sri lanka economic crisis short essay

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Sri Lanka’s Financial Crisis: Origins, Impact, and Next Steps

Sri Lankans organize a protest against the Rajapaksa government.

By Raghav Nath, MBA ’22

Sri Lanka finds itself in a financial crisis that has led to a rise in external debt, depleted foreign exchange reserves, a currency in freefall, and high, double-digit inflation. I will look at some of the factors that have contributed to the nation’s economic downfall, including consolidation of political power, hyper-populist policies, and an ill-thought push towards organic agriculture. Further, I will evaluate the impact that the situation has had on the nation in the form of political instability, shortages of essential items, galloping inflation, and disgruntled citizens.

How did Sri Lanka get here?

Sri Lanka has had economic trouble for the greater part of the last decade. It received a bailout from the International Monetary Fund (IMF), in 2009 and again in 2016, on the condition that it would control its debt and reduce it to 5 percent of its GDP by 2021. The situation worsened due to the twin impacts of the 2019 Easter bombings and Covid-19 on tourism, one of Sri Lanka’s main industries, accounting for approximately 10 percent of its GDP. Below are some of the key events and policy shifts that led Sri Lanka into the economic turmoil it faces today.

• Consolidation of political power | The Gotabaya Rajapaksa government first came to power in 2019, forming a caretaker government until the 2020 parliamentary elections, when Rajapaksa won a landslide victory as president, and his party, Sri Lanka Podujana Peramuna (SLPP), secured 145 out of 225 seats. This landslide victory allowed Rajapaksa to appoint members of his family to key posts including that of a prime minister and finance minister. Rajapaksa also initiated constitutional reforms that gave the incumbent government the ability to hire and fire judges and other members of the judiciary, further consolidating power and paving the way for major policy changes.
• Hyper-populist policies | The Rajapaksa government enacted populist policies, including massive tax breaks, that had an adverse effect on government revenue. The Goods and Services (GST) tax rate was slashed in half from 15 percent to 8 percent. Additionally, the government also cut the income tax by increasing the taxable income band by 600 percent from 500,000 Sri Lankan Rupees (SLR) to 3,000,000 SLR. This resulted in a 33.5 percent decrease in the number of tax payers. The loss of revenue to the Sri Lankan government was estimated at 2 percent of GDP. The reduced revenue to the government hindered its path towards lowering its percent of debt of the GDP and instead increased it, resulting in even higher interest payments.
• Organic agricultural methods | The government in Sri Lanka ordered a shift to organic methods of farming. They did this in a relatively short amount of time and in a very stringent manner, without rolling out support and help for the farmers to assist them in the change. What followed was a sharp reduction in output in agricultural items such as rubber and tea. Due to reduced output, Sri Lanka had to stop exporting these items and instead import them to ensure enough quantity to sustain domestic demand. This led to a negative impact on its balance of payments and increased debt that further weakened its currency, which in turn made these imports even more expensive. Sri Lanka was caught in a vicious cycle of rising debt and rising interest payments due to the mismanagement of its economy.

What impact has the crisis had on Sri Lanka?

The economic crisis has had a crippling effect on the country, with shortages of essential goods, high inflation, and more, leading to mass protests and resignations from the president’s cabinet.

• Shortages of essential goods | Sri Lanka has faced acute shortages of essential items such as fuel and medicines as it struggles to import goods due to its precarious foreign exchange reserves and mounting debt. This has had a compounding impact on the island nation as tourists have stayed away from the country amidst the fallout from the situation. Since tourism accounts for approximately 10 percent of Sri Lanka’s GDP, the failure to see an uptick in tourism following the easing of the Covid-19 pandemic has hit the country hard.
• High inflation | The country has struggled with high inflation owing to the vicious debt trap that it has found itself in. As a result, the interest payments on sovereign debt and the cost of imports have been rising steadily. The increase in inflation has hit every stratum of society hard, but has hit those with the lowest incomes the hardest.

What steps can Sri Lanka take to alleviate the situation?

Resumption of imports that help tackle the shortages of essential goods seems to be of the utmost importance. Without essential medicines, fuels, and food grains, any attempt to return to a state of normalcy will be futile. However, this will only be possible after it refinances its debt and gets a bailout either from its neighboring countries or the IMF. Without this, it will not be able to afford imports.

Sri Lanka estimates that it needs USD 1.5 billion to tide over the crisis immediately and resume its imports of essential items. An IMF bailout that mandates resumption of non-organic ways of farming, cutting back populist tax regimes, and increasing government revenue through more efficient tax collection will not only help the country in the short term but will also lay the foundation to build its future.

About Raghav Nath, MBA ’22

Raghav Nath is a second-year student in the Two-Year MBA program at the Samuel Curtis Johnson Graduate School of Management . He grew up in India and takes a keen interest in South Asian geopolitics. Nath is passionate about fintech and the application of technology to increase financial inclusion in the emerging economies. Upon graduation, he will be joining Fireblocks, a cryptocurrency infrastructure provider, to help promote the adoption of cryptocurrency by institutions.

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Five Things to Know about Sri Lanka’s Crisis

Sri Lanka’s collapse should be a wake-up call to other countries, highlighting the perils of sovereign debt in an era of geopolitical competition.

By: Tamanna Salikuddin

Publication Type: Analysis

Following months of escalating protests, and the May resignation of his brother Prime Minister Mahinda Rajapaksa, Sri Lankan President Gotabaya Rajapaksa fled the country on July 13. Sri Lanka’s economy has hit rock bottom as it defaulted on international loans and is facing rampant fuel and food shortages, and the government imposed a state of emergency. Gotabaya’s flight from the country leaves the government in further disarray. How did Sri Lanka get here and what does this political and economic crisis mean for the country and the region?

Here are five things you should know about the crisis in Sri Lanka:

1. Sri Lanka is facing the worst economic crisis since its independence in 1948.

The Sri Lankan economy has completely collapsed, as then Prime Minister Wickremesinghe declared a few weeks ago. But this economic meltdown is not a surprise: Years of mismanagement have been exacerbated by several external shocks and the Rajapaksa’s unwillingness to seek help from the International Monetary Fund (IMF) earlier. Everything that could go wrong with the economy has: Sri Lanka faces budget and current account deficits, hyperinflation, a devalued currency and a huge sovereign debt that it can no longer pay.

After the civil war ended in 2009, then President Mahinda Rajapaksa took out massive foreign loans to pay for war expenses and, more importantly, to start flashy infrastructure projects to attract tourism and reward cronies. In a vicious cycle, the government had to turn to foreign lenders, such as the Chinese, to help service already existing debt because they had limited foreign reserves. Rather than focus on economic reforms that might increase those reserves, the Rajapaksas implemented several tax cuts to shore up political support.

The 2019 Easter bombings and the COVID-19 pandemic ravaged tourism, Sri Lanka’s main source of foreign revenue. Adding insult to injury, Gotabaya decided to in 2021 to ban chemical fertilizers to make Sri Lankan farming “all organic” — a move that devasted the tea industry, Sri Lanka’s main export crop. The fertilizer ban (which was finally reversed) and global grain shortages due to the war in Ukraine have made the country more food insecure. The Rajapaksa’s economic plan turned out to be a series of missteps and false bravado that led to the collapse of a once vibrant and economically promising South Asian nation.

Whoever takes control of the government, they will have to work out an IMF program as soon as possible and negotiate to restructure loans held by China, India, Japan and commercial lenders. Without a government in power, IMF loans will take longer to finalize, leaving Sri Lankans in dire need of food and fuel aid because they have no foreign reserves to purchase these items.

2. Sri Lankans have taken to the street in record numbers to protest economic hardships.

In the face of severe economic hardships marked by power blackouts, shortages of fuel, cooking oil and food, protesters have been demanding the resignation of the Rajapaksa-led government since March 2022. Tens of thousands of Sri Lankans have taken to the streets of Colombo, and while that included some opposition politicians, most protesters are average Sri Lankans from all ethnic backgrounds. While concentrated in Colombo, there have been small protests in solidarity across Sri Lanka as almost all citizens are facing serious challenges.

The protesters do not have centralized leadership, but several socialist student groups have been key organizers, particularly on the iconic Galle Face Green in the capital city of Colombo. Gotabaya’s regime has responded in heavy-handed ways , declaring states of emergency and curfews, pushing police and the military to arrest civilians, at times roughing up the protesters, and limiting social media access. While largely peaceful, sporadic violence has broken out, notably the burning of the prime minister's residence and the occupation of the ceremonial presidential palace. After Gotabaya’s departure from Sri Lanka, protests continued against Wickremensinghe when he became acting president. Several protesters were injured in the aftermath of military and police action against them.

The sustained protests mark a remarkable movement of common people who ultimately pushed Gotabaya and his regime to resign. Their main demands included the immediate resignation of both President Rajapaksa and Prime Minister Wickremesinghe, dissolution of the current government and the establishment of an interim government that holds new elections within a year, and a referendum to establish a new constitution that endorses the people’s sovereignty and reduces the president’s executive powers.

3. The Rajapaksa government collapsed and left the country in political disarray.

The roots of the current political crisis are directly tied to the actions of former President Gotabaya Rajapaksa and his family, including his brothers former Prime Minister Mahinda Rajapaksa and former Finance Minister Basil Rajapaksa. Gotabaya came to power in 2019, and in 2020 his party, the Sri Lanka People's Front (SLPP), was able to consolidate its supermajority in parliament on a banner of populism and Sinhalese nationalism. By passing the 20th amendment to the constitution, Gotabaya was able to consolidate an unprecedented amount of power in the executive presidency. His dictatorial tendencies were matched by nepotism, corruption, the elevation of retired military officers into almost every sector of government, and serious accusations of human rights violations during the Sri Lankan civil war. But in the end, it was his (and his family’s) terrible governance and mismanagement of Sri Lanka’s economy, especially during the pandemic, that led to the economic crisis in the fall of 2021.

Even after his brother’s resignation as prime minister in early May, Gotabaya had remained defiant and pledged to serve out the remaining two years of his presidential term. In May, Gotabaya appointed Wickremensinghe as prime minister (his sixth time in the job) as a meager conciliatory move. Given that Wickremensinghe’s Union National Party had only one seat in parliament and he was serving on an appointed national list seat rather than elected one, this move did little to gain popular support nor did it help stem the debt default or hyperinflation. Wickremensinghe unsuccessfully attempted to pass a version of the 21st amendment to limit some of the powers of the executive presidency — a move Gotabaya opposed.

By mid-July, the economic crisis was reaching untenable depths and the protesters (though largely peaceful) had burnt down the prime minister’s house and occupied the president palace. As things came to a head, Gotabaya finally promised to resign by July 13 (a particularly auspicious day in the Buddhist calendar). Yet he escaped the country without resigning. Eventually, the speaker of the parliament announced that he had received Gotabaya’s resignation from Singapore and Wikremensinghe was formally sworn in as acting president on July 15.

4. Sri Lanka’s political and economic future is uncertain, but there are significant problems to tackle for whoever takes charge.

Wickremesinghe has asked parliament to undertake the constitutional process to elect a new president. Parliament will convene on July 16 and begin the process to elect a new president from among their ranks, with the election likely on July 20. Following negotiations with all political parties, it is likely that a compromise candidate will take up the presidency (possibly opposition leader Sajith Premadasa or even Wickremesinghe). An all-party coalition government will try to lead Sri Lanka through IMF negotiations to finalize economic relief and set the stage for fresh general elections.

None of the current parliamentary leaders, most notably Wickremesinghe, enjoy much popular support, and protesters have opposed an all-party government because the Rajapaksa’s SLPP would still have a majority. Instead, they are calling for an interim government to prepare for elections. The most pressing priorities for the next government, in addition to the economic and humanitarian woes, will be finding a peaceful way to resolve the ongoing protests and unrest, seeking some political buy-in from the country’s polarized ethnic communities, and likely amending the constitution to undo the executive presidency.

5. Sri Lanka’s economic and political collapse sends a wake-up call to other countries and highlights the perils of sovereign debt in an era of geopolitical competition.

Sri Lanka’s sovereign debt is held by many countries, most notably China, India and Japan. China holds about 10% of Sri Lanka’s debt, and this has often been used as an example of “debt trap diplomacy.” The reality is more complicated — China indeed has not been willing to forgive any of Sri Lanka’s debt during this crisis and the structure of its bilateral debt comes with opaque restrictions and little relief. Additionally, if you count the debt held by Chinese banks, such as EXIM Bank of China and the China Development Bank, the percentage of Chinese-held debt is closer to 26%.

But by far the largest portion of Sri Lanka’s debt is held by commercial institutions, per official government statistics . Over the last 20 years as Sri Lanka’s debt has gone from low interest rate concessionary lending from the World Bank or the Asian Development Bank to mostly commercial loans held by private banks at much higher interest rates . In 2019, 56% of Sri Lanka’s debt was held by commercial lenders, compared to only 2.5% in 2004. Much of this debt was used for large infrastructure projects that did not yield the returns to justify the loans.

This high level of foreign debt undergirds the crisis, and in a post-pandemic world is a wakeup call for several similarly placed countries in Asia and Africa. On the same day that Gotabaya fled Colombo, Pakistan, which is experiencing similar challenges, reached the final stages of an IMF deal that will hopefully pull it back from the brink.

