Learning from Sri Lanka


Asad Tahir Jappa

Sri Lanka’s recent economic meltdown offers some important lessons for other indebted developing countries to find ways to control the collateral damage emanating from the economic and social costs of a crisis

To the utter shock of the many across the world, on April 06 2022, all the members of the 26-member Sri Lankan cabinet resigned apart from the President and the Prime Minister following mass public protests over the ever increasing cost of living and worsening economic crisis. For understandable reasons, debt servicing had become unsustainable with economic and political implications. Therefore, in a pre-emptive move, on 12 April 2022 Sri Lanka temporarily suspended foreign debt payments pending a bailout from the IMF. Sri Lanka’s public debt-to-GDP ratio rose from 91% to 119% between 2018 and 2021. At the end of March 2022, Sri Lanka had external debt service payments of $6 billion for the remainder of 2022 against foreign reserves of US$1.9 billion. Thus, Sri Lanka’s crisis is the outcome of a combination of external economic shocks and some bad policy interventions made by the government.
The severe economic shock from Covid-19 meant an economic contraction of 3.6% in 2020 and an additional half a million new poor, located mostly in urban areas, among formal sector employees, and informal sector workers who fell into poverty-trap. Understandably, debt and economic crises can set back decades of gains in per capita incomes and poverty reduction in developing countries. It pains to witness that once cited as a success story in the developing world for meeting basic human needs for a low-income country as early as the late 1970s, Sri Lanka is in the midst of the worst debt and economic crisis since its independence back in 1948.
It is pertinent to observe that a comprehensive report “Sri Lanka’s economy into the ground” has rightly suggested that “when Gotabaya Rajapaksa became president of Sri Lanka in 2019, he inherited an economy in bad shape. Terrorist attacks and political crises had hit the country hard. Growth was at its lowest since 2001. Tourist arrivals, a big source of foreign currency, were down by nearly a fifth after steadily rising for a decade.” The same report highlighted that “tourism was hit by an even bigger shock in the form of Covid-19. Even as foreign currency receipts plunged, import bills were climbing. Dollars became hard to come, impeding imports that in turn led to the shortages of diesel and cooking gas. The lack of fuel also crippled electricity generation which because of a drought that has diminished output from hydropower plants is increasingly dependent on oil and coal.” Resultantly, by the end of February 2022, Sri Lanka’s foreign exchange reserves were already reduced to $735 million, which downgraded its credit rating. The fast depleting foreign exchange reserves suffered from one more blow with the rise in global crude prices. Prices of basic food items like bread, milk, lentils, sugar, wheat, and rice also went skyrocketing. In March, the government increased the prices of petrol by 43.5% and diesel by 45.5% further burdening the people at large. Despite the fact that the country recently received a $1 billion bailout package from India, it will be insufficient to meet the import of essential items. Furthermore, the country also needs to pay a staggering debt of over $6 billion soon.
To add salt to the injury and compound woes of Sri Lanka, the Russia-Ukraine conflict hit the economy through higher import bills for fuel and food, leading to double-digit inflation and a 30% depreciation of the rupee against the US$. These external shocks took a very heavy toll of an already fragile economy groaning under the heavy burden of economic costs of a thirty-year civil conflict which ended in 2009, persistent fiscal and current account deficits, excessive foreign borrowing for low return infrastructure projects and rising external debt service. A successful Covid vaccine rollout was overshadowed by the recent policy misadventures which include comprehensive tax cuts which reduced government revenues, banning imports of chemical fertilizers without preparing farmers which prompted a surge in food prices, maintaining a highly expansionary monetary policy beyond its shelf life and persisting with a fixed exchange rate without the foreign reserves to support it.
Sri Lanka’s recent economic meltdown offers some important lessons for other indebted developing countries to find ways to control the collateral damage emanating from the economic and social costs of a crisis. Firstly, the government hesitated for nearly 18 months after Covid hit from seeking IMF assistance to solve its balance of payments difficulties. Instead a raft of home grown remediates (e.g. loose monetary policy, stringent import controls and bilateral swap arrangements with regional economies) were deployed to little effect. Concerns existed within the government that the austerity policies the IMF demands would be politically unpopular (including public expenditure cuts, higher taxes, a floating exchange rate, and the removal of fuel subsidies). But the advantages of IMF assistance seem to have been underplayed including a low-interest loan to bail out Sri Lanka, the ability to borrow from international capital markets once again, and the benefit of IMF financial advice. A worsening economic and political crisis forced the government into a U-turn in mid-March 2022 that Sri Lanka will seek an IMF Program. Secondly, Sri Lanka has a British style welfare system providing free health care and education as well as a Samurdhi poverty reduction initiative for 1.2 million families. However, these mechanisms were insufficient to stem growing poverty and social discontent over rising food inflation and shortages of food and fuel. In an ideal world, a temporary rationing system for basic food and fuel should be introduced early in a crisis, followed by donor-funded cash transfers targeted to the poorest.
Thirdly, Sri Lanka has fragmented crisis management capabilities which hinders effective economic decision-making. In March 2020, a large and unwieldy Presidential Task Force was created to coordinate the Covid-19 response. In March 2022, two overlapping committees – one of key ministers and another of business leaders – were appointed to tackle the debt crisis. In early April 2022, a panel of eminent economists with experience of international institutions was appointed to advise the President on debt restructuring and the IMF program.
In an ideal world, a US style President’s Council of Economic Advisors should be mandated with offering objective economic advice to the President supported by a national economic monitoring unit within the Ministry of Finance. Fourthly, a strong macroeconomic and financial regulatory structure is necessary to reduce the economic costs of a crisis. The Central Bank of Sri Lanka lies at the heart of Sri Lanka’s regulatory structure. However, a lack of autonomy means that the Central Bank’s monetary policy and exchange rate decisions were influenced by short-term political pressures. Not only is the Governor of the Central Bank appointed by the Sri Lanka’s President for a six-year term but the Monetary Board which manages the Central Bank includes the Secretary of the Treasury. In an ideal world, the Governor would be appointed by the President on the recommendation of a group of eminent persons and the Monetary Board would have the Governor, a Deputy Governor and three independent members. The Treasury Secretary would not sit on the Monetary Board.
Last but not the least, an ineffective government communication has resulted in considerable public confusion and misunderstanding about Sri Lanka’s crisis and the IMF program. The public has tended to rely on social media which has provided variable quality data and analysis, causing mass unrest and compounding uncertainty. Therefore, a robust and reliable crisis communication needs to be created, staffed by media professionals dedicated to sharing credible information about the economy. It must be kept in mind that there is no one size fits all approach to economic crisis management. These lessons from Sri Lanka’s economic woes may be comprehended and can well be tailor-made to the plight of other countries confronted with similar challenging socio-economic conditions.