In 2005, Sri Lanka sought to become a commercial hub in the Asia-Pacific region after decades of bloody civil war. Today, however, the island is experiencing a dire economic situation.
According to an article published in 2015 by risk the consultancy, Global Risk Insights, "Sri Lanka is set to become the destination of choice for companies looking to take advantage of opportunities in Indian Ocean trade due to its strategic location."
Nonetheless, persistent shortages of fuel, gas and other essentials in Sri Lanka; drove protesters onto the streets. Recently, protesters entered the Presidential Palace. This event, which hastened the resignation of President Gotabaya Rajapaksa and his subsequent departure from the country, has put Sri Lanka back in the world headlines, on par with the war in Ukraine. These latest events have been the subject of analysis, studies and conferences not only in the print media, but also by analytical media, blogs and think tanks. At the same time, this issue will set the diplomatic and economic agenda of many other states on the current geopolitical chessboard.
This article will attempt to shed some light on this much talked about and discussed topic, without clearly discussing the reasons for the delicate economic situation and the economic background and political malpractice that have plunged this island into one of its worst economic crises since its independence in 1948.
Before going into the history and political evolution of Sri Lanka, it is important to understand a few important facts. Sri Lanka is located in the Indian Ocean, southwest of the Bay of Bengal and southeast of the Arabian Sea. This state has a moderate amount of economic resources, among which are: tea, being the fourth largest producer in the world, gems and textiles. In addition, with the passage of time, the importance of tourism has gained traction in the domestic economy. It is worth mentioning that, in 2005, only 10,000 people visited this state, compared to more than 25,000 in 2018.
Several centuries ago, Sri Lanka was not the isolated island group it is today; there was a land bridge, Adam's Bridge, connecting it to southern India. The strategic location of this island would be key to the most important kingdoms of Asia, first Hindu and then Buddhist.
In the 16th century, the Portuguese would be the first Europeans to arrive on this island, followed by the Dutch and finally the British. London took full control of the island in 1815.
Although reluctant to alter traditional Sinhalese institutions, the British quickly initiated a process of reform. London abolished slavery, an institution that existed mainly as a result of unpaid debts, relieved native officials of judicial authority, paid wages in cash and relaxed the system of compulsory service tenure. In addition, agriculture was encouraged and the production of cinnamon, pepper, sugar cane, cotton and coffee flourished, especially in the mountainous parts, and internal communications were expanded (construction of trains and schools). These early changes would make Sri Lanka an important producer of raw materials such as rubber and tea.
1833, would be another key date for this island. During this year, a series of key reforms were implemented for the subsequent political and economic structure of Ceylon. A unitary administrative and judicial system was adopted for the entire island. The reforms reduced the autocratic powers of the governor and established executive and legislative councils to share the task of governance.
At the same time, restrictions on Ceylon's economy were lifted by abolishing all state monopolies and compulsory labor service was withdrawn. They also promoted the liberation of the economy, which gave rise to new economic enterprises. Land belonging to the British crown was sold at low prices to planters to encourage plantation agriculture. Coffee plantations were especially profitable.
These measures would have an immediate success, and coffee production was vital for the economic development of this island. In addition, the area dedicated to coffee cultivation increased, and new roads were built. From 1840 onwards, due to the scarcity of local labor, numerous workers arrived, especially from southern India. However, in the 1870s, coffee was affected by a disease, and tea, rubber and coconuts began to be cultivated.
Tea and rubber attracted large capital investments, and the growth of large-scale industries created a demand for permanent labor. Increased export trade led to the expansion of the port of Colombo and the construction of railroads and roads. Opportunities were created for Ceylonese entrepreneurs, and for those educated in English, employment was easy. These measures would reduce the isolation of rural areas from urban regions.
By the end of the 19th century, a nationalist sentiment had come to permeate the social, religious and educational fronts of Ceylonese society. This turbulent atmosphere paved the way for the social and political changes of the first half of the 20th century.
Image 1: British Parliament building at Colombo Fort, today. Source: https://theculturetrip.com/asia/sri-lanka/articles/how-sri-lanka-was-influenced-by-being-a-british-colony/
At the beginning of the 20th century, regional and communal associations were founded within the formally educated communities and began to voice proposals for reform. They called for Ceylonese participation in the executive branch, broader territorial representation in the legislature, and the adoption of the elective principle instead of nomination.