Sri Lanka has been an arena for competition for India and China (and to some extent Japan), all of whom have historic relations with the island nation. The Rajapaksa regime claimed close relations with China, but ultimately India was most helpful in the crisis. This year, India has sent over $3.8 billion to Sri Lanka , in the form of currency swaps, loans, food and fuel aid. Even before this week’s acute political disarray, India had pledged a comprehensive plan to increase economic and infrastructure ties between the two nations, a move seen as reassertion of its historic influence in Sri Lanka and as a counter to growing Chinese influence. Other members of the QUAD alliance (the United States, Australia and Japan) have also announced various levels of support for the Sri Lankan economy.

Last month at the G-7 Summit, President Biden announced $20 million of additional humanitarian assistance for Sri Lanka , bringing the total U.S. commitments in 2022 for economic and humanitarian assistance to $32 million. It is likely that the United States and other QUAD allies will increase their relief packages for Sri Lankans.

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What’s happening in Sri Lanka and how did the economic crisis start?

Professor of Economics, Tata Institute of Social Sciences

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R. Ramakumar does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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The island nation of Sri Lanka is in the midst of one of the worst economic crises it’s ever seen. It has just defaulted on its foreign debts for the first time since its independence, and the country’s 22 million people are facing crippling 12-hour power cuts , and an extreme scarcity of food, fuel and other essential items such as medicines .

Inflation is at an all-time high of 17.5%, with prices of food items such as a kilogram of rice soaring to 500 Sri Lankan rupees (A$2.10) when it would normally cost around 80 rupees (A$0.34). Amid shortages, one 400g packet of milk powder is reported to cost over 250 rupees (A$1.05), when it usually costs around 60 rupees (A$0.25).

On April 1, President Gotabaya Rajpaksha declared a state of emergency. In less than a week, he withdrew it following massive protests by angry citizens over the government’s handling of the crisis.

The country relies on the import of many essential items including petrol, food items and medicines. Most countries will keep foreign currencies on hand in order to trade for these items, but a shortage of foreign exchange in Sri Lanka is being blamed for the sky-high prices.

Read more: Sri Lanka teeters on economic edge, from pandemic-fueled financial crisis and Ukraine war spillovers

Why are some people blaming China?

Many believe Sri Lanka’s economic relations with China are a main driver behind the crisis. The United States has called this phenomenon “debt-trap diplomacy”. This is where a creditor country or institution extends debt to a borrowing nation to increase the lender’s political leverage – if the borrower extends itself and cannot pay the money back, they are at the creditor’s mercy.

However, loans from China accounted for only about 10% of Sri Lanka’s total foreign debt in 2020. The largest portion – about 30% – can be attributed to international sovereign bonds. Japan actually accounts for a higher proportion of their foreign debt, at 11%.

Defaults over China’s infrastructure-related loans to Sri Lanka, especially the financing of the Hambantota port , are being cited as factors contributing to the crisis.

But these facts don’t add up. The construction of the Hambantota port was financed by the Chinese Exim Bank. The port was running losses, so Sri Lanka leased out the port for 99 years to the Chinese Merchant’s Group, which paid Sri Lanka US$1.12 billion.

So the Hambantota port fiasco did not lead to a balance of payments crisis (where more money or exports are going out than coming in), it actually bolstered Sri Lanka’s foreign exchange reserves by US$1.12 billion.

So what are the real reasons for the crisis?

Post-independence from the British in 1948, Sri Lanka’s agriculture was dominated by export-oriented crops such as tea, coffee, rubber and spices. A large share of its gross domestic product came from the foreign exchange earned from exporting these crops. That money was used to import essential food items.

Over the years, the country also began exporting garments, and earning foreign exchange from tourism and remittances (money sent into Sri Lanka from abroad, perhaps by family members). Any decline in exports would come as an economic shock, and put foreign exchange reserves under strain.

For this reason, Sri Lanka frequently encountered balance of payments crises . From 1965 onwards, it obtained 16 loans from the International Monetary Fund (IMF). Each of these loans came with conditions including that once Sri Lanka received the loan they had to reduce their budget deficit, maintain a tight monetary policy, cut government subsidies for food for the people of Sri Lanka, and depreciate the currency (so exports would become more viable).

But usually in periods of economic downturns, good fiscal policy dictates governments should spend more to inject stimulus into the economy. This becomes impossible with the IMF conditions. Despite this situation, the IMF loans kept coming, and a beleaguered economy soaked up more and more debt.

The last IMF loan to Sri Lanka was in 2016. The country received US$1.5 billion for three years from 2016 to 2019. The conditions were familiar, and the economy’s health nosedived over this period. Growth, investments, savings and revenues fell, while the debt burden rose.

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 stating up to an 80% drop – and drained foreign exchange reserves. Second, the new government under President Gotabaya Rajapaksa irrationally cut taxes .

Value-added tax rates (akin to some nations’ goods and services taxes) were cut from 15% to 8%. Other indirect taxes such as the nation building tax, the pay-as-you-earn tax and economic service charges were abolished. Corporate tax rates were reduced from 28% to 24%. About 2% of the gross domestic product was lost in revenues because of these tax cuts.

In March 2020, the COVID-19 pandemic struck. In April 2021, the Rajapaksa government made another fatal mistake. To prevent the drain of foreign exchange reserves, all fertiliser imports were completely banned . Sri Lanka was declared a 100% organic farming nation. This policy, which was withdrawn in November 2021, led to a drastic fall in agricultural production and more imports became necessary.

But foreign exchange reserves remained under strain. A fall in the productivity of tea and rubber due to the ban on fertiliser also led to lower export incomes. Due to lower export incomes, there was less money available to import food and food shortages arose.

Because there is less food and other items to buy, but no decrease in demand, the prices for these goods rise. In February 2022, inflation rose to 17.5%.

What will happen now?

In all probability, Sri Lanka will now obtain a 17th IMF loan to tide over the present crisis, which will come with fresh conditions.

A deflationary fiscal policy will be followed, which will further limit the prospects of economic revival and exacerbate the sufferings of the Sri Lankan people.

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EXPLAINER: What caused Sri Lanka’s economic collapse?

Sri Lankan army soldiers guard a check point outside prime minister’s residence a day after clashes between government supporters and anti-government protesters in Colombo, Sri Lanka, Tuesday, May 10, 2022. Defying a nationwide curfew in Sri Lanka, several hundred protesters continued to chant slogans against the government Tuesday, a day after violent clashes saw the resignation of the prime minister who is blamed, along with his brother, the president, for leading the country into its worst economic crisis in decades. (AP Photo/Eranga Jayawardena)

Sri Lankan soldiers stand guard next to burnt buses a day after clashes between government supporters and anti-government protesters in Colombo, Sri Lanka, Tuesday, May 10, 2022. Defying a nationwide curfew in Sri Lanka, several hundred protesters continued to chant slogans against the government Tuesday, a day after violent clashes saw the resignation of the prime minister who is blamed, along with his brother, the president, for leading the country into its worst economic crisis in decades. (AP Photo/Eranga Jayawardena)

Sri Lankan anti-government protesters mend a tent at the ongoing protest site a day after it was attacked by government supporters in Colombo, Sri Lanka, Tuesday, May 10, 2022. Defying a nationwide curfew in Sri Lanka, several hundred protesters continued to chant slogans against the government Tuesday, a day after violent clashes saw the resignation of the prime minister who is blamed, along with his brother, the president, for leading the country into its worst economic crisis in decades. (AP Photo/Eranga Jayawardena)

Security officers stand guard a day after clashes between government supporters and anti government protesters in Colombo, Sri Lanka, Tuesday, May 10, 2022. Defying a nationwide curfew in Sri Lanka, several hundred protesters continued to chant slogans against the government Tuesday, a day after violent clashes saw the resignation of the prime minister who is blamed, along with his brother, the president, for leading the country into its worst economic crisis in decades. (AP Photo/Eranga Jayawardena)

Sri Lankan army soldiers man a check point outside the prime minister’s residence in Colombo, Sri Lanka, Tuesday, May 10, 2022. Defying a nationwide curfew in Sri Lanka, several hundred protesters continued to chant slogans against the government Tuesday, a day after violent clashes saw the resignation of the prime minister who is blamed, along with his brother, the president, for leading the country into its worst economic crisis in decades.(AP Photo/Eranga Jayawardena)

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COLOMBO, Sri Lanka (AP) — The South Asian nation of Sri Lanka is experiencing an unprecedented economic collapse that has pushed the government into a deep crisis. The island is struggling to import basic necessities for its 22 million people because of diminishing foreign reserves and crippling debt, spurring weeks of anti-government protests that recently turned violent and led to the prime minister’s resignation.

Much of the public ire has been directed at President Gotabaya Rajapaksa and his brother, former Prime Minister Mahinda Rajapaksa, who are blamed by critics for leading the country into the economic crisis.

WHAT LED TO THE PROTESTS?

For months, Sri Lankans have had to wait in long lines to buy essential items because a foreign exchange crisis caused shortages of imported food, medicines and fuel. Oil shortfalls have led to sweeping power cuts.

The pandemic and the Russia-Ukraine conflict have made things worse, but warnings of a potential economic disaster began long before.

In 2019, President Rajapaksa swept to power months after Easter suicide bombings at churches and hotels killed 290 people. The attacks badly damaged tourism, a key source of foreign exchange, and Rajapaksa promised to pull Sri Lanka out of a deep economic slump and keep it safe.

The government needed to boost its revenues, especially as foreign debt ballooned for big infrastructure projects, some financed by Chinese loans But just days into his presidency, Rajapaksa pushed through the largest tax cuts in Sri Lankan history.

The move sparked quick punishment from the global market. Creditors downgraded Sri Lanka’s ratings, blocking it from borrowing more money as its foreign reserves nosedived. Soon after, the pandemic hit, flattening tourism again as debts mounted.

Then last April, Rajapaksa suddenly announced a ban in the import of chemical fertilizers in a push to promote organic farming, but without proper planning. It caught farmers by surprise, decimated rice crops and drove high the price of staple.

The Ukraine war has also increased food and oil prices globally, making imports more unaffordable. The central bank said inflation was at 30% in April, with food prices up nearly 50%.

The country’s foreign reserves have dropped below $50 million. This has forced the government to suspend payments on $7 billion in foreign debt due this year, with nearly $25 billion due by 2026 out of a total of $51 billion.

WHO ARE THE RAJAPAKSA BROTHERS?

The nationwide protests are demanding the removal of the Rajapaksa brothers — a dramatic reversal for Sri Lanka’s most powerful political dynasty.

Mahinda and Gotabaya Rajapaska were cheered as heroes by the island’s Buddhist-Sinhalese majority for ending a 30-year civil war against ethnic Tamil rebels in 2009. Despite accusations of war atrocities, they amassed great popularity — Mahinda who as president at the time oversaw the end of the war, and Gotabaya, a military strategist whose brutal campaign helped crush the rebels.

A powerful land-owning family from a rural southern district, the Rajapaksas dominated local elections for years before ascending to national politics in 2005 when Mahinda was elected president. He remained in power until 2015, when he was defeated by the opposition led by former aide.

Following the 2019 Easter bombings, the family returned to power under Gotabaya, who ran for president on a high-pitched nationalist campaign that won over voters disillusioned by the previous government over the attacks.

Critics have accused the Rajapaksas of relying heavily on the military to enforce policy, passing laws to weaken independent institutions and maintaining a near-monopoly on decision making. Three other Rajapaksa members were in the Cabinet until early April, when the full Cabinet resigned over the protests.

Mahinda’s resignation on Monday is a partial victory for the demonstrators. With the protests continuing, especially outside the president’s office, there is renewed pressure on the president to quit too.

WHAT HAPPENS NEXT?

President Rajapaksa is without a prime minister and Cabinet, which dissolved automatically after his brother resigned.

He can now select a member of Parliament to become the next prime minister and form a Cabinet. His choice will need the support of a majority of the 225-member legislature. It’s unclear whether he still has enough backing in Parliament for his candidate to be approved.

The president could attempt to form a unity government, but it will likely be difficult to convince opposition members to join.

If the president does resign while there is no prime minister, the Parliament speaker will become interim president for one month, during which Parliament is to select a member to become president until an election can be held.

A motion to impeach Rajapaksa would not be easy. It would need the endorsement of the Parliament speaker, the Supreme Court and the support of at least 150 lawmakers. Opposition parties do not hold a majority in Parliament, making the process even harder.

In the 45 years that Sri Lanka has been ruled by an executive presidential system, there has been one failed attempt to oust a president. The constitution gives the president wide powers as commander-in-chief of the armed forces, head of the Cabinet and powers to appoint the chief justice, police chief and others.

The president, despite his extensive powers, still needs a prime minister and Cabinet to carry out executive functions. The ongoing uncertainty over the president’s next moves and the administrative vacuum have raised fears of a military takeover, especially if violence escalates.

Pathi reported from New Delhi.

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How Sri Lanka Can Overcome Its Economic Crisis

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The government should take advantage of the crisis to do things that it could never attempt before, from addressing regressive subsidies to restructuring state-owned enterprises.

Winston Churchill’s famous dictum, “Never let a good crisis go to waste,” could not be more apt for Sri Lanka in its current context: An economy struck down by one of its worst crises since independence presents a unique opportunity for the country to deliver on much needed reforms. Many countries like India and Thailand implemented wide-ranging economic reforms after undergoing severe economic crises and came out much stronger. The Sri Lankan government should take advantage of the prevailing economic crisis to do things that it could never attempt before – from addressing regressive subsidies to restructuring state-owned enterprises.

