Sri Lankan crisis is also a cautionary tale for climate activists who have taken the green pill and want human race to turn back the clock to an idyllic past
Amid the ongoing economic crisis in Sri Lanka, India has provided $3.8 billion worth of assistance in 2022. AFP
Rajapaksa clan’s ouster, culminating in Gotabaya’s escape to Singapore and resignation as Sri Lankan president, is a political marker. It is a signifier for the Janatha Aragalaya (people’s movement) that has finally succeeded in driving away a leader who became an embodiment of all that is foul plaguing the island nation. His removal, say ordinary Sri Lankans who were out celebrating on the streets, is a “big victory.” Victories are now rare in the troubled nation fighting its worst economic crisis since Independence.
This was an important achievement because it signifies the ‘triumph of good over evil’ morality play that is necessary for a sense of purpose and for Sri Lankans to move ahead after venting all the pent-up frustration and ire. Now that the marker has been achieved, will it lead to political and economic stability?
That could be a mirage yet. The sad part is that the path ahead for Sri Lanka won’t be any easier because the rot goes deeper and further than any political leader or clan. It is a measure of the difficulty ahead that after all the struggle, it is Ranil Wickremesinghe who has been selected as the new president by lawmakers — a leader who has been rejected by the Sri Lankan people, and along with the ousted Gotabaya is the subject of their ire.
Instead of letting a much-maligned Wickremesinghe become the president — who lacks an electoral mandate — the lawmakers (both from the Opposition and the ruling SLPP) could have gotten together for a ‘unity’ government. It was one of the key demands of the Aragalaya protestors.
Ranil Wickremesinghe takes oath as the President of Sri Lanka. ANI
The fact that the Opposition dithered for months, failed to come forward even when Gotabaya was on the ropes, and chose to stay away from power when push came to shove — with Opposition leader Sajith Premadasa pulling out of the presidential race — shows that no one wants to own the catastrophe.
So dire is Sri Lanka’s economic crisis and so toxic is the solution that the Premadasas would rather wait in the wings and allow the old warhorse to take the fall instead of fighting the fire. It is a shameful cop-out that puts paid to people’s demands for a clean start.
Shameful, but not surprising. To fully understand the nature of the beast that is the Sri Lankan economic meltdown, we must go beyond the blind men and the elephant syndrome. The tragedy that has befallen the neighbouring nation has curiously become a reference point for political grandstanding in India. Everything, from “polarization” to “persecution of minorities” have been laid out as reason for the economic collapse, with critics of the Narendra Modi government casting a wishful eye towards the possibility of a similar ‘colour revolution’ in India.
These fanciful chicaneries apart, the Sri Lankan economic and humanitarian horror tale is a septic combination of political opportunism, policy mistakes, structural issues, pigheaded wokery, China’s not-so-invisible hand, rampant corruption, lack of oversight and plain bad luck. It is a veritable lesson for the emerging markets on what not to do, and a cautionary tale for environmentalists and climate activists who have taken the green pill and want human race to turn back the clock to an idyllic past.
The Sri Lankan crisis has its roots in the post-civil war era when Mahinda Rajakapsa during his tenure as president (2005-2015) was binging on infrastructure-related foreign direct investment led by a debt-financed fiscal strategy not unlike other smaller nations dotting the Indo-Pacific. Number of projects were taking off on the ground on transport, energy, and telecommunications sectors as a battle-scarred Sri Lanka sought to start afresh.
Financing growth through external debt, as a policy, is not a bad thing provided it is subjected to optimal use and kept within budgetary limits. After the shock of 2008 financial crisis that roiled global markets, Sri Lanka’s debt-fuelled development strategy gave high dividends. It clocked in astronomical numbers. Sri Lanka’s GDP growth, from 3.5 per cent in 2009, jumped to 8 per cent one year later, culminating in 9.1 per cent growth in 2012 — one of the fastest in Asia.
While Sri Lanka was being seen as a huge success story, there were important things happening behind the scenes. Debt-led financing strategy was accumulating more and more interest by the turn of the second decade of the millennium because Sri Lankan loans were turning from grant-based (that carry soft interest rates) to commercial lending bearing high interest and stiffer conditions. This was happening because Sri Lanka’s high growth was upgrading it from a ‘low-income’ nation to a ‘lower middle-income’ one. The transition took place in early 2010.
