Sri Lanka’s economic crisis, explained

After a month of intense civil protests over Sri Lanka’s deteriorating economy, President Gotabaya Rajapaksa agreed to appoint 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 the grip of the Rajapaksa family dynasty that currently rules the country. At stake 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 over the past two years of the Covid-19 pandemic as food prices soared and power outages increased in frequency. . Sri Lanka currently has around $7 billion in total debt due this year.

Many attribute Sri Lanka’s economic crisis to the mismanagement of its finances by successive governments due to rising foreign debt and continued investment in infrastructure. The Rajapaksa administration also implemented sweeping 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 decline in the country’s income.

The president’s older brother, Mahinda Rajapaksa, is set to be removed as prime minister in a deal brokered by former president Maithripala Sirisena, who defected along with dozens of other members of the ruling party in outgoing president in April to protest against the poverty of the Rajapaksas. governing.

But the country’s power struggle may have sown discord between the two brothers, which could exacerbate his political stalemate. On Friday, The Associated Press reported that a spokesman for the prime minister did not immediately confirm the dismissal of the former Rajapaksa, saying such moves would be announced by the prime minister in due course.

The country continued to accumulate foreign debt without sufficient revenues

A big part of Sri Lanka’s economic woes is its burgeoning foreign debt, not least to fund its aggressive shift towards infrastructure development under former President Mahinda Rajapaksa, Rajapaksa’s older brother and two-time prime minister. With its finances already bleeding, Sri Lanka took out large investment loans from Chinese state-owned banks to finance its infrastructure projects, including a controversial port development in Hambantota district.

The Sri Lankan government has justified the Hambantota project as a way to develop its economy as a bustling commercial hub comparable to Singapore. However, the project was riddled with corruption and stalled, and Sri Lanka eventually ceded control of the port to China as collateral after it was unable to repay its loans.

Over the past decade, Sri Lanka has racked up $5 billion in debt to China alone, accounting for a large chunk of its overall external debt, according to the BBC. Sri Lanka’s ballooning 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 China has expanded this approach to monetary diplomacy through its ambitious Belt and Road Initiative (BRI), a global infrastructure project involving Chinese investment in infrastructure development in parts of Asia. , Africa and Europe, which is then repaid, as part of China’s attempt to increase its global influence as a growing economic power. About 139 of the world’s 146 countries, including Sri Lanka, have joined China’s BRI project. While an infrastructure project on such a global scale can bring certain economic benefits to participating countries, the BRI has inevitably become a strategic means for China to gain political influence with economically vulnerable countries in the Asia-Pacific region. At least 16 countries involved in the BRI project have been saddled with billions of dollars in debt that China then raised, according to an independent analysis by Harvard’s Kennedy School for the US State Department.

According to CNBC, around 22% of Sri Lanka’s debt is owed to bilateral creditors – institutional investors from foreign governments. Neighboring India has sought to expand its bilateral cooperation with Sri Lanka in part to try to secure its influence in South Asia over China. India recently provided Sri Lanka with a $1.5 billion line of credit to weather the country’s energy crisis, on top of another $2.4 billion through a currency swap and loan deferral since January. .

As the country piled up foreign debt, its tourism sector – previously a $44 billion industry and a main source of income for the island – suffered successive blows. In 2019, tourism suffered after a series of church bombings that killed nearly 300 people, including some foreign nationals.

The following year, the Covid-19 pandemic brought tourism and other major sectors to a halt, causing a global economic slowdown. Although Sri Lanka saw some increase in foreign visitors last year, the ongoing pandemic combined with Russia’s invasion of Ukraine – the two main tourism source nations for Sri Lanka before the conflict – have continued to slow the industry’s recovery.

A worsening crisis has sparked mass protests

The country’s problems worsened in March when the Sri Lankan government announced a daily 1 p.m. blackout as a way to save energy amid the current crisis. Without sufficient power, 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 cut to protest the country’s growing crisis.

On April 1, President Rajapaksa declared a state of emergency as unrest grew saw protesters clash with police. The entire Sri Lankan government cabinet resigned in protest soon after the emergency law was implemented, forcing Rajapaksa to revoke 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 growing and no resolution in sight, Rajapaksa’s rivals have issued calls for a vote of no confidence in his administration.

“We are confident that we have the numbers and we will bring the motion forward when the time is right,” opposition MP Harsha de Silva told CNBC. Hoping to appease critics, President Rajapaksa sought to form a new coalition of unity under his leadership but failed to garner support. In April, the government also announced it would temporarily suspend foreign debt payments, marking the first time Sri Lanka had defaulted on foreign loans since independence.

Experts had been warning for some time of a potential dire situation surrounding the country’s finances. When the country defaulted, the government had negotiated a bailout with the International Monetary Fund, which had assessed its accumulated debt as unsustainable.

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

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 the government should have contacted the IMF earlier for help in tackling its out-of-control external debt and should have avoided the import ban on chemical fertilizers that was intended to preserving Sri Lanka’s foreign exchange assets but which has instead harmed its agricultural production.

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

Today, Sri Lanka’s future hinges on whether the president’s proposed changes in government will quell his growing opposition long enough for a solution to come from the IMF. Sri Lankan finance chief Nandalal Weerasinghe, however, said such a hoped-for deal could still take months.

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