The severity of Sri Lanka’s economic crisis is evidenced by the fact that the country is being widely pointed to as a textbook case of how an economy should not be managed. The past few months have seen extreme fuel and gas shortages, currency depreciation leading to near hyperinflation, shortage of medicines, and long power cuts largely due to a shortage of foreign exchange.

Sri Lanka still has a long way to go to come out of this crisis, which has been a long time in the making. Decades of fiscal deficits, current account deficits, a bloated public sector, diminishing tax revenue, and subsidized prices have led to this state. Currently, the country is looking at an IMF bailout, for which it needs to restructure its debt. Debt restructuring can be complicated, especially with China, which prefers to refinance loans instead of restructuring approaches. One of the international sovereign bond holders taking the Sri Lankan government to courts sets a dangerous precedent for the country.

As the economy teeters on the brink, navigating the crisis will require long overdue extensive economic reforms, which could very well be the silver lining to Sri Lanka’s economic recession.

Economic Policy Missteps in the Last Few Years

Many policies of the administration of former President Gotabaya Rajapaksa led to the aggravation of the economic crisis. The tax cuts given in 2019, when Sri Lanka was already seeing low tax revenues, led to larger fiscal deficits, resulting in international ratings agencies downgrading Sri Lanka, effectively shutting the country out of international capital markets. The COVID-19 pandemic, which led to a fall in tourists and in remittance sent home by Sri Lankans working abroad, further exacerbated the situation. The chemical fertilizer ban was another mistake, as admitted by the former president himself, which led to agricultural output decreasing significantly. Fixing the currency exchange rate at 203 Sri Lankan rupees to the U.S. dollar by using up foreign reserves and deferring engagement with the IMF led the economic crisis to spiral out of control.

But a large share of the blame lies in the structural issues of the Sri Lankan economy. Macro risk factors, such as a 26-year-long civil war, cultural predispositions against foreign direct investment, public skepticism about privatization, populist policies, and low taxes have all led to where the country is at the moment.

Structural Causes of the Sri Lankan Economic Crisis

When Sri Lanka achieved independence in 1948, its economy was one of the best in Asia. But things have gone increasingly downhill since then.

Populist macroeconomic policies have dominated the Sri Lankan economy for decades. Many political parties coming to power with election promises including subsidized rice, cheap bread, free fertilizer, and lower taxes. This has had a cascading effect on government revenues, leading to decades of fiscal deficits, increasing government debt, and the printing of money, resulting in a low but steady inflation rate.

Political parties also promise government jobs during election periods, which results in many people getting state sector jobs – even when such jobs do not exist. In Sri Lanka, just over one in six of the country’s total workforce is employed by the state. The total state sector workforce amounts to 1.4 million employees, which resulted in 86 percent of the government’s tax revenue in 2021 going to paying the salaries of state sector employees. To make matters worse, a staggering 71 percent of government revenue goes to paying the interest on Sri Lanka’s sovereign debts. Paying the salaries of state sector employees and interest costs alone result in a large fiscal deficit, which is managed by more borrowing and quantitative easing. This also leaves very little room for government investment in healthcare, education, and other development projects.

Though Sri Lanka was the first country in South Asia to open its economy in the 1980s and still has the second-highest GDP per capita in South Asia, its liberalization was not fully completed and many policies were reversed in the later decades. Since the mid-2000s, the government has shifted focus toward import substitution. Sri Lanka has one of the highest tariff rates in the region protecting many of its industries. This has led to many large companies in protected industries having less incentive to innovate as they are comfortable in selling in the local market. But being less innovative and competitive also meant they could not export globally. Import restrictions, tariff barriers, and a lack of free trade agreements (Sri Lanka only has three FTAs) has led to Sri Lanka being left out of many global supply chains.

Sri Lanka had mostly borrowed from multilaterals at low interest rates, but this changed after the mid-2000s, when Sri Lanka issued its first international sovereign bond in 2007 and in the post-civil war period started borrowing from China at higher interest rates. Most of the money was invested into non-tradable industries and vanity projects such as the Colombo Lotus Tower.

Lastly, since the mid-1990s, Sri Lanka’s tax revenue-to-GDP ratio has dropped significantly. In 1990, the ratio was nearly 20 percent , which paralleled those of many developed countries. The tax-to-GDP ratio was down to 12 percent in 2019, and after the tax cuts, it has dropped to just above 8 percent, one of the lowest levels in the world. To make things worse, direct taxes contribute to less than 2 percent of GDP and only 1 percent of the population comes under the income tax base.

Key Economic Reforms Needed for Sri Lanka

Sri Lanka requires wide-ranging economic reforms for long-term sustainable growth to service its debt obligations and to emerge from this crisis stronger. A stable monetary policy is important to keep macroeconomic stability and confidence in the local currency. The current economic crisis Sri Lanka is facing makes it very evident that an independent Central Bank is of the utmost importance. An independent Central Bank that can refuse to print money can force the Treasury to take fiscal consolidation seriously. Having more respected professionals in Central Bank committees and giving them a fixed term can allow them to make long-term policy decisions on interest rates and reserve requirements without political interference.

Tax reforms are essential for revenue-based fiscal consolidation, another prerequisite for economic sustainability. Instead of merely increasing taxes, the government should widen the tax base and implement a system to efficiently collect taxes.

Reform is needed to rein in state expenditure as well. State-owned enterprises (SOEs) are a colossal drain on the state coffers. This has resulted in a deepening fiscal deficit. The management of state-owned enterprises is inefficient as the ruling parties use SOEs for short-term political gains, resulting in a loss of focus on a long term sustainable strategy for SOEs. As the chairperson and the Board of Directors of SOEs are appointed by the relevant government ministries, they tend to be political party loyalists.

Reforms have to come in the form of restructuring these loss-making state entities with laws passed requiring financial disclosures and independent audits. As SOEs are unconditionally supported by the Treasury and also borrow from other state entities, especially from state banks, they have little incentives to balance their budgets. Requiring SOEs to balance their budgets and limiting support from the Treasury could bring about financial discipline.

Many SOEs should be privatized after a thorough study is done to systematically assess the benefits and risks involved. There is no reason not to privatize SOEs in competitive sectors where there is no need for a state entity to have commercial interests, like supermarkets, hotels, and airlines. As Thailand did after its economic crisis in 1997, certain Sri Lankan SOEs should be restructured and corporatized so they can be privatized in the future when the need arises.

Reforms are also needed to reduce the current account deficits that Sri Lanka has been experiencing for decades. Shifting the country toward an export-oriented economy should be the goal. Sri Lanka has one of the highest tariff rates in the region, which protects Sri Lankan industries with a focus on import substitution. Sri Lanka is a small nation with a GDP of around $80 billion. Trying to produce many products entirely in Sri Lanka for the Sri Lankan market means reduced economies of scale, resulting in products that are of lower quality and/or higher prices. Reducing tariff rates for the short term is not an option due to the forex crisis, but as the economy stabilizes, a strategy to transform the nation into an export-driven economy should be implemented. Even if tariff rates are high, lifting quantitative restrictions would be recommended to address the issue of shortages in the country.

Sri Lanka needs to go with the global trend in manufacturing, which is to be part of global supply chains. An effective way for Sri Lanka to increase its exports is to find niche value additions it can undertake in the supply chains of multinational companies, which has been a strategy of developing countries such as Vietnam. For Sri Lanka to mesh with global supply chains, the country needs to have trade liberalization, export-focused FDI, increased FTAs, and improved trade facilitation. Sri Lanka only has three FTAs while Vietnam, which opened its economy much later, has 26. Sri Lanka can also strategize to utilize its existing FTAs further, especially the one with India to drive exports.

FTAs are also needed to draw in export-targeted FDIs; Sri Lanka has a strategic location that it can leverage. Improving ease of doing business is essential as Sri Lanka ranks 99th in the world when it comes to the World Bank’s ease of doing business rankings. Sri Lanka ranked 164th in the world in 2020 on enforcing contracts, which has to be improved.

Factor market reforms are crucial. The Sri Lankan government owns 82 percent of the land in the country, which severely restricts land usage for the private sector. Government land is leased out, which has two disadvantages, as the tenant occupying the land will not be able to use it as collateral and the tenant may not carry out long-term investments on the land. Land fragmentation is also a major issue as it leads to a lack of large tracts of land for major development projects. A proper valuation system for land is also crucial in attracting investments.

Labor reforms are needed to make the economy more competitive. Sri Lanka has one of the highest retrenchment costs in the world, making it extremely unattractive to investors. For better labor output, the labor force should be developed through education and training with a focus on developing future skills such as analytical thinking and innovation for a future ready workforce.

Overcoming the Twin Deficits

Sri Lanka’s economic performance has been influenced more by “spending performance” (internal finance) than by “trade performance” (external finance). The twin-deficit hypothesis suggests that such countries would end up with unsustainable deficits in both accounts (government budget and international trade), while countries focused on external finance tend to improve both.

Thus, Sri Lanka continued to aggravate its over-spending problem by widening its fiscal deficit and trade deficit, which were financed increasingly with domestic and foreign borrowings. As a result, tradable sector growth slowed down against non-tradable sector growth, which was financed primarily by government spending and was unsustainable in the long-run. The fundamental problem that the government had to face was on how to pay dollar-denominated loans while earning rupee-denominated income from non-tradable sector growth.

Sri Lanka has to improve its forex earning capacity in order to achieve debt sustainability as well as to move beyond and above recovery. Fiscal consolidation is needed as a medium-term measure, but the reforms should be extended to eliminate the country’s anti-export and anti-FDI biases. A crisis is an unprecedented opportunity to carry out the necessary reforms – one that should not be missed.

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News Explainer: The Economic Crisis in Sri Lanka

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Graphics/Design:

Bhabna banerjee.

Explained: the Economic Crisis in Sri Lanka

Sri Lanka is currently in an economic and political crisis of mass proportions, recently culminating in a default on its debt payments. The country is also nearly at empty on their foreign currency reserves, decreasing the ability to purchase imports and driving up domestic prices for goods.

There are several reasons for this crisis and the economic turmoil has sparked mass protests and violence across the country. This visual breaks down some of the elements that led to Sri Lanka’s current situation.

A Timeline of Events

The ongoing problems in Sri Lanka have bubbled up after years of economic mismanagement. Here’s a brief timeline looking at just some of the recent factors.

In 2009, a decades-long civil war in the country ended and the government’s focus turned inward towards domestic production. However, a stress on local production and sales, instead of exports, increased the reliance on foreign goods.

Unprompted cuts were introduced on income tax in 2019, leading to significant losses in government revenue, draining an already cash-strapped country.

The COVID-19 pandemic hit the world causing border closures globally and stifling one of Sri Lanka’s most lucrative industries. Prior to the pandemic, in 2018, tourism contributed nearly 5% of the country’s GDP and generated over 388,000 jobs. In 2020, tourism’s share of GDP had dropped to 0.8% , with over 40,000 jobs lost to that point.

Recently, the Sri Lankan government introduced a ban on foreign-made chemical fertilizers. The ban was meant to counter the depletion of the country’s foreign currency reserves.

However, with only local, organic fertilizers available to farmers, a massive crop failure occurred and Sri Lankans were subsequently forced to rely even more heavily on imports, further depleting reserves.

In early April this year, massive protests calling for President Gotabaya Rajapaksa’s resignation, sparked in Sri Lanka’s capital city, Colombo.

In May, pro-government supporters brutally attacked protesters. Subsequently, Prime Minister Mahinda Rajapaksa, brother of President Rajapaksa, stepped down and was replaced with former PM, Ranil Wickremesinghe.

Recently, the government approved a four-day work week to allow citizens an extra day to grow food, as prices continue to shoot up. Food inflation increased over 57% in May.

Additionally, the increasing prices on grain caused by the war in Ukraine and rising fuel prices globally have played into an already dire situation in Sri Lanka.

The Key Information

“Our economy has completely collapsed.” Prime minister Ranil Wickremesinghe to Parliament last week.

One of the main causes of the economic crisis in Sri Lanka is the reliance on imports and the amount spent on them. Let’s take a look at the numbers:

• 2021 total imports = $20.6 billion USD
• 2022 total imports (to March) = $5.7 billion USD

In contrast, the most recent  reported  foreign currency reserve levels in the country were at an abysmal $50 million, having plummeted an astounding 99% , from $7.6 billion in 2019.

Some of the top imports in 2021, according to the country’s central bank were:

• Refined petroleum = $2.8 billion
• Textiles = $3.1 billion
• Chemical products = $1.1 billion
• Food & beverage = $1.7 billion

Of course, without the cash to purchase these goods from abroad, Sri Lankans face an increasingly drastic situation.

Additionally, the debt Sri Lanka has incurred is huge , further hampering their ability to boost their reserves. Recently, they defaulted on a $78 million loan from international creditors, and in total, they’ve borrowed $50.7 billion .

The largest source of their debt is by far due to market borrowings, followed closely by loans taken from the Asian Development Bank, China, and Japan, among others.

What it Means

Sri Lanka is home to more than 22 million people who are rapidly losing the ability to purchase everyday goods. Consumer inflation reached 39% at the end of May.

Due to power outages meant to save energy and fuel, schools are currently shuttered and children have nowhere to go during the day. Protesters calling for the president’s resignation have been camped in the capital for months, facing tear gas from police and backlash from president Rajapaksa’s supporters, but many have also responded violently to pushback.

India and China have agreed to send help to the country and the the International Monetary Fund recently arrived in the country to discuss a bailout. Additionally, the government has sent ministers to Russia to discuss a deal for discounted oil imports.