These reforms would be approved in 1910, where there would be limited recognition of the elective principle; an "educated Ceylonese" electorate was established to elect a member of the Legislative Council. The other Ceylonese members were to be appointed by the community. With the aim of dividing the local population, the British colonial government would grant greater advantages, better education and higher positions to the Tamil minority, present in the north and east. Over the years, this policy would generate resentment towards the Tamils on the part of the Sinhalese population, the majority in the country.
Under the Independence Act of 1947, Sri Lanka was in a state of semi-independence. Sri Lanka continued to have the link with the United Kingdom and remained within the British Commonwealth. In 1948, Sri Lanka would proclaim its new Constitution and achieve its independence. The successive independent governments were never particularly consolidated, although the government of Solomon Bandaranaike, assassinated in 1959 and succeeded by his wife, Sirimavo Bandaranaike, who would become the first head of state in the world, stood out.
During these years, a protectionist economic policy was adopted. The tea plantations, for example, were expropriated in 1950, during the first SLFP government, from the British colonists and later returned to them a few years later.
In 1971, the country was under the rule of the Prime Minister, Srimavo Bandaranayake. It was during this period that the JVP (Jonathan Vimukthi peramuna) was formed. The JVP was a communist and Marxist political movement. This party started an armed revolt against the government in 1971. The JVP armed revolt overthrew the government with the help of national and international expertise. This incident is an important milestone in Sri Lanka's post-independence history.
After achieving full independence in 1972, Ceylon's name was changed to "The Republic of Sri Lanka", and several notable changes were to take place. First, it was decreed that Sinhala would be the official language of this young republic. The legislature was changed from bicameral to unicameral. The head of the country was changed from the governor general to the president. However, effective executive power remained with the prime minister and the cabinet. Consequently, the enormous economic power of the state led to corruption, partiality and clientelism in the country in an uncontrolled manner.
These changes had an immediate impact on the economy. Protectionist policies would be adopted, and the Sri Lankan economy began to decline. The drastic drop in the unemployment rate was remarkable. For five years it was 15% higher than in 1972.
The first elections after achieving the status of a republic took place in 1977. The people voted against the socialist Sri Lanka Freedom Party (SLFP) and carried the UNP, appointing J.R. Jayawardana as Prime Minister of the Republic of Sri Lanka.
J.R.Jawardana. Source: http://www.thefamouspeople.com/profiles/j-r-jayewardene-7199.php
Jayawardana instructed to rewrite Sri Lanka's constitution. Introducing a presidential system with a new face. The presidential system came into effect as a six-year term.
In addition, there was a complete turnaround in economic policy, adopting a more liberal policy. Jayawardana opened the heavily state-controlled economy to market forces. This resulted in the country's economic growth. The government's policy of openness greatly encouraged new investment. Exports were boosted, promoted and increasingly encouraged.
At the same time, the quarrels between the Sinhalese and the Tamils increased, especially after Sinhalese was decreed as the official language. The Black July was the anti-Tamil riots that took place in Sri Lanka. This action started in 1983 and the reason for the insurrection was the "inequality" of the Tamil population, especially concentrated in the east and south of Sri Lanka.
Consequently, all these incidents adequately fueled the views of the political parties. It was then that the parties organized themselves for revenge. The best example was the formation of the Liberation Tigers of Tamil Eelam (LTTE). The LTTE wanted to establish an independent Tamil state in the north and east of Sri Lanka.
This group planted a bomb under a military patrol vehicle and caused the death of about fifteen men. Sinhalese mobs sought out and attacked the Tigers' targets, starting a bloody civil war in Sri Lanka (1983-2009). The Tamil Tigers managed to put the Sinhalese army in check thanks to a combination of terrorist attacks and guerrilla warfare, as well as internal and external support. For example, from India's Prime Minister Indira Gandhi.
