Not all hope lost for Sri Lanka

There has been a lot of talk about the recent economic and political crisis of mass proportions in Sri Lanka, which recently led to culminating in a default on its debt payments. This article briefly looks at the reasons of the crisis, which have been discussed by economists all over the world in the past few months. But more importantly, the focus of this article is to go beyond the reasons of the crisis and look if certain ramifications to their economic policies might help stabilize their situation in the near future.

What’s happening?

For months, Sri Lanka as an economy has been struggling with shortage of power and basic requirements such as fuel, food and medicine. The country defaulted on its debt for the first time in May 2022 when it failed to pay back $78 million loan from international creditors, even in the 30 days of grace period given for the payment. In consequence, Sri Lanka was declared bankrupt on 5th July 2022. In total, the government has borrowed $50.7 billion. The largest source of their debt is market borrowings, followed closely by loans taken from the Asian Development Bank, China, and Japan, among others.

The country is nearly empty of their foreign currency reserves, decreasing the ability to purchase imports and driving up domestic prices for goods. Certain policy mishaps, government’s mismanagement and poor planning dating from the very start of the COVID-19 pandemic and certain inevitable factors led to the crisis. A major change in the country’s fiscal policy took place in 2019 when unprompted tax cuts were introduced in Sri Lanka which majorly reduced the overall revenue of the government and started draining the cash reserves of the country. With the advent of Covid-19, Sri Lanka was one of the worst hit economies especially with its tourism industry contributing to just 0.8% of the GDP in 2020 compared to over 5% in 2018 and adding over 388,000 jobs in the economy. Post-COVID, the majority of the tourism industry never recovered along with all tourism inter-related industries also suffering heavy losses and job reductions. At the same time, increasing imports of fossils and fuels and the increasing prices of the same have played a pivotal role in draining the economy’s foreign reserves. Sri Lanka’s total imports accounted for $20.6 billion USD in 2021.

The crisis has resulted in an ever-increasing inflation rate (39% as of May 2022) and a major decrease in the overall quantity of everyday products. The inability to purchase or borrow foreign currency resulted in a decline of the desperately needed imports, including food and fuel, causing domestic prices to rise. Furthermore, defaults on loan payments discourage foreign direct investment and devalue the national currency, making future borrowing more difficult.

Way forward

Since 1948, Sri Lanka has achieved a fairly high average growth rate, just coming short of the East Asian “miracle“ club. However, this progress has often been disrupted by various factors like political unrest, incomplete reforms, external shocks or sometimes a combination of all three of them. Post-COVID, the Sri Lankan economy has deviated away from the potential it possesses. Given the situation, we look if there’s a ray of hope for Sri Lanka, where the economy can be revived with certain economic policies in the near future.

Sri Lanka’s strategic location, with all key ingredients to have a rapidly developing economy, positive social indicators with absence of extreme poverty and inequality in its society, well-developed infrastructure, and most importantly a well-defined system of ports and harbors which were already facilitating a fair share of the world trade, can be harnessed to boost the economy.

The first task at hand should be to create a stable source of income, which will be used to repay the ever-growing debt and reduce its future dependence on loans to meet its basic needs and requirements. Such a foresighted vision and subsequent policies are easier said than done, but are still achievable if the nation is able to exploit its own strengths and use them to a certain economic advantage by subsequently gaining and reviving certain prime industries (tourism, food exports etc.). Given its strategic location, it should focus on developing an area which was never utilized to its full potential, its ports and harbors.

Located in the East-West trade route and neighboring India, Sri Lanka possesses the essential geopolitical advantage to become a key logistics hub in South Asia by establishing robust maritime networks with regional actors and greater commitments towards an enhanced infrastructure development framework. Other than this, for a long-term investment it is important for Sri Lanka to also optimize and implement policies on the following grounds:

1) Strategizing in regional port development projects: Sri Lanka must strategize and formulate policies to benefit from regional port development projects such as the Sagarmala port development project. The emergence of South Asia as a growing maritime economic center is an opportune time for Sri Lanka to materialize its vision of becoming a regional transshipment and logistics hub.

2)  Encouraging regional investments and bilateral agreements: Sri Lanka needs to look towards encouraging more Foreign Direct Investments (FDI), public-private partnerships (PPPs) and should consider liberalizing foreign land ownership which can boost out exports and imports and local infrastructure development. Given the regional proximity, Free-trade agreements (FTAs) with India, China, Pakistan and Singapore (to start with at least) could establish Sri Lanka as a trading hub that offers preferential access to regional players.  Increased maritime connectivity through bilateral mechanisms such as a bilateral coastal shipping agreement with Dubai may enable expanding Sri Lanka’s feeder network and stabilize its position as a regional transshipment hub. On the legal perspective, domestic regulations and policies that govern maritime cross-border trade and logistic affairs must efficiently adapt to international best practices while protecting national interests.

3)  Prioritizing on digitalization: It is important for Sri Lanka to improve upon its internal infrastructure and technological capabilities as limitations in operational facilities will lead to a diversion of regional cargo to competitors and leave out potential inflow of cash. It is ripe for Sri Lanka to facilitate and encourage the integration of social paradigms such as digitalization, ‘uberisation,’ and e-commerce within its economy.

4)  Fix the laws to give foreigners absolute ownership rights over Sri Lankan assets: If the external debt can be secured against Sri Lankan assets that are guaranteed by law, the pressure to repay the debt vanishes overnight.

5)  Sell Sri Lankan assets: Sri Lanka as a country has a balance sheet with US$ 400 billion of assets and US$ 50 billion of external debt resulting in a net assets position of US$350 billion. The first easy way out of our debt dilemma is to simply change the legislation around the ownership of Sri Lankan Assets.

These are a few areas where the initiation of reforms in the short run, and continuous push in the long run can help in making the Sri Lankan economy resilient.

Written by:

Harshil Pahuja: Harshil Pahuja is a third year student at ISBF Delhi pursuing Economics and Management. With a keen interest in economic research his main focus is on international economics and economic public policy.

Mentored by:
Payal Sharma
Assistant Professor (Economics), ISBF