A Foreshadowing for Low Income Countries

Governments need foreign currency in order to purchase goods from abroad. Without the ability to purchase or borrow foreign currency, the Sri Lankan government cannot buy desperately needed imports, including food staples and fuel, causing domestic prices to rise.

Furthermore, defaults on loan payments discourage foreign direct investment and devalue the national currency, making future borrowing more difficult.

What’s happening in Sri Lanka may be an ominous preview of what’s to come in other low and middle-income countries, as the risk of  debt distress  continues to rise globally.

The Debt Service Suspension Initiative ( DSSI ) was implemented by G20 countries, suspending nearly $13 billion in debt from the start of the pandemic until late 2021.

Some DSSI and LIC countries facing a high risk of debt distress include Zambia, Ethiopia, and Tajikistan, to name a few.

Going forward, Sri Lanka’s next steps in managing this situation will either serve as a useful example for other countries at risk or a warning worth heeding.

Ongoing Updates

Since this article was published the situation has changed significantly in Sri Lanka. Protesters have received their original demand calling for president Rajapaksa to step down — both he and prime minister Wickremesinghe have agreed to resign. This comes after protesters stormed the president’s palace causing him to flee the country.

Note: The debt breakdown in the main visualization represents total outstanding external debt owed to foreign creditors rather total debt.

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Explained | What caused the Sri Lankan economic crisis?

Among other factors, the tourism industry has been hit hard by the covid-19 pandemic, leading to a dip in foreign exchange..

Updated - September 20, 2021 02:19 pm IST

People queue outside a state-run supermarket to buy essential food items in Colombo on September 3, 2021 as Sri Lanka began imposing price controls on essential food from September 3 after using a state of emergency to seize allegedly hoarded stocks of sugar and rice.

The story so far: Sri Lanka’s government declared an economic emergency last week amid rising food prices, a depreciating currency, and rapidly depleting forex reserves. President Gotabaya Rajapaksa has called in the army to manage the crisis by rationing the supply of various essential goods.

Why is Sri Lanka’s economy in trouble?

A number of factors have led to the current economic crisis in Sri Lanka.

Also read: India sends 150 tonnes of oxygen to Sri Lanka to help it tackle coronavirus surge

The tourism industry, which represents over 10% of the country’s Gross Domestic Product and brings in foreign exchange, has been hit hard by the coronavirus pandemic. As a result, forex reserves have dropped from over $7.5 billion in 2019 to around $2.8 billion in July this year. With the supply of foreign exchange drying up, the amount of money that Sri Lankans have had to shell out to purchase the foreign exchange necessary to import goods has risen. So the value of the Sri Lankan rupee has depreciated by around 8% so far this year. It has to be noted that the country depends heavily on imports to meet even its basic food supplies. So the price of food items has risen in tandem with the depreciating rupee.

The government’s ban on the use of chemical fertilisers in farming has further aggravated the crisis by dampening agricultural production. Earlier this year, Mr. Rajapaksa made public his plan to make Sri Lanka the first country in the world with an agriculture sector that is 100% organic. Many, such as Sri Lankan tea expert Herman Gunaratne, believe that the forced push towards organic farming could halve the production of tea and other crops and lead to a food crisis that is even worse than the current one.

What has been the government’s response to the crisis?

The Sri Lankan government has blamed speculators for causing the rise in food prices by hoarding essential supplies and has declared an economic emergency under the Public Security Ordinance. The army has been tasked with the duty of seizing food supplies from traders and supplying them to consumers at fair prices. It has also been given the powers to ensure that forex reserves are used only for the purchase of essential goods. The government has refused to end its aggressive push for complete organic farming claiming that the short-term pain of going organic will be compensated by its long-term benefits. It has also promised to supply farmers with organic fertilisers as an alternative. Further, Sri Lanka’s central bank earlier this year prohibited traders from exchanging more than 200 Sri Lankan rupees for an American dollar and stopped traders from entering into forward currency contracts.

Will the government’s response help the economy?

Mr. Rajapaksa’s drive to make Sri Lankan agriculture fully organic is likely to lead to a significant drop in domestic food production and cause a further rise in prices. Also, the various steps taken by the government to tackle the crisis may actually make things worse. The capping of food prices, for instance, can lead to severe shortages as demand exceeds supply at the price fixed by the government. People have already had to queue up to buy essential goods due to rising shortages.

The strong-arm tactics of the army can also have unintended consequences. When supplies are seized from traders, there is lesser incentive for them to bring in fresh supplies to the market. This can lead to a further drop in supplies and even higher prices for essential goods. It is also worth noting that speculative traders help contain price volatility by allocating scarce supplies rationally across time. So, to the extent the army’s actions discourage speculation, it can lead to greater volatility in food prices.

Further, the decision of the Sri Lankan central bank to ban forward contracts and the spot trading of rupees at above 200 rupees to an American dollar may affect essential supplies. For example, a rice trader who wants to pay more than 200 rupees for an American dollar to import rice may no longer be able to carry out the trade. In fact, trading of currency in the spot market has dried up since the central bank’s order. Also, without forward contracts, which help traders offload the risk of currency volatility onto professional speculators, many traders may be unwilling to import essential supplies.

Published - September 06, 2021 09:16 am IST

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Infographic: Sri Lanka’s economic crisis and political turmoil

The tourism-reliant island nation faces one of its worst financial and political crises.

Sri Lanka is facing its worst financial crisis in more than 70 years. Food prices on the island nation rose by a record 30 percent in March alone. Here’s how much basic necessities now cost in the country of 22 million people.

The cost of living in the tourism-reliant country has become unbearable for many. Thousands have recently taken to the streets in massive protests across the country demanding the president’s resignation.

There is a great deal of dissatisfaction with the powerful Rajapaksa family , whose members hold several top positions in government, including President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa.

In the face of public anger, the cabinet of ministers resigned in full on Monday, and a new finance minister was appointed. On Tuesday, he too resigned.

The parliament said it would debate the ongoing crisis until Thursday. Protesters surrounded the parliament complex on Tuesday, demanding solutions for the economic crisis.

Sri Lanka was already grappling with Asia’s highest rate of inflation because of lockdowns during the COVID pandemic and the diminished tourism industry before Russia’s war against Ukraine added to its woes.

A hard-currency squeeze saw food and fuel shortages, with people queuing for kilometres outside petrol stations and power cuts as long as seven hours.

Mounting foreign debt

Cash-strapped Sri Lanka has taken short-term loans from India, China and Bangladesh. In June 2021, Bangladesh loaned Sri Lanka $200m and in December it renewed the credit facility .

In January this year, Sri Lanka a ppealed to China to reschedule its debt. In February, it borrowed $500m from India to buy oil. On March 18, I ndia gave Sri Lanka a $1bn line of credit to pay for essentials such as food and medicine.

As of February, Sri Lanka only had $2.31bn in its foreign exchange reserves, according to its central bank. With debt payments of about $7bn due in 2022 – including $1bn in international sovereign bonds (ISB) maturing in July – Sri Lanka may find itself with no usable reserves.

At $12.55bn, ISBs make up the largest share of Sri Lanka’s foreign debt, with the Asian Development Bank, Japan and China among the major lenders.

In a review of the country’s economy last month, the International Monetary Fund (IMF) said public debt has hit “unsustainable levels” and foreign exchange reserves are insufficient for near-term debt payments.

Rising food prices

Sri Lanka’s food inflation in March was 30.2 percent, which means the average price of food cost 30 percent more compared to the year before, a record high. In comparison, food inflation was -1.4 percent in March of 2019.

Essentials, even locally produced ones, have become unaffordable for many. The price of white rice, a common Sri Lankan staple, increased by 93 percent since 2019. Chicken and lentils have gone up by at least 55 and 117 percent, respectively, since 2019.

Nisha Shari, a self-employed woman with a disability who lives in the city of Kandy, said she is finding it extremely difficult to make ends meet.

“Since I have mobility issues I cannot use public transport, so I generally use a three-wheeler [automobile] to get around. That costs me 1,000 rupees [$3.25] from home to town since the fuel price rise,” she said.

“I need adult diapers and other health accessories but some of these are not available to buy now. It’s difficult to afford even a nourishing meal with this situation.”

The crisis has also pushed the country’s free healthcare system to the brink. About 85 percent of its pharmaceuticals are imported, according to the International Trade Administration.

The prolonged blackouts mean many doctors are forced to treat patients by flashlight. Other equipment such as catheters, anaesthetics, and gloves are also running low.

Fuel and cooking oil prices

In March, the state-owned Ceylon Petroleum Corporation raised the price of a litre of petrol from 137 in 2021 to 254 rupees ($0.45 to $0.85; or from $2.04 a gallon in 2021 to $3.86). The price of diesel also increased from 104 rupees a litre the year before to 176 rupees ($0.34 to $0.58; or from $1.54 a gallon in 2021 to $2.63).

A standard household 12.5kg cylinder of cooking gas increased from 1,493 rupees ($4.9) in 2021 to 2,750 rupees ($9) in 2022. Many Sri Lankans are switching to firewood and kerosene alternatives as cooking gas is now too expensive to afford.

“It is a struggle even to prepare the food one buys at a high price. All businesses, including micro-enterprises which depend on a reliable supply of electricity, are in difficulty,” economist Rohan Samarajiva told Al Jazeera.

“Economic reforms will be painful. Therefore implementing a targeted social safety net programme to protect the poor from the rising cost of living is vital,” he added.

Weak currency and record inflation

The purchasing power of the Sri Lankan rupee has eroded immensely. The central bank has expanded the broad money supply by 40 percent over the past two years, eroding its value. The rupee lost more momentum last month when the government steeply devalued it ahead of talks on debt restructuring with the IMF.

On the official exchange, 310 rupees buy one US dollar, but on the black market the price is upwards of 350.

In March, Sri Lanka’s inflation rate climbed to 18.7 percent, up from 15.1 percent in February – its highest level since October 2008.

Inflation in Sri Lanka had not entered double-digit territory since 2008. Food inflation had never exceeded 15 percent until now.

The COVID-19 pandemic had already stressed many households with stagnant or, in many cases, severely depleted incomes.

The huge increase in prices can be attributed to the government’s October 2021 decision to remove price controls, which suppressed inflation for many years.

On top of that, import bans in March 2020 , a failed organic agriculture policy decision, as well as global commodity price increases, have contributed to inflationary pressure.

Sri Lanka’s controversial ex-central bank chief, Ajith Nivard Cabraal , stepped down three days ago along with a cabinet of ministers and is now succeeded by the respected banker Nandalal Weerasinghe.

There is hope now that monetary authority will return to orthodox policy-making, which is likely to increase the central bank’s credibility both domestically and internationally.

The government is set to commence discussions with the IMF this week, but without a finance minister in place, the outlook remains unclear.

Calls from the public for the president and prime minister to step down remain unheeded and protests grow tenser.

Sri Lanka heads into the Sinhala and Tamil New Year festivities next week, but with skyrocketing prices, a shortage in essentials and no solutions in place, the economic and political situation could worsen.

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Sri Lanka’s Economic Crisis: Causes, Consequences and Cure

on 05/24/2023 05/24/2023

Photo courtesy of Bloomberg

The principal problem faced by people due to the economic crisis is of rising prices while incomes for many remain unchanged. As a result, the poverty rate has doubled from 2021 from 13% to 25%, according to the  World Bank.

Inflation is a problem worldwide but global inflation in 2022 averaged only 10.1% while Sri Lanka’s inflation was 57.2%, according to the IMF. Global problems have certainly added to Sri Lanka’s woes but external factors cannot explain the dramatic rise in local prices. Local supply chain disruptions did impact prices in 2020/21 but this is no longer a major factor although some effects still linger. What then, were the causes?

Import restrictions, foreign exchange shortages and currency depreciation have contributed. All of these are connected to the balance of payments therefore understanding the cause of the balance of payments problem is one key to the puzzle. The other key is to identify the cause of demand-pull inflation, which arises from rapid growth in aggregate demand.

These are interconnected and the root of the problem lies the debasement of the currency. This article attempts to explain how the Central Bank’s funding of the government fuels both inflation and the balance of payments problem. Debasing the currency also results in distributional consequences, the painful effects of which are now being experienced.

Balance of payments

The trade flows – imports and exports that appear in the balance of payments statistics – do not exist in isolation; they are a function of the overall demand and supply within the economy. Trade flows are directly affected by decisions of consumption and savings that are made by citizens and the government. Spending by individual or businesses is limited by their income or what they can borrow. If they chose to borrow, the funds they use represent the savings of others. The financial sector mediates between savers and borrowers but what is borrowed is limited to what is saved so no imbalance can occur.

The actions of government, because of sheer size, have a major impact on overall demand and savings; this is the rationale for stimulus spending but it can also create imbalances. If the government is spending less than it collects it is a net saver and no imbalance arises. If it spends more than it collects it is a net dis-saver (or borrower). If the dis-saving is financed by the Central Bank it causes an imbalance that affects the balance of payments and inflation.

Public finances: taxes, debt and money printing

The government has three avenues to finance its expenditure: taxes, debt and credit from the Central Bank (money printing). If government revenues cover its expenditure public finances are sustainable. When a government runs a deficit it can cover this by borrowing. As long as the borrowing is from the market it does not cause an imbalance but the problem is that it tends to bid up the rates of interest in the market. However if the borrowing is from the Central Bank there is no pressure on interest rates which makes it an attractive option.