As a result of the civil war, Sri Lanka faced a number of economic difficulties. The country's tourism industry was one of Sri Lanka's main sources of income. However, during these years, Sri Lanka experienced a very strong bipartisanship in its Parliament (the Sri Lanka Freedom Party, social democratic; and the United National Party, liberal conservative).
Sri Lanka was one of the founding members of the World Trade Organization (WTO), and between 1973 and 2001, the island's economy grew at an average rate of 4.9%. Sri Lanka has a moderate amount of economic resources, including tea production, gems, and recently the textile sector. Despite this economic turnaround, the island failed to consolidate a significant and competitive industry.
In 2005, Mahinda Rajapaksa was elected president and abruptly ended the annihilation of anyone close to the Tamil Tigers. During this bloody 30-year war, more than 100,000 civilians and almost half of the soldiers on both sides would die. In addition, Rajapaksa sought to invest the economic dividends of peace in transforming Sri Lanka into a new Singapore: a hub for maritime trade between the Bay of Bengal and the Bay of Bengal.
To attract investment, in the mid-2000s, the country reoriented itself towards foreign investors and lenders. Sri Lanka issued its first international sovereign bond in 2007, one with higher interest rates, designed to attract investors. The money was used to finance, under government directives, projects of little or no domestic utility, such as the Colombo Lotus Tower.
The Sinhalese Buddhist majority's distrust of the Tamils, and of New Delhi, explains the Rajapaksa brothers' rapprochement with China. Between 2005 and 2008, Chinese credits increased from a few million to 1 billion dollars, which were used to buy Chinese fighter jets, armored vehicles, missiles and anti-aircraft batteries. In addition, China provided loans for road projects, power plants, ports and airports in a country key to what it has dubbed the 21st Century Silk Road.
After the war in 2009, in 2010, construction began on the southern tip of Sri Lanka, the Hambantota port with a Chinese loan of about 1.25 billion dollars. This port was planned to be one of the largest in Southeast Asia.
Image of Hambantota harbor. Source: https://www.marineinsight.com/know-more/5-major-ports-of-sri-lanka/
After the civil war, tourism gained traction in the economy. It is worth mentioning that in 2005, only 10,000 people visited this state, compared to more than 25,000 in 2018. This would cause over the years, foreign currency reserves to increase exponentially. Case in point, in 2007, the volume of foreign exchange stood at almost around US$3 billion, compared to 9935.80 in 2018. These factors would cause the island's economy to grow (measured in GDP) in 2012, by 9.14%.
In addition, new sectors began to gain traction in the Sri Lankan economy, such as logistics. The year-on-year growth of logistics and transport services has been above the overall GDP growth and, between 2010 and 2015, the sector expanded by 40%. Since 2011 and 2016, the sector's contribution to growth has averaged 12%.
During this decade, 75% of the volumes of the Colombo port are already transshipments from India. In addition, Sri Lanka taking advantage of its geographical location, signed free trade agreements with Pakistan since 2005, India in 2015 and, Singapore in 2018.
In addition, in 2017, Sri Lanka regained Generalized System of Preferences (GSP+) privileges from the European Union (EU) for its exports. This scheme consists of the total removal of duties on 66% of tariff lines, covering a wide range of products, including textiles and fisheries.
In 2015, Gotabaya Rajapacksa lost the elections against Maithriparla Sirisena, due to the unpopularity of the indebtedness with China and suspicions of corruption, influence peddling and collusion with Chinese bankers and businessmen. During this new government, measures would be adopted to seal the wounds of the civil war, while it would manage to maintain economic growth on this island.
It should be mentioned that, in 2015, the Ministry of Coexistence, Dialogue and Official Languages was created, and in May 2017, the "policy of national reconciliation and coexistence" was approved. Any discrimination based on race, ethnicity, religion or politics was prohibited and Sinhalese and Tamils are present in the vast majority of public institutions.
In 2017, due to the poor profitability of the Hambantota port, the Sri Lankan government ceded its management for 99 years to the China Merchants Group in exchange for a lease that it used to pay off its debts to the Chinese banks that financed the project. For Beijing, this port was a blow at India's doorstep as part of China's Silk Road and Belt and Road project.
However, successive governments in Sri Lanka failed to solve several key problems.