As a Sri Lankan research economist had noted in 2012, the country was becoming “increasingly less eligible for concessionary loans from sources like IDA (International Development Association) – which carry low interest rates, long tenors and grace periods and a high grant element.”
Therefore, to finance its development needs, Sri Lanka now needed to borrow from international capital markets or bilateral lenders at a much higher rate of interest. As the Mahinda Rajapaksa government trapped the bond market through issuing of International Sovereign Bonds (ISBs), it dovetailed with the interests of western investors who wanted to make a fast buck from an Asian success story.
As the World Bank noted in a report, “between 2007 and 2015, the (Sri Lankan) government sold $7.65 billion of sovereign bonds. As a result of increased commercial borrowings, the non-concessional and commercial component of the government foreign debt rose from 1 per cent in 2000 to 51 per cent in 2015. Meanwhile, the interest rate risks on foreign currency debt has risen while average interest rate also increased.”
Even at higher interest rates, that borrowing would have made sense if this money was spent wisely in creating assets that yield jobs or create growth. This is where political opportunism, corruption and policy mistakes made a fatal difference. Instead of commercially viable projects, Mahinda built a spate of useless mega projects — many of these in his hometown Hambantota, a sleepy fishing village — through money derived from expensive loans.
According to data from London-based think tank Chatham House, president Mahinda, through Chinese support built “the coal-fired Norocholai power station in 2006, the Hambantota port in 2007, the Mattala International Airport in 2010, the Colombo International Container Terminal (CICT) at the Colombo port in 2011, and the Lotus Tower in 2012.”
With the launch of China’s Belt and Road Initiative in 2013 under president Xi Jinping, a spate of new projects was launched that included Colombo Port City development and a bunch of road, expressway water and sanitation projects. Cumulatively, as a Chatham House paper indicates, “investment in Sri Lanka amounts to $12.1 billion between 2006 and July 2019 or equivalent to 14 per cent of Sri Lanka’s 2018 GDP.” This isn’t pathbreaking compared to China’s investments in other South Asian countries, but the commercial unviability of these investments added to debt repayment pressures which eventually led to ravaging of the country’s foreign exchange reserves
Far from being a thriving commercial hub, Mahinda’s hometown bears the ugly reality of the clan’s political and corruptive legacy. Hambantota is home to a port which now struggles to attract ships and has been leased back to China to service debts, an empty airport which has no takers and incurs heavy losses, and an empty cricket stadium which is now rent out as a wedding venue to generate revenue.
The Mattala Rajapaksa International Airport, for instance, in the past eight years has had revenues of around Rs 474 million (Sri Lankan currency) and expenditure of over Rs 14.4 billion, reported Sunday Times in June this year. Meanwhile, the interest rate for the airport which cost $209 million to build, was increased from 1.3 per cent to 6.3 per cent in September 2013.
As New York Times observes, “this enormous waste — more than $1 billion spent on the port, $250 million on the airport, nearly $200 million on underused roads and bridges, and millions more (figures vary) on the cricket stadium — made Hambantota a throne to the vanity of a political dynasty that increasingly ran the country as a family business.”
In addition, there were allegations that Chinese companies had made kickbacks to Mahinda Rajapaksa’s reelection campaign in 2015 and gave ‘donations’ to the Rajapaksa clan’s charitable projects.
An equally noxious contribution to Sri Lankan debt levels becoming unsustainable was the servicing of its other short-term debt — the ISBs, which the Mahinda government had recklessly dipped into. It shows the structural flaws in once one of Asia’s fastest economies that the “largest portion of Sri Lanka’s foreign debt, at 39 per cent, is in ISBs which typically have higher interest rates and shorter payment schedules, usually within seven years.”
The domino effect of ‘blingfrastructure’ from costly investments and stiff interest payment schedule meant that Sri Lanka was spending most of its annual revenue in servicing debt and paying interest on loan, and consequently borrowing even more money to meet its needs. An understanding of this vicious cycle is necessary to gauge the germination of the current crisis that has now imploded.