Money printing, inflation and the balance of payments

Unlike commercial banks the Central Bank does not accept deposits or raise funds from the market yet somehow finances government. This sleight-of-hand is accomplished through accounting entries in the banking system. When the Central Bank buys government securities instead of paying for these by a transfer of funds it simply passes an accounting entry crediting the account of the Treasury and debiting the Central Bank’s holding of government securities. This is new money created out of thin air with no underlying economic activity. This is the source of the imbalance; if the quantum small then the effects can pass unnoticed but if it is large problems are inevitable.

The account of the Treasury is used to make cashless interbank payments for government salaries, pensions, interest and for various goods and services. The money thus spent is received in the hands of people who then use it for their own expenses. The new money starts to circulate in the economy but a problem exists – the quantity of goods and services has not changed.

Greater quantities of money are being spent on the same quantity of goods and services. Depending on the quantities printed, over time this leads to rising prices but critically the changes that take places in prices are not uniform. This has important distributional effects. It also causes the balance of payments problem.

When people spend the new money they do not spend money solely on domestic goods; they also buy imported goods. Moreover many domestic goods use imported inputs. Therefore even if people spend newly created money on purely domestic goods it will create demand for the imported inputs. For example domestically produced rice will use imported fertiliser, pesticides and other inputs so an increase in demand for domestic rice will eventually lead an increase in demand for the imported inputs. Therefore not only does the money printing drive inflation it also drives imports directly when people consume imported goods and indirectly via the demand for imported inputs by local producers.

If the demand for imports starts to increase and the increase is persistent, then the demand for foreign exchange will grow. This brings pressure on the currency to depreciate. If the currency depreciates then this brings foreign exchange market back into balance. Imports become more expensive, people consume less and the demand for imports eases and the pressure on the currency disappears.

However if the government tries to control or fix the rate of exchange artificially, then the demand for imports continues unabated and foreign exchange starts to become scarce. A balance of payments problem is born [1] .

This, in a nutshell, is the problem. To understand how this has affected people we need to understand the nature of the economy and the role that prices play.

What is the economy?

The economy is made up of the sum of the millions and millions of transactions made every day by people, wherever money is involved. What consumers buy in turn leads to a multitude of decisions taken by thousands of people responsible for producing goods and services: businesspeople, manufacturers, farmers, merchants and hoteliers and all others. They erect buildings, buy machinery, hire workers, develop marketing campaigns based on the prices for which they can sell their goods or services and the costs of obtaining the labour and inputs used in production.

It is a vast and multi-layered entity made up of an extremely delicate and complex web of relationships that are coordinated and held together by prices. It also very dynamic, constantly changing with people’s behaviour which makes it very hard to predict or control.

How did Sri Lanka stumble into this crisis?

Starting in December 2019 and continuing until mid 2022 the government increased spending . For example some 100,000 new jobs were created. It also cut taxes. With increased expenditure and reduced income the budget deficit grew rapidly. It financed much of this spending and even the rollover of its domestic debt  through credit from the Central Bank. The Central Bank simply kept bidding at low rates and buying government securities. Interest rates fell to record lows and for a while the economy boomed. The monetary base expanded by 49% between 2020 to 2022 creating a massive shock to the economy.

Distributional effects of an injection of new money into the economy

The monetary shock does not create an immediate or uniform change in prices. Instead the shock percolates through the economy, affecting some prices first, others later while some may remain unaffected. Prices of consumer items will change faster although again not all are affected equally as it depends on spending patterns but the prices of commercial goods, where the demand is derived from consumer goods, will rise more slowly. Among commercial goods, prices of raw materials and components to production process may rise faster than that of factors of production – land, capital assets and labour. Prices of anything on fixed contracts such as wages and rents will change much more slowly. For prices of the factors of production to change the production processes themselves need to change but this changes only in the long term.

Gradually, the new money ripples through the economy, raising demand and prices as it goes. Income and wealth are redistributed to those who receive the new money early in the process (i.e. before prices rise) at the expense of those who receive the new money late in the day (when prices have risen) and of those on fixed incomes who receive no new money at all.

Two types of shifts in relative prices occur as the result of this increase in money: the redistribution from late receivers to early receivers that occurs during the inflation process and the permanent shifts in wealth and income that continue even after the effects of the increase in the money supply have worked themselves out. When a new equilibrium eventually emerges it will reflect a changed pattern of wealth, income and demand resulting from the changes during the intervening inflationary process. For example, the fixed income groups permanently lose in relative wealth and income.

The alternate reality: developments between 2020 to 2022

Between 2020 to 2022 while the purchasing power of money fell, the government disguised the obvious symptoms through price controls (to fix rising prices), exchange rate and import controls (to fix the currency and foreign exchange shortages) and a multitude of others.

These controls did not ultimately work; the problem continued but the restrictions kept the economy tied in knots and masked the most obvious symptoms. A divergence emerged between official prices and reality. As the volumes of money creation grew the divergence widened and the economy entered a phantom state where prices were fixed but goods were not available.

The shortages and queues simply reflected the divergence between the real and nominal buying power of the rupee. The prices of gas and fuel are officially fixed but not enough is available at that price. The same is true for electricity; power cuts indicate the gap between demand and supply. It is the government that was supplying energy but since it depended on imported inputs it could no longer buy sufficient quantities because the rupees it collects from customers bought fewer dollars. The same is true of foreign exchange where the official rate was Rs. 200 but little or nothing was available.

Although the reserves were running out currency swaps and bailouts from friendly countries kept the illusion going for a while longer. Life continued in this twilight zone but reality eventually dawned when no further imports were possible.

Waking up to reality: addressing the imbalances

The government had suppressed many of the visible symptoms of the problem; the controls and regulations that did so hindered some of the normal adjustment that would take place over time in response to increased money creation.

Addressing the problem meant that the huge imbalances that had built up had to be unwound. Fundamentally what had happened is that the currency has been debased, its real purchasing power has diminished greatly. The first step to adjust to the grim reality is to devalue the currency to reflect its real value in the foreign exchange market. Then all prices within the economy needed to adjust to the realistic value of the rupee. As the adjustments needed are huge they deliver a massive, dislocating shock. This is the pain that people are experiencing.

All economic relations within the economy are governed and coordinated by prices. Prices are expressed in money. As long as the value of money remains stable prices will coordinate this complex set of interactions.

A sudden change in the value of the rupee, especially when that change is large, disorders all economic relations. The very foundation of the economy is lost; the entire economy must now adjust to the new value of the rupee that is what is taking place now.

Returning to reality  

The measures put in place since 2022 are designed to address the root causes. The imbalances become visible in the foreign exchange market but the causes lie elsewhere in the public finances and monetary policy. In short, the government needs to balance its budget, stop using Central Bank credit and use other sources of funding. Therefore it must raise taxes, cut expenditure and borrow from the market instead of the Central Bank.

How is the problem to be fixed?

The starting point is to restore the currency to a realistic value. The devaluation of the currency is needed to readjust its value to account for all the new money that has been created over the cycle of the boom.

The government then needs to borrow in the market instead of printing, which is why interest rates on treasury bills are hovering around 30% from 6% to 7% in 2021 and taxes have been raised.

It can also reduce expenditure but since much of it is spent on salaries and pensions it will seek other avenues. Fuel and energy were being sold below cost, more so once the currency depreciated so electricity, fuel, gas and water prices have been raised. Costs include the costs of waste, corruption and inefficiency that take place within those entities which is why the government needs to restructure these so costs can be reduced then the savings can be passed on to consumers. Debt is being restructured to reduce interest payments. Losses in state enterprises that add to government expenditure need to be reduced, hence the need for State Owned Enterprise restructuring.

Over the last year as these measures have been implemented shortages have reduced, the balance of trade in goods and services is in surplus, the Central Bank is now acquiring foreign reserves, the rupee has started to strengthen and the rate of inflation has started to fall.

The importance growth

Putting public finances in order brings macroeconomic stability such as stable exchange rates, lower inflation and restores the balance of payments. These have slowed the speed of decline, people are not getting poorer as fast. It has stopped things from getting much worse but cannot address the distributional consequences of the fall in the value of money.

To restore lost wealth requires restoring sustained economic growth, not a temporary boom based on an artificial stimulus. Since 2004 successive governments have tried to increase growth through stimulus such as state spending and capital expenditure, which achieved short term improvements in GDP. The current state of public finances renders this impossible as the government cannot spend or borrow more.

Sustainable growth must be based on improved productivity. Growth comes about when activity increases in in sectors with higher productivity at the expense of sectors with lower productivity in the economy. As a result of the changes in relative prices some businesses will no longer be viable, they may need to downsize or close down; meanwhile new opportunities can emerge based on new patterns of consumption.

Therefore the processes of production must also change. The structure of the economy is changing and the government needs to facilitate this. Investment is needed to create jobs; the government cannot function as employer of last resort and keep recruiting people and borrowing or printing to pay them. Resources in the economy need to be reallocated from lower productivity to higher productivity activities so laws and regulations that hinder the reallocation of resources must be reformed.

Bankruptcy procedures must be streamlined to allow firms to exit and for debts to be recovered. Prudential regulation needs to be strengthened to prevent a wave of bad debt destabilising the banks. For firms that are not unviable but need to downsize or restructure, labour regulations need to be reformed to speed this process. To create new jobs regulations and licenses that hinder new investment need to be reviewed including restrictions on land ownership and use to allow different crops or activities to take place on former agricultural land.

The danger ahead

People may have expected immediate relief with reforms but unfortunately the higher taxes, higher energy prices and currency depreciation paradoxically increased the burden on people, sparking popular anger. Unfortunately the bitter medicine is necessary and can only deliver benefits in the long term.

There is a clear lack of understanding of the fundamentals of the problem both among politicians and the public. Various political parties are attempting to capitalise on public anger; there is a search for scapegoats and conspiracy theories are in circulation. Populist policies – simplistic solutions to complex problems – are on offer from various quarters. Unfortunately there are no quick or easy solutions; there is only a long and rocky path that must be traversed to put the country back on a path of growth.

The danger is that an angry population could vote in parties that abandon the reforms and the pursue the various short term unorthodox policies. This would be a grave mistake since the problems of today are the result of harebrained unorthodox, homegrown alternative solutions. The economy is stabilising slowly but the recovery is far from secure. A few missteps is all it will take for things to quickly become much worse.

The problems of Sri Lanka are self-inflicted, people are paying a heavy price for past errors and while things still bad, with the right reforms incomes can grow again. The public, policymakers and would-be policymakers need to learn from the mistakes of the past and avoid the temptation of further quick fixes.

[1] Note: It is possible to maintain a fixed exchange rate without balance of payments problems provided it is consistent with the monetary policy, if money is being printed continuously then a fixed exchange rate cannot be maintained.

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Sri Lankan Economic Crisis

In January 2021, the Sri Lankan Government declared officially that the country was hit by the worst economic crisis in its 73 year history.

On March 18, 2022 India extended a USD 1 billion line of credit to Sri Lanka on Thursday to help the country deal with the economic crisis.

How did a country, which in recent years, was doing well on all economic fronts as well on human development indices, come to face such an unprecedented crisis?

It is not because of a single factor, but a myriad of factors responsible for the current economic crisis. What those factors are will be highlighted in this article. The information in this article will be used in the sense that they can be asked in the Economy segment as well as the international affairs segment of the IAS Exam .

The International Monetary Fund (IMF) extended financial assistance to the tune of $3 billion under the Extended Fund Facility (EFF) for Sri Lanka which has been facing economic crises. 

How will the Bailout help Sri Lanka?

• The financial assistance under EFF by the IMF potentially unlocks more loans of up to $7 billion in funding from IMF & IFIs (International Financial Institutions) for the crisis-hit country which is trying to recover from 2022’s economic meltdown and associated protests.
• The IMF-supported programme is expected to restore macroeconomic stability, and debt sustainability, protect financial stability and boost structural reforms to strengthen the economy.
• The IMF officials identified corruption as a key issue and the IMF “ Governance diagnostic mission” is assessing the governance and anti-corruption framework of Sri Lanka.
• In 2022, Sri Lanka defaulted on its foreign debt and faced a severe forex reserve crunch.
• Sri Lankan President Ranil Wickremesinghe after securing a loan under EFF announced that Sri Lanka is no longer a bankrupt country and the loan by IMF will provide assurance to world countries that Sri Lanka can service its debt.
• India, Japan and China, being the crisis-hit nation’s top three bilateral creditors, provided financial assurances for the loan provided by the IMF.
• However, Sri Lankan economists warn that there are also serious challenges to address such as h igh debt burden, persistent trade deficit and balance of payment problem.

What is the Extended Fund Facility?

• Under Extended Fund Facility (EFF), the IMF provides loans to countries facing serious medium-term balance of payment crises due to structural issues in the economy which will require more time to resolve.
• Since medium-term structural reforms will require time to rectify, the EFF gives a longer time to repay the loan and longer program engagement.
• All member countries are eligible to avail of the loan under EFF and this is most often used by advanced emerging economies.
• The low-income countries also use EFF sometimes along with Extended Credit Facilities.
• Funds under EFF come with conditions like commitments to take steps for structural reforms to address institutional or economic measures and to maintain macroeconomic stability.

Sri Lankan Economic Crisis – Download PDF Here

General Overview of the Sri Lankan Economic Crisis

Sri Lanka is facing an unprecedented crisis due to economic mismanagement, corruption and an agricultural crisis.

For starters, a series of policy miscalculations such as imposing tax cuts took a heavy toll on government revenues. This was part of a populist agenda that was used to win the 2019 presidential election and the subsequent 2020 parliamentary elections.

