Sri Lanka put on life support by the IMF
The coronavirus pandemic, an energy crisis, soaring inflation, recession — these are all well-known problems. No doubt Sri Lanka is in trouble, yet the short description above does not give you an accurate picture of this country that is home to 22 million people.
Sri Lanka put on life support by the IMF

Sri Lanka put on life support by the IMF

Demonstrators lights candles and flash mobile phone lights during a silent protest to pay respect to the victims of the 2019 Easter Sunday suicide bombings in Colombo, April 2022 (Photo: AFP)
Attila Andor 23/02/2023 05:00

The coronavirus pandemic, an energy crisis, soaring inflation, recession — these are all well-known problems. No doubt Sri Lanka is in trouble, yet the short description above does not give you an accurate picture of this country that is home to 22 million people. Here problems started well before the pandemic and they ran deeper than usual as they caused a political crises and forced the country to call for help from the International Monetary Fund (IMF). Although despite the help they received, the country is still in a very difficult situation.

The economy of Sri Lanka in the 2010s was much different from that of today. The GDP growth rate of this South Asian country exceeded 8% back then. They fought a successful fight against poverty, living conditions improved in general, however, the structure of growth was rather fragile, largely because the economy was predominantly boosted by the services sector. Then by 2019 the economic growth rate dropped to a mere 2.3% which indicated new problems.

In 2015 more than 60% of Sri Lankan GDP came from services, which would not be considered high in Europe, but it is high in Asia, not including Japan. In the meantime the industry only accounted for 31% of the GDP, and agriculture for less than 9%. The largest sector within the industry is natural rubber production, which can satisfy almost one fourth of global demand, while textiles, rice and diamonds are also among the most important items exported by Sri Lanka.

The country’s trade relations are the strongest with the United States, but the United Kingdom, China, India, Germany and the United Arab Emirates are also important partners.

And then came the pandemic

In the world before Covid, tourism in Sri Lanka was growing at an exceptional rate, and it lifted the whole services sector; the country even became a major maritime and transport hub.

However, it was these exact industrial sectors that lost the most through the pandemic, so they could not contribute to the economic growth of Sri Lanka despite the fact that the country made it through the crisis relatively well, says the Lowy Institute in its report claiming that Sri Lanka was the top 10th country that managed the pandemic the most successfully globally. The claim that the country surpassed this obstacle relatively easily is of course a question of point of view: by 2020 the Sri Lankan economy had already shrunk by 3.6%. This was the worst recession since the country became independent in 1948.

In the meantime, relations with China became gradually closer which triggered feelings of resentment on the part of the two large investors, India and the United States. No wonder that they refer to Sri Lanka as the classic example of the Chinese debt-trap diplomacy, says Péter Klemensits, a senior research fellow at the John von Neumann University Eurasia Centre in his analysis.

Failed money printing

The causes of these problems are multiple, however the spark that ignited the economy into total chaos was clearly started by the local central bank. As opposed to large economies, unlimited and unrestricted money printing has not brought this little country the expected results, rather it caused the collapse of the Sri Lankan rupee, and caused inflation to run wild.

At the beginning of March, the central bank devalued the rupee, and the foreign exchange rates that had been artificially stabilised for months, dropped by 36% at the end of March against the US dollar, and by the beginning of April it became the worst performing currency in the world.

Whenever foreign debt is high and the local currency weakens, that will cause an increase in debt burden. In response to the record fall in the value of the currency, the Government announced that was unable to repay its debts, meaning that they declared technical bankruptcy.

The parties reached an agreement on a loan of about USD 2.9 billion at the beginning of September. However, according to the BBC, the financial aid is conditional on the country receiving money from private creditors as well. After the announcement on the preliminary agreement, India said that it entered into negotiations to restructure Sri Lankan debt, and that it offered the country long term investments.

Prices have soared, for example food prices rose by almost 85% in a year, and Sri Lanka would be happy if its inflation rate was only as high as the record high inflation rates in Europe. The Indian business reporter for the BBC, Arunoday Mukharji warns that the country is fighting against the huge problem affecting food security.

Double-digit inflation, long-term outages and hours-long queues for fuel and other essential goods have provoked nationwide demonstrations. A series of demonstrations escalated and peaked in an attack against the presidential palace and other governmental buildings causing President Gotabaya Rajapaksa to flee and to resign. Ranil Wickeremesinghe was elected by the Parliament of Sri Lanka as his successor.

The IMF will only release money to Sri Lanka if the IMF Board of Directors approves the disbursement after confirming that sufficient progress has been made with the country’s creditors, primarily with China, Japan and India. In the meantime the new President has presented the interim budget which includes several measures which are proposed to put a stop to inflation and to control finances.

The 11th hour

Péter Klemensits says the IMF agreement is only the first step, and there are still some difficult meetings to come for Sri Lanka’s leaders. The USD 2.9 billion agreed may be enough for the country to survive this time, but the question of how the Government will use this money and whether it will be able to meet international expectations, still remains.

He also added that the other big question is whether the Government will be permitted to implement the reforms, as the restrictions are expected to cause some uproar among the country’s citizens. What they need is democratisation in the political sense, but after the long reign of the Rajapaksa family there is little hope of rapid changes. Even the break-out of another civil war cannot be ruled out, although it would be in the best interests of all parties for this not to happen.

The most serious problem Sri Lanka must face is not of an economic nature, but rather a political one. What the country needs is new leadership dedicated to democracy, which would be capable of righting the wrongs of the past, including eliminating discrimination against the Tamil people, while keeping the long-term interest of the nation in mind.

This article was originally published in our Hungarian-language magazine Eurázsia in 2022.

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