackle the financial crisis and manage shortages. However, daily power cuts continue due to the fuel shortage and the government is struggling to find money to pay government employees’ salaries and conduct other administrative functions. It announced this month it is cutting 6% from budgets for each ministry this year and plans to downsize its military, which had swelled to more than 200,000 personnel due to a long civil war. The government plans to cut the military’s size by nearly half by 2030. Sri Lankan struggle is far from over. But its foreign exchange earning sector has started looking up and the process of fresh elections is hoped to start soon.