The cuts in taxes led to budget deficits soaring from 5% in 2020 to 15% in 2022. The bad monetary policies have led to soaring inflation that has triggered unrest and protests as ordinary Sri Lankans are unable to bear the high cost of living.

What’s more, the country is on the verge of bankruptcy, as the remaining foreign reserves of US$ 2.3 billion (As of March 2022) is not enough to pay its debts. The national inflation rate increased to 17.5% in February 2022.

Sri Lanka depends heavily on imports to meet its various needs such as petroleum, food, paper, sugar, lentils, medicines, and transportation equipment, among other essential items.

A lack of foreign currency means the country does not have the money to buy (import) these commodities.

The economic crisis is accompanied by a severe food shortage. There was a rise in food prices that was caused by depreciation in the currency. It forced the government on August 31, 2022 to impose an economic emergency. It gave the authorities the following powers:

• Right to seize food stocks designated as staple foods
• Help set the price of staple food
• Helps in rationing food

The army was deployed to help better manage food rationing following a series of protests by the local populace.

What were the factors that triggered the Sri Lankan Economic Crisis

Some of the factors that triggered the economic crisis in Sri Lanka were:

• The Covid-19 Pandemic put the tourism industry on hold. It accounted for 10% of Sri Lanka’s GDP
• This led to a dip in the forex reserve (from $7.5 billion in 2019 to $2.8 billion in July 2021).
• A dip in other sources of revenue led to high costs in importing of essential items, including food.
• A depreciated currency, high dependence on imports and hoarding led to a steep rise in food prices in Sri Lanka.
• The Hambantota port was another white elephant project by the present government to shorten its economic woes. Instead it only further increased the debt problem that Sri Lanka faced as it had taken $1 billion from China.
• The ongoing Russo-Ukrainian Conflict also is a factor which is affecting the already precarious economic condition of Sri Lanka.
• The reason is that Sri Lankan tourism relies on arrivals from Russia and Ukraine.
• Russia is also the second biggest market to Sri Lanka when it comes to tea exports.
• Thus, the war in Ukraine put a serious dent in the path of the economic recovery of Sri Lanka.

Now how does a food shortage figure into this economic crisis? For that a single agricultural policy is responsible, the detail of that will be discussed below:

How did an Agricultural Policy cause a food shortage in Sri Lanka?

The Sri Lankan government decided to make their country the first to produce their foodstuff from “100 % organic farming”. To this end, they imposed a nationwide ban on chemical fertilizers and pesticides in June 2021.

All it was widely accepted, the program came under widespread criticism from the scientific and farming community for the following reasons:

• A possible collapse of the farming industry, which was based around the tea industry
• A rapid transition from chemical farming to organic farming would be near impossible as low rainfall – which organic farming is reliant upon – would make such a transition difficult.
• Organic farming is expensive and the yield is far less in comparison. Thus ordinary farmers would be hesitant to take up organic farming.

The policy led to a massive drop in agricultural output by about 50%. The food shortages further deteriorated the situation at hand. The tea industry was the hardest hit as a result. The government was forced to import food as a result.

The situation was further aggravated by the falling national currency exchange rate, inflation rising as result of high food prices, and pandemic restrictions in tourism which further decreased the country’s income.

The severe shortage of food forced the government to introduce peacetime rationing of goods.

In November 2021, Sri Lanka was forced to abandon its policy to become the world’s first organic farming nation, leading to continuous food price rise and weeks of unrest and protests against it.

How has this crisis affected Indo-Sri Lankan Relations?

The current economic crisis has given a new life to the Indian-Sri Lanka relationship which was under strain over the ensuing decades, a fact taken advantage of by China who figured top of Sri Lanka’s foreign policy priorities.

• Sri Lanka sought both China’s and India’s help in this crisis. In this context, India has proven more reliable than China.
• India has taken advantage of this opportunity to improve its economic presence in the country, a counterbalance to the increasing Chinese presence in the Indian Ocean
• The line of credit extended by India ($400 million in China and $1 billion in March) can lead to India possibly becoming the top source of imports for Sri Lanka.
• The crisis has also allowed India to further its geopolitical interests by increasing its presence in strategically important places in Sri Lanka.

Way Forward for Sri Lanka

Experts opine that Sri Lanka’s forex reserves have reached bottom-low and it faces mounting challenges in the form of rising unsustainable public debts, low international reserves and the need for large financing in coming years.

Thus, there is a need for ambitious fiscal consolidation based on high-quality revenue measures, raising income tax and VAT rates and minimising exemptions, complemented with revenue administration reform. Overall, the nation requires immediate economic reforms to have stable economic health in the long run.

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Fiscal considerations of proposed adjustments to public sector salary structure

Tuesday, 17 September 2024 00:00 -     - {{hitsCtrl.values.hits}}

Given the fact that public sector pay was already relatively low, public servants felt a great deal of pain like many others in society

Given the various views, including numerous misconceptions, expressed in print, broadcast and social media in the recent past on public sector wages, the Finance, Economic Stabilisation and National Policies Ministry issued the following statement to correct the position on these matters in the context of responsible management of the Government fiscal operations amidst the ongoing deep, complex and unprecedented economic crisis since 2022.

What happened to public sector wages during the economic crisis? 

The unprecedented, deep, and complex economic crisis since 2022 affected the public across every segment of society. Like everyone else, the employees of the public sector were also very badly affected as the real value of their salaries declined significantly when inflation accelerated to 70% by September 2022. Given the fact that public sector pay was already relatively low, public servants felt a great deal of pain like many others in society. Considering the high level of inflation, the already low real wage was significantly eroded. The resulting diminished living standards are reported to be a major reason for the increased migration of professionals and skilled workers across several sectors.

Source: Central Bank of Sri Lanka, Weekly Economic Indicators

Source: Ministry of Finance, Economic Stabilisation, and National Policies *Estimate   **Projection

Was there any consideration to reduce public sector salaries as part of fiscal consolidation efforts?

The cash flow challenges continued to intensify even in early 2023 as by this time, monetary financing was being substantially phased out. In fact, the situation was so severe that at one point, a Cabinet paper was drafted in March 2023 on “Payment of Government salary bill for the month of April”, which proposed to pay the public sector monthly salary in two instalments (50% in each instalment) for the April 2023 salary1. 

However, it was not submitted to the Cabinet of Ministers for approval considering the well-being of public servants and potential implications for public service delivery. Accordingly, salaries and pensions were paid without any reduction or delay amidst severe cash flow constraints and serious difficulties faced by the General Treasury at the time. 

In other countries facing debt distress, the outcomes were very different. Consider for example the decisions taken by the Government in Greece during the financial crisis where there were several rounds of salary reductions in the 2010-2012 period. “During the crisis, the Greek Government initiated three major waves of public wage reform. In 2010, all wages were cut horizontally (by 10%) and holiday bonuses were also reduced. In 2011, pay-scales for the so-called “narrow” public sector were unified – a process which involved a marginal increase in basic pay combined with the abolition of most non-basic benefits. The overall reduction in the public sector wages over 2009-2013 was 22.5% and took place mostly after the enforcement of the unified pay-scales (post-2011)”2. In July 2023, the Greek Parliament approved legislation that authorized 25,000 public sector job cuts and other expenditure cuts3.

What was the Government’s response to the diminished real value of the salaries of public servants?

During the initial stages of crisis response in 2022 and 2023, the Government simply did not have the fiscal space to provide additional relief to the public sector. There were consequences of this inability to adjust public sector wages as evident in the migration of several high-skilled public servants. It was also not feasible to adjust wages of only selected or strategic sectors like health or education given the problematic anomalies that would result and broader fairness issues. 

Whilst public sector wages remained static in 2022 and 2023, the private sector and informal sector of the economy were all able to benefit from nominal wage adjustments. Between January 2022 and December 2023, private sector wages increased by 28%, whilst Government sector wages did not change4. 

Given the Government’s inability to adjust public sector wages in the initial years of the crisis, the Government’s expenditure on salaries and wages of public servants declined gradually from 4.8% of GDP in 2021 to 4% of GDP in 2022, and 3.4% of GDP in 2023. Considering the adverse impacts on the well-being of public servants, the Government committed to adjust public sector wages gradually in line with improvements in the fiscal position and overall economic stabilisation. It was expected that an initial increase could be provided in 2024 followed by a more substantial adjustment in 2025 when the fiscal position is expected to have recovered to a stable level.

Why did the Government not meet the demands of the striking public servants who demanded a salary increase a few months ago?

The demands of a number of public sector unions in June 2024 was to increase public sector salaries immediately. Sri Lanka’s fiscal practice is that the annual budget is approved in December of the previous year which establishes planned expenditure, revenue, and borrowing limits. When the country is in a reform programme supported by the International Monetary Fund (IMF), there are more stringent budgetary targets for each year. Accordingly, for 2024, Sri Lanka had agreed on fiscal targets, including a primary budget surplus of 0.8% of GDP. Expenditure allocations throughout the year are predicated on these targets and the Treasury carefully manages cash-flow to ensure these targets are met and that the reform programme remains on track. 

Given this context, in the event of a demand for an increase in expenditure within a fiscal year, it becomes necessary to compensate for such an increase by either increasing revenue to the same extent, or by reducing expenditure elsewhere, in a manner that maintains a neutral fiscal path and ensures achievement of the primary budget balance target. Given the rigidities in public expenditure and mandatory cash outflow obligations, the only realistic means of maintaining a neutral fiscal path in the context of an immediate salary increase would have been to increase VAT by around 3 percentage points to 21% in order to increase Government revenue to match the higher expenditure. 

What is different about the proposed salary adjustment for 2025? 

As indicated earlier, the Government’s overall economic recovery plan had factored in an initial cost of living allowance increase for public servants in 2024 along with a more substantial salary adjustment in 2025. Accordingly, the proposed salary adjustment for 2025 falls within a new fiscal year and is structured in a manner that complies with the overall fiscal path. It was also important to ensure that such an adjustment is not done on an ad hoc basis but addresses long standing legacy salary anomalies and establishes a clear structure for public sector wages. Such an adjustment necessitated a balance between sufficient remuneration to attract and retain talent in the public sector, whilst at the same time, ensuring the wage bill is within fiscal constraints. Going forward, the Government cadre should also be gradually right sized, with a lower cadre supported by increased automation and productivity, but with better remuneration to attract talent. Towards this end, the Government appointed a Presidential Expert Committee5 comprising representatives of the Government and private sector experts to explore the issues in detail and provide recommendations on a scientific and credible basis. 

How does the Government sector salary adjustment fall within fiscal targets?

From a fiscal standpoint, the salary adjustments in 2024 and proposed adjustment in 2025 would be structured such that the expenditure on public sector salaries will be contained at 3.6% of GDP in 2024 and 3.8% of GDP in 2025, which is still below the 2022 level. Most importantly, the overall 2025 fiscal path ensures that Government revenue would reach 15% of GDP, supported by the gradual relaxation of motor vehicle imports and primary expenditure would be 12.7% of GDP, which includes 4% of GDP on capital expenditure. The 3.8% of GDP expenditure on public sector wages will fall within the remaining space for recurrent primary expenditure. Revenue of 15% of GDP and primary expenditure of 12.7% of GDP will ensure that the primary surplus of 2.3% of GDP will be met in 2025, ensuring compliance with the IMF program targets. 

What measures will be taken to ensure productivity and quality of public service delivery in line with adjustment of salaries?

The Presidential Expert Committee report included a number of other recommendations which address issues of productivity enhancement, ensuring quality of recruitment, and other measures to ensure value for money from the perspective of the taxpayer. The recommendations of the Expert Committee were approved by the Cabinet of Ministers and key highlights of the same are reproduced as follows6.

1. Classification of all posts in the entire public sector under 04 Main levels and classification of recruitment qualifications into sub-categories based on the Sri Lanka Qualification Guide (SLQF) and National Vocational Qualification (NVQ) and taking into account the relevant job role, responsibilities and attracting employees with skills for the special jobs and keeping them in jobs.

2. Following the Sri Lanka Qualification Guide as basic qualifications for recruitment for the Primary Service categories as well and following the appropriate selection procedures on the service requirement based on the National Vocational Skills.

3. Recruitment for all other service categories only through formal competitive examinations and interview methods.

4. Accordingly, expeditious revision of existing approved recruitment procedures as appropriate.

5. Payment of Rs. 25,000 per month as the cost of living allowance to all the Government employees (subject to revision once in every 3 years), adding all the allowances such as, various adjustments made to the cost of living allowances and the allowances already added, considering 2025 as the base year.

6. Increasing the minimum Initial monthly salary of the Public service by a minimum percentage of 24% and taking the gross salary with cost of living allowance as Rs. 55,000 and adjusting the basic salary for all other posts accordingly.

7. Implementation of this new Salary and Allowance Procedure for all the public institutions except Business State Companies and Banks.

8. Taking measures to limit the total number of employees in the public service to ten lakhs (1,000,000) or less, by 2030.

9. Accordingly, introducing a methodology for the administration of the Government (E-Governance) in every possible field of the entire public service, through Digitalisation and Automation and giving the priority of investment for that, within 3 years from 2025.

10. Implementation of a Medical Insurance Scheme including all the employees and retirees of the public sector, being entitled to the most attractive benefits with a minimum monthly contribution of Rs. 1,000, from January 2025.

