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How Sri Lanka became Bankrupt – Economic & Political Lessons for India

If anyone seriously wants to know what happens to a country when it runs out of money then one simply needs to turn its attention to Sri Lanka. The island nation is currently witnessing its probably worst ever economic crisis in its history. The current situation in the island nation is so bad that common Sri Lankans fed up with the sporadic rise in inflation have hit the streets. What’s even worse & shocking, when Sri Lankans are going through such horror times, Sri Lanka’s Prime Minister and President have both fled the country. This simply means that currently Sri Lanka doesn’t even have a functional government in place.

In a nutshell, a sense of hopelessness, chaos and mayhem currently prevails in the island nation. Sri Lanka’s current miserable economic plight obviously throws many fundamental questions. Who is primarily responsible for this economic catastrophe and what are the economic and political factors that are responsible for pushing Sri Lanka to such a dire state? And most importantly, could Sri Lanka have avoided this economic crisis.

In this special feature story, we’ll try to find answers to all these questions.

We’ll start our feature story by immediately focusing on the important economic factors behind the ongoing economic crisis facing the island nation.

Economic Factors:

Economically speaking, the ongoing economic crisis in the island nation can be fundamentally blamed on two major economic factors. First is the ‘legacy problem’ and second is the gross economic mismanagement by the Gotabaya Rajapaksa government. Let us first talk about Sri Lanka’s legacy problems. Legacy problems simply refers to economic issues and problems that have been plaguing Sri Lanka’s economy for much of its independent history. The successive Sri Lankan governments over the decades never showed the political will to resolve these legacy problems. As a result, these historic problems remained unresolved and Sri Lanka eventually paid a heavy price for overlooking them.

But what are really these legacy problems that has apparently played a huge role in the current economic crisis. Sri Lanka basically has two major legacy problems that have traditionally strained its economy.

  1. The trade deficit problem.
  2. The island nation’s troubled history with IMF bail outs.

Let us first talk about the trade deficit problem.

Trade Deficit:

Historically, Sri Lanka has always been a trade deficit country. Trade deficit simply refers to a situation when a country imports more than it exports. This simply means that a country’s expenses are higher than its income, which obviously accounts for bad economics. And this bad economic practice has the direct impact on the country’s foreign exchange reserves, which is the main and the principal source through which any country pays for its import bills. Therefore, if a country has more money and gold assets in its reserves then it can comfortably pay for its import bills and easily cater to economic demands & needs of its citizens. Besides, a country with higher foreign exchange reserves will easily be able to pay its import bills even in the case of global economic downturn or when a domestic economy gets hit by adverse international events.

Now coming back to Sri Lanka, since the island nation has always been a traditionally trade deficit country, its foreign exchange reserve level has never been in a comfortable position. In fact, since 2009 Sri Lanka’s import has been growing exponentially while its exports remained pretty much stagnant, which means that the island nation’s foreign exchange has been under considerable constrain for well over a decade.

One peculiar aspect, or should I say a negative aspect of Sri Lanka’s trade deficit, is that it even imports basic necessities from other countries including agriculture products. This includes milk, wheat, pluses, grain and even basic medicines. Conventionally, the Island nation should have achieved self-sufficiency by encouraging domestic production of all its basic necessities, which would have reduced the country’s dependence on imports and kept its balance of payment problem under control. However, it seems Sri Lanka’s successive governments were least interested in addressing this major economic issue.

Shifting back the focus on Sri Lanka’s current foreign exchange crisis, the island nation is currently left with little over $50 Mn, which is good enough to pay the import bills barely for few weeks.

Here I’d like to explicitly highlight that it is not entirely a bad thing to be a trade deficit country. Almost all developing countries including our own country India have historically been a trade deficit country. In fact, even United States, which is a highly developed country, boosts a huge trade deficit. However, unlike India and U.S, Sri Lanka does not enjoy other conducive economic factors that could have helped it in overcoming and outweighing its trade deficit problem.

These conducive factors include not having a diversified and modernized economy and a lack of a booming middle class population. Now let us try to know in little more great detail how Sri Lanka could have averted this economic mess had it enjoyed these conducive factors.

Let us talk strictly about the benefits of having a diversified and modernized economy. Guys today most economists unanimously agree that any country’s economy that is well diversified and is in tune with modern globalization, it is more likely to absorb global shocks and economic recession. However, Sri Lanka over the decades failed in diversifying and modernizing its economy. The island nation historically has always been overwhelmingly dependent on tourism and commodity exports, with the country especially exporting textiles, garments and tea to other countries. What this simply means is that the Sri Lanka has always been too dependent on few traditional sectors and never really bothered to develop modern industries or carry out an extensive industrialization.

But depending too much on a few industries or sectors is like running the risk of putting too many eggs in a few baskets. In other words, Sri Lanka’s economy was never prepared to cope or absorb the adverse impacts of unforeseen challenges. And to the utter dismay of the island nation, Sri Lanka’s economy got badly battered by two Tsunami like events. First was the 2019 serial bomb last and second was the COVID pandemic that struck the world with a vengeance in 2020.