According to February 2022 data from, Vérité Research, a local think tank, Sri Lanka’s total debt stock increased by 42.8 per cent during the period 2015 and 2019 and 89.8% of that increase went in paying interest on past loans.
This created a situation that 70 per cent of Sri Lankan government’s earnings were vanishing to meet loan obligations, and the remaining 30 per cent for governmental obligations towards citizens. As Sri Lankan finance ministry’s 2020 annual report data shows, the government’s interest cost accounted for 71.7 per cent of its revenue in 2020, which means Sri Lanka pays “more than two thirds of its revenue as interest cost, whereas countries with much higher debt to GDP Ratios such as Japan pay only 8.2% of its revenue as interest cost.”
As fiscal deficit increased, current account deficit expanded due to rampant protectionism. Foreign exchange was falling dangerously low by 2016, the credit rating agencies started downgrading the country owing to low forex reserves, external liquidity position and risks attached to high component of external debt.
This led to a downgrade by Fitch, S&P and Moody’s. “The key drivers of the downgrade were the increasing refinancing risks, significant debt maturities, weaker public finances, a decline in foreign exchange reserves and a high foreign-currency debt portion in the portfolio.”
With rating downgrade, now Sri Lanka found it difficult to raise money from capital markets. Along with these headwinds, there were grave policy mistakes and extraneous factors beyond the country’s control. The 2019 Easter Sunday terror attacks dented earnings from tourism as foreign tourists stopped arriving, dealing a blow to the $5 billion industry that brings precious foreign exchange. Alongside, Gotabaya became president and implemented a range of sweeping tax cuts and abolitions in November 2019 — a poll promise — that wiped away 2 per cent of the GDP.
File image of Gotabaya Rajapaksa. AFP
Sri Lanka’s finance minister Ali Sabry told the Parliament in May this year that the country lost around 10 lakh taxpayers in 2019 and 2020 (five lakh each year) since the introduction of tax cuts and reports say the country’s foreign reserves dropped from $8,864 million in June 2019 to $2,361 million in January 2022.
These cuts in income tax, corporate tax and value added tax meant that the government’s revenue suffered a precipitous decline from a steady decline. From a revenue of 19% of the GDP in 1990, it had come down to 10.1% in 2014 and eventually fell to 8.1% in 2020 as receipts from tourism declined and effects of the ill-fated tax cuts set in.
The signs were ominous. There was another round of downgrading by credit rating agencies (S&P, Fitch) by 2020 that further restricted Sri Lankan government’s ability to raise money from external sources. No one wanted to lend money to Sri Lanka any more.
However, the existing debts and interest on loans had to be serviced, so the government had no option but to raid its central bank and cannibalise its foreign exchange reserves to pay sovereign bondholders. Compounding the country’s problems, the pandemic in 2020 broke the back completely of the tourism sector and another key source of revenue was lost.
The storm clouds were brewing. The IMF in a March 2022 note, observed, “annual fiscal deficits exceeded 10 per cent of GDP in 2020 and 2021, due to the pre-pandemic tax cuts, weak revenue performance in the wake of the pandemic, and expenditure measures to combat the pandemic. Limited availability of external financing resulted in a large amount of central bank direct financing of the budget. Public debt is projected to have risen from 94 percent of GDP in 2019 to 119 in 2021. Large foreign exchange debt service payments by the government and a wider current account deficit have led to a significant shortage in the economy.”
Akhil Bery of Asia Society Policy Institute writes in Atlantic Council that Sri Lanka erred in not negotiating with its creditors to obtain debt relief and it also didn’t approach the IMF fearing austerity measures. With its back to the wall, the government started printing money to pay salaries and meet pension obligations, and to keep the interest rates low.
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The combined effect of all these factors is represented by the depletion of Sri Lanka’s forex reserves that stood at $7.6 billion by the end of 2019, fell to $5.7 billion by the end of 2020. As the pandemic set in and the government became plagued by unsustainable debts and macroeconomic imbalance, forex reserves declined to $3.1 billion by 2021, and to $1.9 billion by the end of March 2022 — with the usable reserves below $50 million — a crash of over 70 per cent in just two years.