11. Obtaining services by following the prescribed methodologies so as to maximise the efficiency and minimising the cost burden of the Government through methodologies such as Outsourcing whenever possible.

12. Implementation of the restructuring programme for conversion of the identified Government Departments/Corporations/Statutory Institutions into Public Liability Companies listed in the Stock Market. 13. Conduct a proper work study and take action to conduct a scientific study on the entire public sector staff and services in year 2025.

14. Accordingly, preparing the performance indicators for all the public servants and provide salary increments based on their progress.

15. Providing salary increments entitled for the public officers retired before year 2020 and revising their pension and resolving the relevant anomalies.

16. Providing the Cost of Living Allowance to the retirees, equivalent to 50% of the Cost of Living Allowance provided for the public officers engaged in active service, from January 2025 onwards.

17. Implementation of the Salary System, subject to the management of these expenditures within the existing tax policy and implementation of the proposed Salary System from 2025-01-01 in stages, taking into consideration the fiscal space as well.

1 The proposal in this drafted Cabinet paper was “to pay 50 percent of the April net salary bill of the government employees on 10th April 2023 and the balance on 25th April 2023”.

2 “Two tales of wage adjustment” | Greece@LSE

3 Greek Debt Crisis - https://www.cfr.org/timeline/greeces-debt-crisis-timeline

4 See Table 1.8 of Weekly Economic Indicators of the Central Bank of Sri Lanka. https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/statistics/wei/WEI_20240222_e.pdf and https://www.cbsl.gov.lk/sites/default/files/cbslweb_documents/statistics/wei/WEI_20240906_e.pdf

5 The Presidential Expert Committee was chaired by former Presidential Secretary Udaya R. Seneviratne and included several key members: Jude Nilukshan- Director General of the Department of National Budget, Hiransa Kalutanthri- Director General of the Department of Management Services, S. Aloka Bandara- Director General of Combined Services, H.A. Chandana Kumarasinghe- Director General of Establishments, Dr. Terence Gamini de Silva- retired Deputy Director General of the Ministry of Health, Duminda Hulangamuwa- Chairman of the Ceylon Chamber of Commerce, Chandi H. Dharmaratne- Chief Public Officer of BCS International Technology PTY LTD, Isuru Thilakawardena-Deputy General Manager (Human Resources) of Commercial Bank and G.L. Varnan Perera, Additional Secretary to the President https://pmd.gov.lk/news/1217-

2/#:~:text=The%20expert%20committee%20on%20restructuring,the%20public%20and%20private%20sector.  

6 https://www.cabinetoffice.gov.lk/cab/index.php? option=com_content&view=article&id=16&Itemid=49&lang=en&dID=12754

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Economic Crisis in Sri Lanka

• Sri Lanka is in the middle of one of the worst economic crises in its history since independence.
• With the economy defaulting on foreign debt , the situation in the nation is grim. Inflation is at an all-time high and the public is facing great unease in getting the essentials. 
• The Sri Lankan PM resigned recently in the wake of fierce public protests.

Factors behind the crisis

• Long-run historical imbalance:
• Sri Lanka for long has been a high fiscal deficit economy. It was an inward-looking closed economy from the 1950s to the late 70s with low levels of growth.
• Thereafter ethnic conflict between the majority Sinhalese and the minority Tamils, which spanned over a period of nearly three decades further widened the fiscal deficit.
• In the post-war phase, the government for its lust for world-class infrastructure ended up taking huge loans from China and various other multilateral institutions without giving a second thought to debt servicing.
• Short-run imbalances in economy:  
• In the run-up to the 2019 elections, Mahendra Rajapaksa announced deep tax cuts in his manifesto which led to a steep fall in revenues. 
• This severely impacted Sri Lanka’s capacity to service the import bills which ultimately led to plummeting of forex reserves by 70 percent.
• Huge infrastructural debt:  
• Sri Lanka tried emulating the China-led model of growth and development by rapidly developing the infrastructure.
• In order to achieve the development goals, it took huge long gestation loans without analysing the financial, and ecological viability of the projects. 
• This led to a vicious cycle of debt and its interest payments.
• Dwindling tourism sector:  
• Sri Lanka primarily is a tourism led economy. 
• The Easter bombing in 2019 led to a sharp downfall in tourists’ arrival which got further aggravated due to the Covid-19 crisis thus leading to huge unemployment and revenue loss.
• Misguided policies of the authoritative regime:
• In 2021, the Sri Lankan government declared that it would be opting for 100 percent organic farming thus wiping out conventional farming, deploying chemical fertilizers and High Yielding Variety (HYV) seeds at once.
• The move led to a sharp decline in grain production which compelled the government to import food items thus further aggravating the debt and balance of payment problem.
• Impact of Covid-19:
• Covid further exacerbated the already fragile economic condition in Sri Lanka. 
• Exports of tea, and rubber further took a sharp dip and the tourism sector with various backward and forward linkages came to halt.
• Sri Lankan laborers were left stranded amidst war and many lost their jobs. They had to return home jobless.
• Thus, remittances also dropped significantly. Government expenditure rose while revenue took a hit.
• This has led to a drop in sovereignty rating which means Sri Lanka will face problems while seeking loans from multilateral institutions 
• It would also hinder the inflow of foreign investment i n the near future resulting in a downward spiral in the economy.
• Narrow production basket:
• Island economy production basket comprises rubber and tea mostly. 
• Other vital contributors to the economy are tourism and remittances.  
• All these contributors are highly elastic whose prices fluctuate to a great variation.
• Aging demography:  
• Sri Lankan society is an aging one whose demographic dividend epoch has already passed. 
• The increase in economic productivity has not been able to offset the aging population thus keeping the production base small.
• Impact of Russia Ukraine war: 
• The war has accentuated the price level of commodities across the world.

  Impact on the economy due to the crisis

• Macroeconomic instability: Because of the crisis, the economy is running low on forex reserves, and high external debt and thus is not able to pay for essential import bills such as fuel, food items and other essential goods.
• High inflation rate: Economic crisis has led to inflation nearing 17.5 percent with food inflation at 25 percent. This has led to public unrest on the streets and high food and fuel shortages.
• Food and fuel shortage: There is a serious shortage of food grains, fuel and other essential imports as the island nation’s production basket is too narrow to self-sustain its domestic demand.
• Health care in shambles: Nation relies on imports for 85 percent of its medicinal needs.  The nation is short of medical drugs, anesthetic drugs, implants, and suture materials.  Doctors’ consortium has warned that healthcare services can collapse if immediate relief is not provided.
• Plummeting employment level: Unemployment has become a common phenomenon in almost every household. The government has identified that a large chunk of households has severe financial distress and the number of poor has gone up.
• Foreign Investment suffering: Because of bad macro indicators, the sovereign rating has come down because of which fresh foreign investment has stalled thus negatively impacting the income and employment levels.
• Looming political crisis: There is great angst amongst the citizenry against the incumbent government. Huge protests have been organized by civil society to oust the Government. The Prime Minister has finally resigned which will lead to the fall of the government, However the protestors are adamant on President’s resignation as well.

India’s Role So Far

• Extending credit:  
• Relief from India so far has been USD 1.4 billion – a USD 400 currency swap, a USD 500 loan deferment and a USD 500 Line of Credit for essentials.  
• India has also extended an additional USD 1 billion short-term concessional loans to the island nation to help the country as it faces an unprecedented economic crisis.
• Essential supplies: India has also sent food and grains shipments to Sri Lanka so as to tide over the tough times.
• Currency Swap: India has inked SAARC currency swap deal with Sri Lanka. This will help in saving up precious forex reserves for Sri Lanka.

Way Forward for Sri Lanka

• Short-Run steps 
• Immediate policy prescription: Urgency in policy intervention is needed to address the unmanageable levels of debt and debt service, reducing the fiscal deficit, restoring external stability and doing away with the adverse impacts on the vulnerable citizenry.
• Arresting inflation: The Central Bank should arrest the high inflation rate of nearly 18 percent and more so in the case of food inflation which has shot past 25 percent.
• Reviving agriculture: The agrochemical imports ban should be done away with at once and organic farming across the island should be implemented in a graded fashion so as to avoid the supply shocks.
• Import ban: it should stop the import of non-essentials in the short run thus saving up precious forex reserves which in turn can be used to finance essential imports.
• Seeking bail out: from multilateral institutions  but should be cautiously used so as to incentivize the export sector which can increase the export earnings and fill up the forex coffers in addition to bridging the trade deficit which as of now is $8.1 billion.
• High powered interim administration: As the PM has already given the resignation and protestors are demanding the resignation of the President too. SL will see the cabinet resignation soon. The President should immediately appoint an interim administrative unit with domain experts who can guide the country through tough times.
• Long run steps
• Controlling fiscal deficit: Fiscal deficit is estimated to have remained at 11.1 percent of GDP in 2021 which should be dragged down to 5 percent in the medium run and 3.5 percent in the long run. This will increase the sovereign rating and attract fresh foreign investments.
• Robust macro tools: It should be more proactive in using macroeconomic tools to mitigate any shocks to the growth and stability of the economy and not in a reactionary way.
• Assessing viability of the projects: it should institutionalize a robust mechanism to assess the economic, and environmental viability of the heavy infrastructure projects using the overseas credits.

Expanding export basket: Sri Lanka should expand its exports baskets and not just rely on handful products that are susceptible to global price shocks.

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International Relations

Make Your Note

Sri Lanka’s Economic Crisis

• 02 Apr 2022
• 11 min read
• GS Paper - 2
• Effect of Policies & Politics of Countries on India's Interests
• India and its Neighbourhood

This editorial is based on “Explaining Sri Lanka’s economic crisis” which was published in The Hindu on 31/03/2022. It talks about the causes of the economic crisis in Sri Lanka and India’s role as the country’s immediate neighbour.

For Prelims: India-Sri Lanka Relations, Forex Reserves, Debt to GDP Ratio, Fiscal Deficit, Sri Lanka’s Civil War, Palk Bay

For Mains: Economic Crises in Sri Lanka, India-Sri Lanka Relations, India’s Assistance and Role in solving the crisis in Sri Lanka, Significance of Sri Lanka for India

The Sri Lankan economy has been facing a crisis owing to a serious Balance of Payments (BoP) problem. Its foreign exchange reserves are depleting rapidly and it is becoming increasingly difficult for the country to import essential consumption goods .

The current Sri Lankan economic crisis is the product of the historical imbalances in the economic structure , the International Monetary Fund (IMF) ’s loan-related conditionalities and the misguided policies of authoritarian rulers.

Why is Sri Lanka Suffering from Crisis?

• However, its average GDP growth rate almost halved after 2013 as global commodity prices fell, exports slowed down and imports rose.
• Sri Lanka’s budget deficits were high during the war and the global financial crisis of 2008 drained its forex reserves which led to the country borrowing a loan of $2.6 billion loan from the IMF in 2009.
• It again approached the IMF in 2016 for another US$1.5 billion loan, however the conditionalities of the IMF further deteriorated Sri Lanka’s economic health.
• The quick implementation of these ill-advised promises further exacerbated the problem.
• Exports of tea, rubber, spices and garments suffered.
• Tourism arrivals and revenues fell further
• Due to a rise in government expenditures, the fiscal deficit exceeded 10% in 2020-21, and the debt to GDP ratio rose from 94% in 2019 to 119% in 2021.
• This overnight shift to organic fertilisers heavily impacted food production.
• Consequently, the Sri Lankan President declared an economic emergency to contain rising food prices , a depreciating currency, and rapidly depleting forex reserves.

The lack of foreign currency, coupled with the disastrous overnight ban on chemical fertilisers and pesticides, has sent food prices soaring. Inflation is currently over 15% and is forecast to average 17.5%, pushing millions of poorer Sri Lankans to the brink.

How has India Assisted Sri Lanka in this Crisis?

• Beginning January 2022, India has been providing crucial economic support to the island nation in the grip of a severe dollar crisis that, many fear, might lead to a sovereign default, and a severe shortage of essentials in the import-reliant country.
• The relief extended by India from the beginning of 2022 totals over USD 1.4 billion - a USD 400 million  currency swap , a USD 500 million loan deferment and a USD 500 million  Line of Credit for fuel imports.
• More recently, India extended a USD 1 billion short-term concessional loan to Sri Lanka to help the country as it faces an unprecedented economic crisis.

Why Helping Sri Lanka is in India’s Interests?

• It is in India’s interest to contain Chinese presence and influence in this region.
• To the extent India can extend low-cost help to alleviate the hardships of Sri Lankans, it should, however it must be done with due care keeping in mind that the optics of its aid matters too.

What Can Be the Way Forward?

• The government should also join hands with the Tamil political leadership to create a roadmap for the economic development of the war-affected northern and eastern provinces, among the areas badly hit by the current crisis.
• Tough measures should be taken for restructuring the administration of concessions and subsidies.
• Indian businesses must build supply chains that intertwine the Indian and Sri Lankan economies in goods and services ranging from the export of tea to information technology services.
• India, rather than any other nation, should help steer Sri Lanka towards realising its potential, to reap the rewards of a stable, friendly neighbourhood.
• Tamil Nadu was home to nearly three lakh refugees after the anti-Tamil pogrom of 1983.
• The authorities, both in India and Sri Lanka, should ensure that the present crisis is not used to step up smuggling activities and trafficking or whip up emotions in both countries.
• There is also a need to step up our people-centric developmental activities while scrupulously staying clear of any interference in Colombo’s domestic affairs.
• The crisis should be used as an opportunity for New Delhi and Colombo to thrash out a solution to the Palk Bay fisheries dispute - a longstanding irritant in bilateral ties.