Both these events had a catastrophic impact on Sri Lanka’s tourism and export commodity industry, which – as I said before – were the two money spinning industries for the island nation. But these two money spinning industries got crippled completely, which put unbearable pressure on the country’s foreign exchange reserves. In fact, with minimal inflow of tourists and very low exports after 2020 Sri Lanka’s forex reserves has been on a downward spiral. And by the start of 2022 (i.e. this year), the island nation was left with barely $1 Bn to pay for its import bills.

In a nutshell, Sri Lanka paid a heavy price for not developing a diversified economy that is dependent on several sectors rather than being dependent on only on one or two sectors.

Troubled history with IMF Bailouts:

Now since historically Sri Lanka has always faced vulnerability on the front of foreign exchange reserves, the country was left with no option but to become overdependent on loans and credits for fixing its balance of payment problem. Usually, most countries source loans and credits from several recognized sources like international bond markets, institutions like IMF and world bank or taking direct loans from other countries.

Now speaking strictly in the context of the IMF or International Monetary Fund, which gives loans to mostly poor and developing countries, Sri Lanka has a pretty long history with this financial institution. Despite being a small country and a minuscule population, the island nation has taken a total 16 IMF bailouts since its independence. This is a pretty shocking number especially if you compare Sri Lanka’s bailout history with its immediate neighbor India. India, despite being the largest country in South Asia and the second most populated country in the world, has taken only four IMF bailouts in its entire history. In fact, after the 1991 foreign exchange crisis, India has not taken a single loan from the IMF.

In the case of Sri Lanka, the island nation continued its fixation with IMF bailouts. The island nation’s last IMF bailout came in 2016, when the international monetary fund loaned out nearly $1.4 Bn to the country. This was followed by an IMF bailout in 2009. Back then, both these bailouts helped Sri Lanka in averting the balance payment crisis.

Apart from taking constant loans from the IMF, India’s neighbor has also been borrowing heavily from bond markets and even taking loans from other countries like India, China and Japan. Now if one takes into account all the debts and loans that Sri Lanka has taken over the years then today its total outstanding debt stands out at a whopping $52 Bn, which is a huge number considering the small size of Sri Lanka’s economy. And as I had already informed before, the island nation is currently left with little over $50 Mn.

This simply means that Sri Lanka won’t be able to repay its debt to any of its creditors anytime soon.

To sum it up, Sri Lanka’s long over-dependence on loans and external debt accounts for a huge reason for its current economic mess. Its constant fixation with IMF bailouts and external debt clearly proves that Sri Lanka – despite boosting a per capita income that is better than most other South Asian countries – failed to become a self-sufficient economy in a true sense.

Now let us move away from the legacy problems and focus on the recent economic decisions taken preceding the ongoing economic crisis. Many experts argue that these decisions backfired and hold them responsible for further deepening the crisis. In the next part, we’ll talk about the gross incompetency shown by the Gotabaya Rajapaksa government in handling the Sri Lanka’s economy.

Economic mismanagement by Gotabaya Rajapaksa Government

Image Source: Flickr

Gotabaya Rajapaksa was elected as the eighth president of Sri Lanka after his party Sri Lanka People’s Front swept the 2019 general election. Sri Lanka’s former President and Gotabaya Rajapaksa’s younger brother Mahinda Rajapaksa was also sworn as the Prime Minister in this government.

Now both Rajapaksa brothers occupy a very special place in Sri Lanka’s politics. This is mainly because both brothers played a key role in ending Sri Lanka’s 30-year-old civil war. But more importantly, both of them achieved heroic status for finishing off the dangerous Tamil separatist organization LTTE and its leader Velupillai Prabhakaran. As a result, since 2009 Gotabaya Rajapaksa and Mahinda Rajapaksa became the champions of the Sinhalese Buddhist community, which is the majority community of the Island nation.

In the 2010’s presidential election, the support of the majority Sinhalese community played a key role in propelling Mahinda Rajapaksa to a thumping victory. Although Mahinda Rajapaksa lost the next presidential election (i.e. 2015), both he and his brother came to power after winning the 2019 election with a brute majority. However, the 2019 general election took place barely months after the deadly serial bomb last that killed nearly 270 people. This deadly bomb last spurred and ignited a strong feeling of Sinhalese nationalism among the Sinhalese community.

It is now important to understand why am I talking so extensively about Sri Lanka’s decade long civil war and the 2019 serial bomb last. That’s because both these incidents played a critical role in shaping the Sinhalese nationalism, which was largely responsible in putting a majoritarian Sinhalese government in place in 2019. Today many political and economic experts partially blame Sinhalese nationalism or Sinhalese majortianism for Sri Lanka’s current economic mess.

The majoritarian governments are generally known for their autocratic nature and suppressing the opposition as well as the media. And Gotabaya Rajapaksa government was a Sinhalese majoritarian government in every way possible and had earned a reputation for taking sweeping decisions. Many of these sweeping decisions, by the way, had a catastrophic impact on Sri Lanka’s economy and played a major role in pushing its national economy on a disastrous path.

