Sri Lanka’s economic crisis explained

After a month of intense civilian-led protests against Sri Lanka’s deteriorating economy, President Gotabaya Rajapaksa agreed to name a new council on Friday to lead the formation of an interim government. The resolution would create an all-party coalition in Parliament and remove control from the Rajapaksa family dynasty that currently rules the country. At issue is the country’s economic future, which is in shambles after defaulting on its mountain of foreign loans – estimated at $50 billion – for the first time since the country gained independence from the British in 1948.

Signs of Sri Lanka’s impending economic crisis have become increasingly apparent in the last two years of the Covid-19 pandemic, as food prices have soared and power blackouts have increased in frequency. Sri Lanka currently has about $7 billion in total debt due this year.

Many attribute Sri Lanka’s economic crisis to the mismanagement of its finances by successive governments through mounting foreign debt and continued investment in infrastructure. The Rajapaksa government also implemented tax cuts in 2019, reducing the rate of value added tax (VAT) – the tax applied to imports and domestic supplies – from 15% to 8%, which contributed to a decrease in the country’s revenue.

The president’s older brother, Mahinda Rajapaksa, is expected to be removed as prime minister as part of a deal brokered by former president Maithripala Sirisena, who defected with dozens of other members of the current president’s ruling party in April. in protest to the poor of the Rajapaksas. ruling.

But the power struggle in the country may have sowed discord between the two brothers, which could exacerbate their political impasse. On Friday, the Associated Press reported that a spokesperson for the prime minister did not immediately confirm the elder Rajapaksa’s removal, saying such decisions would be announced by the prime minister in due course.

The country continued to accumulate external debt without sufficient revenue

A big part of Sri Lanka’s economic problems is its growing foreign debt, namely to finance its aggressive turn to infrastructure development under former President Mahinda Rajapaksa, Rajapaksa’s older brother and two-time prime minister. With its finances already bleeding, Sri Lanka has taken out large investment loans from Chinese state-owned banks to finance its infrastructure projects, including a controversial port development in the district of Hambantota.

The Sri Lankan government justified the Hambantota project as a way to boost its economy as a bustling commercial hub comparable to Singapore. However, the project was riddled with corruption and stalled, and Sri Lanka ended up handing control of the port to China as collateral after it failed to repay its loans.

Over the past decade, Sri Lanka has accumulated a $5 billion debt to China alone, accounting for much of its overall external debt, according to the BBC. Sri Lanka’s bloated debt to China and the failure of the Hambantota project are often held up as an example of the “debt book diplomacy” that China has pursued over the past two decades.

Some believe that China has expanded this monetary diplomacy approach through its ambitious Belt and Road Initiative (BRI), a global infrastructure project involving Chinese investment in infrastructure developments in parts of Asia, Africa and Europe that is subsequently repaid, as part of China’s attempt to increase global influence as a growing economic power. About 139 of the world’s 146 countries, including Sri Lanka, have signed up to China’s BRI project. While a global-scale infrastructure project may provide some economic benefits to participating countries, the BRI has inevitably become a strategic way for China to gain political influence with economically vulnerable countries across the Asia-Pacific region. At least 16 countries involved in the BRI project have been saddled with billions of dollars in debt that China has leveraged, according to an independent Harvard Kennedy School analysis for the US Department of State.

About 22 percent of Sri Lanka’s debt is owed to bilateral creditors — institutional investors in foreign governments — according to CNBC. Neighboring India has sought to increase its bilateral cooperation with Sri Lanka, in part as an attempt to secure its South Asian influence over China. India recently gave Sri Lanka a $1.5 billion line of credit to overcome the country’s fuel crisis, plus another $2.4 billion through a currency swap and loan deferral since January.

As the country racked up foreign debt, its tourism sector — previously a $44 billion industry and a primary source of revenue for the island — took successive blows. In 2019, tourism suffered after a series of bomb attacks that killed nearly 300 people, including some foreigners.

The following year, the Covid-19 pandemic disrupted tourism and other key sectors, spurring a global economic slowdown. While Sri Lanka has seen some uptick in foreign visitors over the past year, the ongoing pandemic combined with Russia’s invasion of Ukraine – both major sources of tourism to Sri Lanka before the conflict – has continued to slow recovery. of the sector.

The worsening crisis triggered mass protests

The country’s troubles escalated in March, when the Sri Lankan government announced a 13-hour daily power outage as a way to save energy amid the ongoing crisis. Without enough energy, many were unable to do their jobs as the economic crisis continued, causing mass unrest. Thousands of Sri Lankans took to the streets in the weeks following the power outage to protest the country’s growing crisis.

On April 1, President Rajapaksa declared an emergency due to growing unrest saw protesters clash with police. The entire Sri Lankan government cabinet resigned in protest shortly after the implementation of the emergency law, causing Rajapaksa to repeal the law. Among those who resigned was Sports Minister Namal Rajapaksa, another member of the Rajapaksa family and the president’s nephew.

With political unrest mounting and no resolution in sight, Rajapaksa’s rivals have begun calling for a vote of no confidence against his government.

“We are confident we have the numbers and will file the motion at the appropriate time,” opposition lawmaker Harsha de Silva told CNBC. Hoping to placate critics, President Rajapaksa sought to form a new unity coalition under his leadership, but failed to gain support. In April, the government also announced that it would temporarily suspend payments on foreign debt, marking the first time Sri Lanka has defaulted on foreign loans since independence.

Experts have been warning for some time about a possible dire situation in the country’s finances. When the country went into default, the government was negotiating a rescue plan with the International Monetary Fund, which had assessed its accumulated debt as unsustainable.

“The government intends to continue its discussions with the IMF as soon as possible with a view to formulating and presenting to the country’s creditors a comprehensive plan to restore Sri Lanka’s external public debt to a fully sustainable position,” the Ministry of Finance said in a statement. communicated. .

In a meeting with Cabinet officials a week later, President Rajapaksa acknowledged his government’s role in the country’s declining economy. Specifically, the president said that the government should have approached the IMF earlier for support in tackling its unruly foreign debt and that they should have avoided a ban on imported chemical fertilizers, which was supposed to preserve Sri Lanka’s currency holdings but harm its agricultural production.

“During the last two and a half years we have had great challenges. The Covid-19 pandemic as well as the debt burden and some mistakes on our part,” Rajapaksa said.

Now, Sri Lanka’s future depends on whether the president’s proposed changes of government quell its growing opposition long enough for a solution to come from the IMF. Sri Lanka’s finance chief Nandalal Weerasinghe said a long-awaited deal could still take months.

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