First, the centrality of rural populations in Sri Lanka's choices led to economic policies aimed at stifling competition, e.g. significant tariffs imposed on imports, and a broader focus on import substitution. With a consistently crippled export sector, the country has come to rely heavily on remittances from expatriate workers, the garment industry and tea exports for foreign exchange.
The second problem would be the maintenance of erratic macroeconomic policy by the different political parties. People have often been promised many things before elections, such as low priced bread, subsidised rice, free fertiliser, public sector wage increases and tax cuts. Sri Lankans were offered: rice, electricity, fuel and gas at below market prices. Eliminating or reducing these subsidies has remained politically unpopular, and key structural reforms in the country were avoided. It is worth mentioning that companies such as the Ceylon Petroleum Corporation and the Ceylon Electricity Board suffered large deficits and losses at the hands of an inefficient state.
Finally, excessive transfer payments and subsidies from the Sri Lankan state are rendered fundamentally useless. Sri Lanka would manage to have a workforce of 1.4 million government employees. In 2019, 36% of government revenue went to pay the salaries and pensions of current and past state sector employees. This cocktail would slowly start to explode in 2019.
In 2019, the country experienced one of the worst terrorist attacks in its history. An attack on three churches and three hotels left more than 300 people dead on the island. This event undermined the population's confidence in the president, Maithriparla Sirisena, and reduced the number of visitors to the country. This led to a crisis in the tourism sector, which is key to Sri Lanka's economic future.
In this year, elections were held, where the Rajapatska returned to power with 6.9 million votes. The Rajapaksa party won two-thirds of the seats in Parliament, which allowed them to amend the Constitution to concentrate power in their hands. In 2019, after restoring the dynasty to power, Gotabaya appointed Mahinda as Prime Minister.
Nov. 22, 2019 Photo, Sri Lanka's new President Gotabaya Rajapaksa (right) and his brother Prime Minister Mahinda Rajapaksa pose for a group photo after the ministerial swearing-in ceremony in Colombo. Source: https://www.thestar.com.my/aseanplus/aseanplus-news/2022/07/17/sri-lanka-crisis-how-president-gotabaya039s-rule-ended-in-a-singapore-hotel
Prior to the Rajapatska's fiscal policies in 2019, Sri Lanka had achieved its first primary budget surplus in decades and had been largely on track to regain its middle-income country status. However, the Rajapacksa increased government spending and, lowered VAT from 15% to 8%. The tax cuts increased fiscal deficits, which caused international rating agencies to downgrade Sri Lanka's credit rating, thus closing the country to much of the international capital market.
Between 2010 and 2020, external debt doubled. It is worth mentioning that China has gone from holding 5% in 2006 to the current 29% of the total volume of the state's debt. Beijing is currently Sri Lanka's third largest creditor (10%), after Japan and the Asian Development Bank. To this must be added another aggravating factor. Since 2019, the foreign currency reserve was reduced and, the money supply increased by 42%, triggering inflation to 30%, the highest rate in Asia. This was the first alarm signal that would loom the economic cataclysm on the island.
SARS-CoV-2 pandemic, further weakened the tourism industry, which was just recovering from the May 2019 terrorist attacks. The impact of the pandemic on Sri Lankan workers working abroad also precipitated a drop in expatriate remittances, a major source of foreign exchange for the country. This would further aggravate the crisis and inflation. The dwindling stock of foreign reserves would mean that power outages would become commonplace, negatively impacting business and the economy.
To alleviate this crisis, the Rajapatska attempted to artificially maintain the exchange rate of the Sri Lankan rupee at 300 rupees to one US dollar. This measure would further impact the public accounts and the economy. To this, from the end of 2020 and, aggravated in 2021-22, the Rajapatska government banned the import and use of fertilizers, supposedly to promote organic agriculture, and reduce the island's trade deficit.
Without fertilizers, productivity in the countryside, which employs a third of the population and accounts for 8% of GDP, plummeted. This measure also reduced the quantity of the harvest, almost by half. The impact of the remaining rice crop could raise the retail price by around 30%. This adversely affected the tea industry, which had been another important source of foreign exchange. This measure would aggravate the shortage of food, medicine, fuel and other basic necessities, started to become commonplace on this island.