One such sweeping decision was the decision of pushing Sri Lanka’s agriculture sector towards organic farming. Let us now see in great detail how this one decision wreaked havoc on Sri Lanka.

In 2021, Sri Lankan government made a controversial announcement of imposing a nation-wide ban on the sale and import of pesticides and chemical fertilizers. This decision was a part of the Sri Lankan government’s ambitious plan to push Sri Lanka’s agriculture sector steadily towards organic farming. Back then, Gotabaya promised Sri Lankans that this decision will not only help in increasing agriculture production but help in saving huge amounts of foreign exchange reserves for the country. Apparently, the island nation was spending millions of USD dollars in importing pesticides and chemical fertilizers from other countries.

However, as it turned out, this decision backfired big time. Instead of increasing agriculture production, Sri Lanka’s food production crashed to unprecedented levels. The situation of food production went so bad that Sri Lanka, which was a self-sufficient country in rice production, had to import rice for the first time in its history. Not only this, due to transition to organic farming, Sri Lanka’s tea production fell to historic low. And tea being one of the main export commodities of the island nation, this development did not bode well for the country’s foreign exchange reserves, which was already in a precarious situation. Worse, with Sri Lanka now facing acute food shortage, the island nation’s food inflation was starting to head northwards and started importing even more foods and agrarian products.

If one thinks holistically and objectively then it won’t be wrong to say that Gotabaya Rajapaksa’s decision to opt for organic farming proved to be a disastrous decision. Moreso on the front of foreign exchange reserves. Instead of saving the country’s precious foreign exchange reserves, the decision actually ended up eroding the country’s foreign exchange reserves at a faster rate. In hindsight, one might argue that had Gotabaya Rajapaksa not taken this ill-informed and drastic decision then Sri Lanka’s economic condition would not have been as worse as it has become today.

Now we’ll quickly head to the final section of this video. In the final section, we’ll seek to find an answer to a very question: What will happen if Sri Lanka never ever comes out of this economic mess.

Is Sri Lanka heading towards Anarchy?

Currently, the island nation is desperately trying very hard to get a bailout package from the IMF. It is equally trying very hard to get a soft loan from friendly countries like India and China. But right now Sri Lanka is financially in such a helpless situation that getting an IMF bailout or a loan from a friendly country looks like a monumental challenge. With its outstanding debt of more than $50 Bn still unpaid, everyone including IMF are not looking forthcoming in giving a helping hand to the island nation. This hopeless situation brings me to a very pertinent question, which I’m afraid not many people are asking. Will Sri Lanka drift towards political anarchy if it fails to overcome the ongoing economic mess? Mind you, this fear is not misplaced or exaggerated. In fact, the world recently got to see the glimpse of Sri Lankans resorting to mobocracy and lawlessness when millions of citizens stormed the President Gotabaya Rajapaksa’s palace. The videos of Sri Lankan citizens storming the president’s palace has gone viral on the internet, stoking the fear whether the Island nation is becoming the next Somalia.

Again, mind you guys, If Sri Lanka indeed fails to come out of the ongoing economic tsunami, the chances of the island nation drifting towards a Somalia like situation cannot be really ruled out. What does this actually mean is in reality? Let us try to break this hypothesis.

Just like in African nation Somalia, the Sri Lankans will witness economic hopelessness all around. High rate of unemployment, wide-spread poverty, unbearable inflation, malnutrition and many other extreme economic and social problems that one can think of. Above all, the relentless and unforgiving economic situation may also plunge the island nation once again into a civil war. And this time around the civil war may cost a lot more bloodshed as Sinhalese and non- Sinhalese communities will have to fight off for limited economic resources.

And imagine guys all these social and economic upheaval will be taking place in India’s very own backyard. This simply means guys if Sri Lanka does not come out of the current economic mess then it can pose a huge national security threat to India. And let us not forget guys it was Sri Lanka’s bloody civil war that cost the life of India’s former Prime Minister Rajiv Gandhi. former Prime Minister Rajiv Gandhi was assassinated in 1991 by a LTTE human bomb.

Rajiv Gandhi’s deadly assignation is a historic lesson that clearly proves that India cannot escape from the impact of any adverse event taking place in Sri Lanka.

To sum it up, the world and more so India cannot allow Sri Lanka to become a failed country. Considering that Sri Lanka is India’s immediate neighbor, there are certainly dangerous implications for India if Sri Lanka eventually goes the Somalia way.

The important global leaders need to sit down and think hard about ways through which Sri Lanka can be removed from the current economic turmoil. Last but not least, the world at large needs to see the current Sri Lankan crisis not only from an economic perspective but also from a humanitarian perspective.

And in the end, I’d also like to add that all Sri Lankans need to stand completely united and fight this adversity with great courage. Sri Lankans should not forget wherever there is ‘courage,’ there is always a ‘hope.’

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