This left Sri Lanka unable to buy even basic necessities such as fuel, food and medicines leading to widespread unrest. Analysts say the country’s debt servicing alone would amount to $7 billion this year, with the current account deficit coming in around $3 billion. In May, Sri Lanka defaulted on its debts for the first time in history and requires $6 billion over the next six months to just stay afloat. The coup de grâce to its economy, however, was dealt by the Russian invasion of Ukraine that hiked by fuel and commodity prices and scuppered Gotabaya’s plan to muddle through.
This account of Sri Lanka’s horror story, however, would remain incomplete if we don’t discuss the final fatal mistake that pushed the country off the edge. Partly to remove the subsidies on chemical fertilizers, partly to save precious foreign exchange by banning import of synthetic fertilizers and to meet his pre-poll promise of turning Sri Lanka into a green haven of organic farming, president Gotabaya in 2021 implemented a tone-deaf, sudden ban on chemical fertilizers. He went against the advice of noted agronomists and domain experts and relied on a small coterie of organic farming advocates and the quackery of green elites, ending up ravaging Sri Lanka’s agricultural sector and completely decimating its rice and tea production.
Almost overnight, from a rice-surplus nation that was self-sufficient, Sri Lanka became a rice importing nation due to steep harvest losses owing to the ban. Analysts Ted Nordhaus and Saloni Shah of the Breakthrough Institute note in Foreign Policy how Sri Lanka’s “domestic rice production fell 20 percent in just the first six months.” Long self-sufficient in rice production, the country was “forced to import $450 million worth of rice even as domestic prices for this staple of the national diet surged by around 50 percent.”
An even greater harm was done to the nation’s tea production, a key foreign exchange earner. As Michael Shellenberger points out, tea “paid for 71% of the nation’s food imports before 2021. Then, tea production and exports crashed 18% between November 2021 and February 2022, reaching their lowest level in 23 years.”
With more than 90 per cent of Sri Lankan farmers using chemical fertilizers, and with the president crunching the timeframe of a ‘revolutionary step’ in farming from 10 years to one, the almost 35 per cent drop in tea production resulted in income losses of $425 million. It also devastated the rural economy sustained by the tea industry.
As rice and tea production tanked, the Gotabaya government gave compensation and subsidies to pacify affected farmers and drained whatever savings were made from the import substitution. Sri Lanka’s catastrophic experimentation with organic farming shows that feeding large urban population with organic manure is unfeasible because organic agriculture would require more land to produce the same amount of food because the yields are considerably lower.
To quote again from Nordhaus and Shah’s column, a sustained shift to organic production would “slash yields of every major crop in the country, including drops of 35 per cent for rice, 50 per cent for tea, 50 per cent for corn, and 30 per cent for coconut. The economics of such a transition are not just daunting; they are impossible.”
Sri Lanka was the darling of green elites who mostly don’t suffer the consequences of their advice. It had a high ESG score (referring to investments in higher Environmental, Social, and Governance criteria) of 98, higher than even Sweden (96) or the United States (51) but that didn’t save it from disaster.
The path to Sri Lankan crisis, as far as the ban on chemical fertilizers is concerned, was paved through good intentions. Dogmatic belief in dodgy science and fantastic ideas about returning to an idyllic economy through woolly policies contributed to the disaster, but Sri Lanka might not be the last test case of elitist wet dreams.
It is therefore evident that the crisis affecting Sri Lanka is deep and won’t be erased with the election of a new president, much less a leader who does not enjoy popular sanction. Its problems are serious. The country needs economic stability which cannot be achieved without political stability. It needs to renegotiate with the IMF — that will come with own set of onerous conditions that may further entrench popular revolt. It also needs to restructure its unsustainable debt with creditors such as China that has so far resisted all attempts to do so, possibly because Beijing doesn’t want to set a precedent before borrowers such as Pakistan.
Meanwhile, the chronic food, fuel and medicine shortages are here to stay. Fears that Indian economy may go the Sri Lanka way are frivolous and merit no serious rebuttal beyond pointing out that India’s macroeconomic fundamentals are strong enough.
Sri Lanka, does, however, offer a cautionary tale. It had long been living beyond its means, but then its profligacy caught up with it as the pandemic hit and the global geopolitical climate turned sour. Going forward, we may see many more fragile economies tottering on the brink.
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