UPSC Civil Services Examination, Previous Year Questions (PYQs):

Q. Consider the following statements: (2020)

• The value of Indo-Sri Lanka trade has consistently increased in the last decade.
• “Textile and textile articles” constitute an important item of trade between India and Bangladesh.
• In the last five years, Nepal has been the largest trading partner of India in South Asia.

Which of the statements given above is/are correct?

(a) 1 and 2 only (b) 2 only (c) 3 only (d) 1, 2 and 3

Q. Three of the following criteria have contributed to the recognition of Western Ghats, Sri Lanka and Indo-Burma regions as hot-spots of biodiversity: (2011)

• Species richness
• Vegetation density
• Ethno-botanical importance
• Threat perception
• Adaptation of flora and fauna to warm and humid conditions

Which three of the above are correct criteria in this context?

(a) 1, 2 and 6 (b) 2, 4 and 6 (c) 1, 3 and 5 (d) 3, 4 and 6

Q. Elephant Pass, sometimes seen in the news, is mentioned in the context of the affairs of which one of the following? (2009)

(a) Bangladesh (b) India (c) Nepal (d) Sri Lanka

17th September, 2024

Sri Lanka’s political trajectory: Sri Lanka has never voted for economic hardship: Jayatilleka

17 Sep 2024 | BY Asiri Fernando

• Says Wickremesinghe represents status quo, Premadasa moderate change and Dissanayake complete change
• Has serious misgivings about AKD’s manifesto even though it is good to see a youth-driven movement
• Says the dynamic is for change at the upcoming election, but SL need moderate outcomes
• Says IMF agreement is flawed and should be revisited

With Sri Lanka on the countdown for what has been termed one of the most decisive elections of the century, The Daily Morning discussed the key concerns facing Sri Lankans at the upcoming election with political analyst, academic, writer and former diplomat Dr. Dayan Jayatilleka in an exclusive interview.

Jayatilleke, former Permanent Representative of Sri Lanka to the United Nations in Geneva, and Sri Lankan envoy to Moscow opined out that Sri Lanka like many other countries is transiting a period of change, and that many citizens who have endured the pressures of multiple crises and austerity will likely vote for a change in the status quo.

Following are excerpts from the Interview:

Now that election campaigns are at its final stages, what is your view about the campaign run by the leading candidates?

Well, it seems to me to be a tripolar race. One between Anura, Sajith and Ranil, in whichever order you like to list it in. But increasingly, it seems to be turning into a bipolar game, between the two younger gentlemen, Sajith Premadasa and Anura Kumara Dissanayake. This is globally, a period of history, where there is a massive wave against the incumbent. This has been even noted by think tanks and publications like the Times magazine. This is a global phenomenon.

In Sri Lanka you also have an austerity package, which is a result of an agreement between President Wickremesinghe and the IMF, that has caused poverty to nearly double according to statistics from UN agencies and that of the Department of Statistics. So, unless one assumes that voters are masochistic, one must logically assume that they will vote for change. President Wickremesinghe also has his own drawbacks. His own party, the UNP, is extremely weak and is hardly functional. His campaign is really run by directors from the ruling party SLPP, who are mainly sitting ministers and deputy ministers. With Namal Rajapaksa’s candidacy, it can only be expected that only one or two legs of that platform (SLPP) will come off, because the voters at the grassroots will have to decide between Namal who is waging a spirited campaign and the same old faces of the ‘Pohottuwa’ frontline who have widely been discredited in the public eye, who support Wickremesinghe. So, even though the President receives considerable publicity, and wages a campaign about ‘crisis’, it will probably not keep him at the front of the competition.

The dynamic is for change. Wickremesinghe represents the opposite of change and represents the status quo. And he is arguing for the status quo, he is not offering anything better than continuity. The Sri Lankan voters have always voted against economic hardship and their standards of living. Therefore, they will likely vote for change and the two change agents are Sajith and Anura, in whichever order. I would say that as the race goes ‘down to the wire’, it is neck and neck between Anura Dissanayake and Sajith Premadasa.

What are your thoughts about the campaign promises and manifestos the candidates have released?

You can group them into three or four categories. The four would be – essential policy continuity; represented by Wickremesinghe, moderate change; represented by Premadasa, radical change; represented by Dissanayake, and a return to a pre-Ranil/Pre-Gotabaya as pledged by Namal Rajapaksa. Namal is an important candidate as he can draw away SLPP votes from Ranil, but no one considers this year as an election where he is a leading contender. So, if we look at the top three, you have the status quo represented by Ranil, balanced and moderate change represented by Sajith, and a total change represented by Anura Dissanayake.

This Election is a decisive one. How do you feel this Presidential Election will affect the future trajectory of Sri Lanka?

Yes, it is the most decisive election since 2005, where Sri Lanka chose Mahinda Rajapaksa, and he put an end to a thirty-year long conflict in three years. I think if the outcome is one of the status quo, it will be followed by a period of great instability. Because Sri Lanka’s political history has proved that continuity has led to some of the most terrible periods of instability. The obvious case and point is that of 1982; where after President Jayawardena won the Presidential Election, he decided to postpone for a full term the Parliamentary Election scheduled for 1983, and to hold instead a referendum. The referendum itself was seriously flawed. He did win the referendum, and therefore there was a continuity of the UNP’s majority in the Legislature. And that continuity led to the worst instability in the island’s history, resulting in two insurrections, both in the North and the South, and a foreign intervention.

I think if there is a vote for the status quo, we are setting ourselves up for loss of instability. We have never had this kind of expansion in poverty. We must understand that the growth in poverty is not only due to the debt crisis Sri Lanka faces but is also due to the austerity measures which were enacted by Wickremesinghe and the IMF as a solution to the debt crisis. If the change that the people want does not come, and the status quo continues, there will likely be followed up by a ‘socio-economic’ version of the ‘aragalaya’ and God knows what else. I hope it won’t lead to conflict. This is one scenario.

Other scenarios are from the outcomes of the ‘wins’ of other two leading candidates. I think if Sajith Premadasa wins, you will have some degree of political instability due to the left refusing to accept the legitimacy of his national leadership achieved through elections. However, I think a win for Sajith will bring a fairly stable situation, as he would likely move to make changes for the State to soak up the worst of the poverty and slow the pace of poverty. It will also see a stimulus of the economy. So, Premadasa’s model will likely emulate what the Chinese did, which is called ‘Walking on two legs’: growth and equity together. I think that is probably the best formula to ensure social and political stability. I don’t think he will experiment drastically. And he and his team have experience in governance. His broad alliance brings much experience to the table. I don’t think there will be a dramatic upheaval.

Now about a Win for Anura; the positive thing Anura brings is he is channelling a huge amount of social energy. So, that is a good thing. The social energy of a whole new generation is a nice thing to see. His NPP’s is mainly but not exclusively a youth driven phenomenon. It includes the support of many university academics, and will make for change. However, to be frank, although I have sympathy for the left-wing alternatives. I have very grave misgivings about a few things regarding Dissanayake's manifesto. For example I reject as dangerous this notion that Dissanayake pushes for “76 years of disaster”. Sri Lanka since Independence has had many achievements which as a country we can be proud of. We are in some respects, we are ahead of many countries in the global South. And in some respects, even ahead of some countries in the global North. We have had considerable achievements. People feel like post-independence has been a disaster because we are not used to such austerity shocks like the economic shock we are facing now. It is ridiculous to say we are in crisis because of everything that happened since 1948, and it’s only useful to edge out the NPP’s electoral competitors, that’s why the JVP is doing this. That is the wrong diagnosis, and you can't cure the patient, in this case the economic crisis is based on a wrong diagnosis. Even the latest NPP documents say that this situation started from Independence and was exacerbated by the open market economy of 1977. While there were some downsides, all rational minded people would agree the upsides were greater than the downside. So, if Anura’s framework is wrong and says it got worse from 1977, I really don’t see how they can fix it. I think the crisis will worsen if they govern. If he wins, I don’t expect him to resolve the crisis.

Of the three options (candidates) of Ranil, Sajith and Anura, I think Sajith is the safe bet.

There is a palpable feeling of disgust with the long-standing political order amongst the people. Some say they don’t want to vote. Do you think those who are undecided about voting should consider voting?

Voting is absolutely important. People must vote. It has always been so. Voting is the only effective weapon citizens have and it is something we have had since 1931. I would urge everyone to vote. Otherwise, you are a victim of someone else’s choice.

All of the contenders have been making many election promises. How practical are the election promises the candidates make?

  The set of policies which I do not see as deliverable are the ones made by President Wickremesinghe. His line seems to be what’s not to be liked at present. He seems to be taking a classic Margret Thatcher approach – of there is no alternative. When you tell that to people there is backlash, as seen in other places of the world. People will not listen as they are suffering. They will try to get an alternative. If they can’t get one they will try to overthrow the President which is what happened in 2022. Even Modi was taught this lesson in Uttar Pradesh, where he lost. So, for me, the only non-deliverable package is by Wickremesinghe. The Sri Lankan voter has never picked the alternative which meant greater economic hardship, nor do they pick an option which offers greater inequality.

I find the second unrealistic set of proposals to be that of Anura. I see fundamental flaws about their logic of political economy. The NPP’s prognosis is wrong and they think only they can cure it. Their approach is not endorsed or agreed upon by any international experts, even from the left. If you believe in absurdities, you will eventually commit some economic atrocities. It could lead to a far worse situation. And that is what I think may happen if Anura becomes president and tries to follow his plan. I am not saying that he is not qualified to be president someday. He may have to try again.   

The IMF and several international experts have warned about changing Sri Lanka’s economic recovery plan. If we are going to change the agreements or its parameters post-election, how will it impact Sri Lanka?

We have heard of such talks before. Sometimes to achieve the outcome you want; you have to rectify a flawed agreement. I do believe the IMF Agreement with Sri Lanka is flawed. I believe it is flawed because of the nature of the administration. It was negotiated by a President who was not elected and did not know what the people wanted or not. He was never an elected President. And the team that handled the negotiation was brought in by Gotabaya Rajapaksa. So, I think we can do better. That does not mean that I think Aruna and the NPP ‘team’ can do a better job. They are good academics, but they are amateurs at practical matters.

I am not in complete agreement with the SJB’s economic team as well. I agree more with Dr. Harsahan Sooriyapperuma on the DSA. I agree with moderates like Dr. Nishan De Mel, who have very realistic views about what we can and cannot renegotiate with the IMF. But none of them are on any candidate’s team, and is concerning. Let’s not forget Prof. Howard Nickolas. So, I wonder if Sri Lanka is facing this renegotiation without the best team of economists that we can muster. So, therefore I choose to trust the broader political team that supports Sajith Premadasa, as it inhabits a paradigm of growth with equity. He knows the importance of working with the international community, but he also knows that sometimes agreements have to be tweaked. He also knows how to get domestic consensus that is needed to implement them. He is in a broad alliance which will bring different experiences and brings with it governance experience. So, I think Sajith will be better equipped to create a sound cabinet. So, I would place my bets there. Not in terms of who will win, I don’t know that. But that’s where I would feel safest.

Sri Lanka still faces multiple challenges, including poverty. With limited resources and limited state income, how can we address the social challenges?

We have seen this situation before. When President Premadasa took over, there were two insurgencies that were affecting Sri Lanka. We literally had a shattered economy. But you also had an economic miracle. We had under President Premadasa’s leadership a rapid increase in growth, rapid inflow of direct foreign investment. We also had the export-oriented garment factory program of nearly 200 factories. You also had welfare programs like the preschool midday meals, schools’ uniforms, Jansaviya and the continuation of the housing programme. Sri Lanka had a reduction of poverty, while the economy grew and so did the stock exchange. So, we had a rapidly growing economy. So, it has been done before. I think that it is possible to improve the situation.

I believe Sajith and the SJB will hit the ground running if they win. And SJB will move in a way that the NPP can’t. The NPP if they win will move fast too, but they have a steep learning curve.

Sri Lanka goes into elections while our geopolitical challenges remain unchanged. Do you think Sri Lanka should revisit our foreign policy post elections?

I think we need to get our foreign policy fundamentals right. Because I don’t think we have been really thinking about the bigger picture, we have two Asian powers competing for leadership. We have a global situation where there is contention between the United States and China. We have flashpoints in Russian – Ukraine and with Israel in the Middle East. All of this will be influenced by the elections in the US.  More immediately, we must strengthen our relationship with India while very weary and watchful about entering into agreements which can have a serious domestic blowback. So, we have to be measured and consensual about what we do with India. So, all of this must be reviewed. I don’t see any of the major contenders having undertaken that kind of policy review. I don’t see any real analysis or big thinking on foreign policy, which is a pity. I trust we will get around to it soon.  

Apart from what the three key contenders say about foreign policy, I don’t think there is much wrong. However, international relations have less to do with what political manifestos say. What can seriously impact Sri Lanka’s international relations is chronic instability in the island. However, if there are significant and sudden changes to how Sri Lanka deals with the world and its economic model changes, the instability that comes from such polarising action is bound to impact on the geopolitical interest of the big powers and great powers, and they are bound to respond. I have read what the NPP and SJB has said about the foreign policy in their manifestos. Again I would say that the Sajith Premadasa option with the broad coalition backing with probably give stability and the middle path policy that will be conducive to manage our external relations well, and one which the global and regional powers will find least turbulence, and will be conducive to their shared interests. 

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