My home country has been plunged into crisis. Crippled by Covid-19 and years of Government failure, Sri Lanka is on the verge of societal collapse. With a President disposed by a baying mob as the curtain of an emergency state descended, many are saying this is the worst crisis to hit our country since independence. And they are right.
While being the straw that broke the Camel’s back, the global pandemic should not be scapegoated as the culprit of all our woes. The reality is far more deeply rooted. Years of central mismanagement has gradually eroded away the country’s foundations. It was only a matter of time until a singular shock would tear the nation apart.
Cracks began emerging ever since independence. Free from the shackles of the British Empire, Sri Lanka in 1948 was a country bustling with optimism. Eager to make good of this newly-found liberation, extensive periods of profligacy reigned supreme – resulting in debt as a proportion of GDP exceeding the elusive 100% mark just three decades later.
There has, to date, never been a concerted effort to eliminate Sri Lanka’s problematic and growing fiscal deficit. This is particularly true in recent years. Almost 90% of debt taken between 2015-19 was simply to service the interest on inherited loans granted up to 2014. Government debt as a percentage of GDP had increased from just over 70% in 2010 to 101% in 2020, and an increasing amount of this debt was high interest rate international sovereign bonds at commercial rates. Sri Lanka was upgraded from a low income nation to a lower middle income nation in 1997, and lost access to a lot of loans at concessionary interest rates. Seeking an alternative, we tapped bond markets beginning in 2007, taking advantage of Western investors’ desire for high-yielding assets during a period of zero-interest rate policy (ZIRP) in the West, as we sought to finance reconstruction following the Civil War ending.
This coincided with a policy of economic growth through debt-funded large infrastructure projects. Sri Lanka basically loaded up on debt and borrowed huge sums to invest in massive infrastructure projects — such as the Chinese-funded Hambantota International Port — with hopes that the end result would drive economic growth. But many of these costly infrastructure projects have been little more than vanity projects – and without any genuine source of revenue – the government was left unable to repay the interest on its loans. Bankruptcy was once again on the table.
A bad situation turned worse with two economic shocks in 2019. First, there was a series of bomb blasts in churches and luxury hotels in Colombo in April 2019. The blasts led to a steep decline in tourist arrivals – with some reports citing up to an 80% reduction – and drained foreign exchange reserves. Second, the new government under President Gotabaya Rajapaksa began a bout of extreme fiscal loosening. Taxes were slashed while government expenditure soared.
The great divergence of a tax base contracting by a third while central spending stood firm was only going to be plugged by one possible thing: money printing. Forced into a corner, The Central Bank of Sri Lanka (CBSL) called upon a radical new strategy – Modern Monetary Theory. CBSL engaged in large scale money printing: From December 2019 to August 2021 alone, Sri Lanka's money supply increased by a goliath 42%. Much of the money went to pay the salaries of 1.2 million state sector employees, and to cover pensions that each year cost the government a thumping one trillion rupees. Money was also printed with a view to keeping interest rates low. Today, this is seen as one of the main causes of the depreciation of the Sri Lankan rupee and the 60% inflation we are experiencing at present. This was simply exacerbated once the CBSL’s attempts to soft-peg the rupee to the dollar ended and imports became comparatively more expensive
In March 2020, Covid-19 struck. With the country’s lucrative tourism industry and foreign workers’ remittances sapped by the pandemic, credit ratings agencies moved to downgrade Sri Lanka and effectively locked it out of international capital markets. The CBSL had little choice but to ramp up the money printing.The government, as with many other governments worldwide, attempted to stimulate the economy to keep businesses afloat. This included direct cash transfers, debt moratoriums, and low-interest loans. The stimulus was an expensive proposition, but to some extent necessary. However, some measures, like the increase in liquidity through money printing, should have been avoided. Further, unlike the private sector, which suffered salary cuts during the COVID-19 pandemic, state employees carried on at full pay despite the empty public coffers.
In 2021, an unexpected decision to ban all chemical fertilizers was imposed. This shock overnight decision was ostensibly to aid Sri Lanka in becoming a sustainable and green economy. However, it was actually implemented with the aim of reducing the use of scarce foreign exchange reserves on imported chemical fertilizer. Unfortunately, it ended up diminishing the productivity of Sri Lanka’s agricultural crops, reducing agricultural production and increasing the demand for imported agricultural products and ironically increasing the use of foreign currencies. The ban also devastated Sri Lanka’s tea crop, one of our primary agricultural exports and a significant earner of foreign exchange.
Although it has long been clear that Sri Lanka’s debt was unsustainable, the government chose to ignore this fact and continued to pay off valuable foreign exchange reserves. It was only in mid-April 2022 that the government announced that it would default on its debt, pending a restructuring. This would include negotiations with the International Monetary Fund (IMF) and creditors, towards a multi-year recovery plan. Things were made worse by Sri Lanka suddenly devaluing their currency 15% to shore up maneuverability before heading to the IMF, further stoking inflation. However, the recent hike in interest rates to the highest level in two decades, as well and wider economic tightening is a surefire sign of a government set on rebounding.
For this rebound to be a success, Sri Lanka has much to learn from the ‘Asian Tigers’. Central to these group of nations emerging from poverty and into being classified as ‘high income‘ has been the full embrace of capitalism and markets. This has gone hand-in-hand with their governments knowing where to draw the line. According to the Asian Development Bank, the Tigers were willing to adopt the use of market institutions and openness "earlier and much more than other developing economies...A common error in South Asia and elsewhere was trying to do too much - not only providing public goods but also running bakeries, mines, steel mills, hotels, and banks."
The future of Sri Lanka remains uncertain. With widespread instability and half a million people sinking into poverty, things have never seemed so bleak. Yet we must remain steadfast in our optimism and focus on the necessary reforms to turn around our beloved country.