Lanka’s descent into anarchy: Lessons for India

Deepanshu Mohan

Even as nations all over the globe are yet to recover from a pandemic’s catastrophic impact, most South Asian countries – in recent months – have been badly hit by multiple crises. From Afghanistan to Myanmar to Pakistan, and now, Sri Lanka, each nation’s political economy landscape appears to be in a depressing situation.

Sri Lanka’s economy, in recent months, started experiencing, what economists refer to as a ‘twin crisis’: in form of a combined balance of payment and sovereign debt crisis.

This happens usually when a nation’s growth outlook remains weak, its foreign currency reserves (mostly in US$) are drying up, and, the government finds it difficult to honour its (external) debt obligations. Solvency issues may affect governments at first but ultimately the crisis effects pass on to the people in the worst possible ways.

In the past, countries like Argentina, Mexico and Brazil have been often affected by such ‘twin shocks’, taking decades to recover.

The IMF in a recent report explained how COVID-19 severely hit the Sri Lankan economy. The annual GDP growth rate of 2.3% in 2019 became -3.6% in 2020.

During the pandemic, the Lankan government promptly announced a series of relief measures through a macroeconomic policy stimulus; an increase in social safety net spending, and loan repayment moratoria for affected businesses.

These measures were simultaneously complemented by a strong vaccination drive which helped in restoring the GDP growth to a recovered rate of 3.6% in 2021, with mobility indicators largely going back to their prepandemic levels and tourist arrivals starting to recover in late 2021.

Nevertheless, the pandemic, necessitating several strict lockdowns, caused a colossal loss of tourism receipts: one of the main revenue-generating sectors for the nation. Adding to this, the Gotabaya Rajapaksa government’s own pre-pandemic policies had serious flaws.

The Rajapaksa government introduced populist tax cuts prior to the pandemic, limiting the government’s revenue options from corporate tax revenue. Foreign remittances from Sri Lankan workers abroad were drying up already. The adverse impact of COVID-19 and the announced relief spending measures led to higher government spending made fiscal deficits to be larger than 10% of GDP in 2020 and 2021, while the economy witnessed a rapid increase in public debt to 119% of GDP in 2021.

Sri Lanka lost access to international capital markets in 2020, prompting a decline of international reserves to critically low levels and large-scale direct lending to the government by the Central Bank of Sri Lanka (CBSL). External debt repayments and a widening current account deficit led to foreign exchange (FX) shortages, while the official exchange rate remained de facto fixed since April 2021.

Making matters worse was Rajapaksa’s pivot last year to organic farming with a ban on chemical fertilizers that triggered farmer protests saw a decline in the production of critical tea and rice crops.

Inflation rates continued to climb up, reaching double digits in December 2021, while reflecting the cascading effects of imported inflation from rising oil-food import prices, supply shocks, and a pickup in domestic consumer demand, amidst a loose monetary policy

Bad macroeconomic policy management further accentuated the economic crisis making the common citizenry suffer.

Sri Lankan people in recent weeks have taken to the streets to protest against the Rajapaksa government due to rising power cuts, their difficulty to get food at affordable prices, while queuing outside gasoline pumps that are now being guarded by the army.

The political turmoil, surfacing from the economic crisis, has made it difficult to gauge how the situation will unfold for the Rajapaksa government in the days ahead.

This week, Rajapaksa’s ruling party, Sri Lanka Podujana Peramuna (SLPP) lost its majority in parliament as 42 MPs (14 from Sri Lanka Freedom Party, 10 belong to constituent parties of the government, and 12 are SLPP MPs, among others) announced they would sit independently.

Rajapaksa said that he will not resign, but was ready to hand over the government to whichever party holds 113 seats in parliament.

Whichever government comes/ stays in power, would need to adopt a long term approach to fix a struggling economy.

What the Lankan economy would need is a robust path towards revenue based fiscal consolidation. Reforms must focus on strengthening VAT, income and corporate taxes, through gradual rate increases and base broadening measures. Fiscal adjustment would need to be accompanied by energy pricing reforms to reduce fiscal risks from loss-making public enterprises.

Near-term monetary poli