From the summer of 2021, strikes began in protest of shortages amid blackouts of up to 13 hours a day. By 2022, the national currency plummeted by 80%, making imports more expensive and exacerbating inflation that is already out of control, with the cost of food rising 57%, according to official data. The Finance Ministry said Sri Lanka had only $25 million in available foreign reserves. This has left it without the means to pay for imports, and would aggravate the crisis and anti-government protests.
The Ukranian war further accelerated the economic debacle on the island. In 2021, Russia and Ukraine were first and third as countries of origin of tourists to the island. The ongoing war in Ukraine has led to a worldwide increase in the price of food, and fuel; further impacting the almost non-existent foreign exchange reserves in the country.
In April 2022, Rajapaksa dissolves the cabinet, which includes his younger brother Basil Rajapaksa as Finance Minister, but his elder brother Mahinda Rajapaksa continues as Prime Minister. This move would intensify peaceful protests. The protesters called for the ouster of the former president, Gotabaya Rajapaksa.
In May 2022, Sri Lanka defaulted since 1948 and, the former Sri Lankan government negotiated a $4 billion bailout with the International Monetary Fund that will include the withdrawal of tax cuts and the removal of subsidies. Other players have also been closely following this crisis, notably India and China.
Recently, in 2022, New Delhi took advantage of the crisis to regain positions in the island by offering Colombo new lines of credit, debt swaps and other aid estimated at some $3.5 billion. In June 2022, the United States, in an attempt to counterbalance China's weight on the island, announced that it will provide $6 million in emergency aid to Sri Lanka to address the needs of marginalized and vulnerable communities affected by the country's economic crisis.
During this July 2022, Colombo is asking a $1 billion loan from China to repay an equivalent amount of Chinese debt maturing in 2022. Sri Lanka is also seeking a $1.5 billion line of credit to pay for Chinese imports.
These moves have not been enough to save the Rajapaksa, and on July 13, 2022, former president Gotabaya Rajapaksa flees Sri Lanka, initially heading for the Maldives. Two days later, Ranil Wickremesinghe declares a state of emergency, and succeeds in becoming the new president.
Protesters gather outside the Sri Lankan prime minister's office, July 13, 2022. Source: https://www.reuters.com/world/asia-pacific/how-sri-lankan-protests-unfolded-2022-07-22/
However, a large part of public opinion remains dissatisfied with the election of the new president by Parliament, and demonstrations have continued in intensity. The country's economic situation remains fragile, and the options for getting out of this delicate economic situation are limited. The IMF bailout has become a necessity, as currency swaps with India and China have been insufficient to ameliorate the foreign exchange crisis. Sri Lanka cannot neither obtain more foreign exchange, nor more debt relief, at this time without making readjustments and drastically changing its economy to get it out of this vicious cycle.
These changes can be undertaken, along with major political and structural reforms to dramatically improve the island's economic situation. Otherwise, it will be too late for the economy to be saved.
Political misguidedness and poor economic policies can cause a small island with potential to live through the most difficult times in its history. It is said that there is a curse "may you live in interesting times". We are living this period, but only time will tell if this curse is a reality or just a phrase. The future is uncertain, but the coming months and years will be decisive in determining the future of Sri Lanka, and the potential domino effect of this crisis within and outside this nation.
Recommended readings:
Hunt, L., 2022. Sri Lanka’s Future May Not Be All That Bleak. [online] Thediplomat.com. Available at: https://thediplomat.com/2022/07/sri-lankas-future-may-not-be-all-that-bleak/
NDTV.com. 2022. Sri Lanka's Economic Crisis A Warning To Other Countries With High Debt: IMF Chief. [online] Available at: https://www.ndtv.com/business/crisis-in-sri-lanka-a-warning-to-other-countries-with-high-debt-levels-and-limited-policy-space-imf-chief-3169649
Wickremesinghe, R., 2018. How we will make Sri Lanka rich by 2025. [online] World Economic Forum (WEF). Available at: https://www.weforum.org/agenda/2018/08/this-is-how-we-will-make-sri-lanka-rich-by-2025
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