Lessons from Sri Lanka

FOR MONTHS NOW, Sri Lanka has been gripped by economic, political and social disturbance. Last weekend, the world saw images of thousands of protesters storming key government buildings in the capital Colombo, including the official residence of President Gotabaya Rajapaksa. Rajapaksa subsequently announced his decision to resign on July 13, 2022. Protesters also set fire to the personal residence of Prime Minister Ranil Wickremesinghe, who also offered to resign.

Sri Lanka was 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. However, today, Sri Lanka is in the midst of it worst debt and economic crisis since independence in 1948.

It is now exhibit A for how debt and economic crises can set back decades of gains in per capita incomes and poverty reduction in developing countries.

According to Ganeshan Wignaraja, a Senior Research Associate with the Overseas Development Institute (ODI), a leading global affairs think tank, Sri Lanka’s crisis is due to a combination of external economic shocks and policy mis-steps. The severe economic shock from Covid-19 contributed to an economic contraction of 3.6 per cent in 2020 and an additional half a million new poor, most of them from urban areas, in both the formal and informal sectors.

The shock of the Russia-Ukraine conflict has also hit Sri Lanka’s economy hard, resulting in higher import bills for fuel and food. Inflation now hovers around 30 per cent and the country’s currency, the rupee, has deteriorated against the United States Dollar.

What the external shocks have done is that they have battered an already weak economy which only emerged from over three decades of civil conflict less than 15 years ago.

Decision-makers in Sri Lanka are not entirely faultless in terms of where the country is now. Persistent fiscal and current account deficits and excessive borrowing from foreign lenders for low return infrastructure projects have also contributed to the country’s current predicament. Other policy mis-steps include comprehensive tax cuts which reduced government revenues; maintaining an expansionary monetary policy beyond what was required; and preserving a fixed exchange rate in the absence of sufficient foreign reserves to support it.

Sri Lanka is now struggling to pay its creditors and meet some of the basic needs of its people, including for fuel and medicines. The frustrations of the people have culminated in mass protests and a rejection of the current political leadership. Of course, conditions on the ground will not improve if the country is torn apart. However, the population is sufficiently angered to ignore this fact, demonstrating the depth of their disaffection.

While no country is the same, the crisis in Sri Lanka reveals some truths about vulnerable economies and also serves up a few lessons in governance.

Very often, small vulnerable economies go through great pains to communicate to the international community that they have certain peculiarities which demand differential treatment in areas such as access to finance, development assistance and the like. Too often, the ears of the rich and powerful are closed to these pleas. Sri Lanka is now a compelling case study about how external shocks can devastate small vulnerable economies.

In terms of lessons, the Sri Lanka crisis reinforces the value in strengthening safety nets to mitigate against poverty and political instability. The crisis further highlights the need countries to invest in effective crisis management capabilities to better respond to political unrest.

Finally, fiscal profligacy seldom has a happy ending. India in the early 1990s, Greece in the 2010s and now Sri Lanka in the 2020s — all point to the perils of fiscal mismanagement. The lesson here is that fiscal prudence needs to be top of any government’s agenda. Ultimately, policy goals that require spending will be unattainable in the absence of a judicious approach to debt and fiscal matters.