TORU TAKAHASHI, Nikkei senior staff writer
May 15, 2022 17:00 JST
TOKYO -- Sri Lanka is on the brink of economic collapse, mired in its biggest financial crisis since independence in 1948.
Colombo, the commercial capital of the island nation of 22 million people, saw its inflation, as measured by the year-on-year change in the consumer price index, hit 29.8% in April, up from 18.7% in March. The nation's foreign exchange reserves, which totaled $7.6 billion at the end of 2019, have plunged to $1.8 billion, worsening shortages of imported fuel and medicine.
"We should have sought assistance from the International Monetary Fund earlier," said Finance Minister Ali Sabry after his appointment in April. On May 4, he told parliament: "We have to endure economic hardship for two years or more."
The Sri Lankan government, which declared a state of emergency in early April, reinstituted the measure on May 6 to quell growing anti-government demonstrations by citizens angered by the economic chaos. Prime Minister Mahinda Rajapaksa on May 9 announced his resignation, but that has not mollified protesters. They are demanding that his younger brother, President Gotabaya Rajapaksa, step down as well.
The current crisis began with bombings in Colombo and other cities in April 2019 that killed more than 250 people and dealt a serious blow to the country's vital tourism industry. The spread of COVID-19 has further deepened its predicament.
Inflows of foreign currency fell sharply as tourists deserted the country and remittances from an estimated 1.5 million Sri Lankan workers living overseas plummeted. The country has also been hit by high inflation stemming from the global supply chain crunch.
The last straw was soaring commodity prices in the wake of Russia's Ukraine invasion, which has set off a vicious cycle of rising import costs, falling foreign reserves, supply shortages and high inflation.
Some experts blame the crisis on China's "debt trap diplomacy," which critics say aims to ensnare developing countries with massive loans. A prime example is a 99-year lease granted to China in 2017 for the use of Hambantota Port in southern Sri Lanka in exchange for a debt waiver.
Sri Lanka's debt to China accounts for about 10% of its total external borrowing, roughly the same level as its debt to Japan, according to the Sri Lankan government. But experts say that figure only covers loans from the Chinese government and does not include debt owed to Chinese state-run companies. "It is true that interest rates on those loans are high, and projects are often based on overly optimistic profit scenarios, but I cannot say whether China is responsible for the current crisis or not," said a person involved in financial aid to Sri Lanka.
But Sri Lanka is not the only country that is deeply indebted to China and dealing with the debilitating impact of COVID-19 and the Ukraine crisis. What sets it apart from other countries facing similar challenges is inept leadership.
The Rajapaksa family has long dominated politics in Sri Lanka. In 2005, Mahinda Rajapaksa, a longtime legislator, won the presidential election and appointed his younger brother Gotabaya, a former military officer, as defense secretary. Four years later, the pair succeeded in crushing Tamil rebels who had been fighting for the independence of the northern and eastern regions, ending the country's 26-year civil war.
Once civic order was restored, the economy boomed. Projects for roads, railways, ports and other infrastructure began moving forward. Foreign tourists started to flock to the country, which boasts eight World Heritage sites. The New York Times named Sri Lanka as the No. 1 travel destination in its ranking of "Places to Go in 2010," prompting a rush of luxury hotel construction.
Post-civil war euphoria also fueled consumer spending, helping push economic growth to 9.2% in 2012.
But as the years wore on, Mahinda began to show authoritarian tendencies. Following his reelection in 2010, he appointed not only Gotabaya but other family members to key government posts. He also solicited investment from China to build a port and airport in his hometown of Hambantota. In 2015, however, he failed to secure a third term as president, as many voters were fed up with the nepotism and corruption in his government as well as Sri Lanka's excessive reliance on China.
But the terrorist attacks in 2019 brought the Rajapaksa family back to power once again as the public looked for strong leaders. Because a constitutional amendment prohibited Mahinda from seeking a third term as president, Gotabaya ran instead and won the presidency. Gotabaya then named Mahinda prime minister and appointed other family members to key ministry posts such as finance, irrigation, and youth and sports.
Many experts say both Rajapaksa brothers made serious mistakes that have contributed to the current crisis.
Mahinda blundered by pushing ahead with vanity infrastructure projects with little economic value. It is true that Sri Lanka desperately needed harbors and airports after the long civil conflict, but there was little demand for a port in Hambantota. Since its completion in 2010, it has mostly been used to unload used vehicles. Mattala Rajapaksa International Airport, which opened in 2013, has been ridiculed as "the world's emptiest airport" due to the small number of airlines that use it. Despite the fanfare, Mahinda's infrastructure projects have done little to help the economy.
Although it is not endowed with vast natural resources or a large population, Sri Lanka has industrial potential as part of the global supply chain. The end of the civil war offered a golden opportunity to attract foreign capital. But the country "lacked a policy of developing export items that could follow its traditional products such as tea and apparel," according to Etsuyo Arai, a Sri Lanka expert at the Institute of Developing Economies, a think tank affiliated with the Japan External Trade Organization.
Gotabaya's mistake was to choose populist policies over painful but necessary reforms. During the nearly four years from 2016 when the Rajapaksa family was out of power, Sri Lanka pushed structural reform to boost revenue and strengthen its fiscal base in return for an IMF loan facility of $1.5 billion. Gotabaya, who took office in 2019, reversed that policy by promoting tax cuts, which caused government revenue to decline by 500 billion Sri Lankan rupees ($1.36 billion).
Gotabaya also banned imports of chemical fertilizers to "promote organic agriculture," devastating the country's crucial tea and rice harvests. In addition, he was slow to seek IMF support to cope with the current crisis for fear of being asked to raise taxes.
However, Sri Lanka is already in a state of "selective default" by failing to meet debt payments. It can ill afford to let the Rajapaksa family act with impunity. The country has no choice but to carry out structural reform and debt restructuring under an IMF program, while tapping the World Bank, India, China and other sources for bridge loans. Although a pickup in tourism and remittances can be expected as COVID eases, Finance Minister Sabry's prediction that Sri Lankans will have to endure "at least two years" of economic hardship seems likely to come to pass.
The opposition camp hopes to oust Gotabaya from power by passing a nonconfidence motion, but the country's political outlook remains murky. Still, Sri Lanka has a strong democratic tradition and has always had changes of power through elections rather than coups.
The country also has a lot of economic potential. Compared with other South Asian countries, its literacy rate is high. The island also has a talented labor pool with good command of English. The Port of Colombo, one of the largest on the Indian Ocean, is an East-West hub that links Asia to the Middle East and Africa. The country is relatively close to large population centers in India, Pakistan and Bangladesh.
What Sri Lanka needs is to find a way to translate its potential into sustainable growth, say many experts. Now is the time to think seriously about a policy to diversify and promote its industry.
Update: Sri Lanka has defaulted on a pair of foreign bonds worth $US 78 million.
