SRI LANKA LIMPED into December with its economic sovereignty in shreds. The media headlines in the South Asian nation echoed the obvious — that the financial destiny of the country was firmly in the hands of foreigners. They ranged from the main bilateral lenders, such as China, Japan and India, to an exhaustive list of private creditors. The latter included asset manager BlackRock and those like JP Morgan Chase, HSBC and Allianz, all of whom have invested in Sri Lanka’s international sovereign bonds.
This shift in power was the consequence of the Indian Ocean island running out of dollars to service its foreign debt in April, resulting in its first sovereign default. That brought the International Monetary Fund into the picture. It was a belated move by the then ultra-nationalist government, headed by hawkish President Gotabaya Rajapaksa, to desperately seek an IMF financial bailout after the country was reduced to begging from foreign governments for a lifeline. But the Fund’s eventual nod for a US$2.9 billion bailout, which was made public in early September, came with many strings attached. Among them: Sri Lanka needed to negotiate deals with its bilateral and private creditors about restructuring its debt before any dollars from the IMF would trickle into Colombo’s coffers. Such a route, as Sri Lanka has realized, is daunting. Already, an expected deadline in December to secure bilateral “creditor assurances” that would have paved the way for IMF cash has been missed.
That, however, was not the only national humiliation. Sri Lanka’s debt debacle has become an overnight reference point across many capitals in the Global South. Government officials in some African and Asian countries, for instance, rushed to assure their respective foreign lenders that they will avoid Sri Lanka’s folly of living on unsustainable debt and then going bankrupt. Two expressions — “We are not like Sri Lanka” and “We will not be the next Sri Lanka” — have been heard in countries from Ghana, on one end, to Pakistan, on the other. Both belong to a list of at least 60 least developed countries — and a third of emerging markets — that the IMF has warned are in the throes of crippling “debt distress.”
Media commentaries and discussions within global policy circles followed, turning Sri Lanka into a convenient example of the price countries will have to pay if they stick to the toxic mix that had become Sri Lankan staples — political hubris, economic mismanagement, unbridled corruption and unsustainable foreign debt. It is no different among the views shared by fund managers and private investors who have emerging market bonds in their sights. Sri Lanka’s economic downfall has become a ready reference for them to cite, just as others, in a different context, would point to Uganda under Idi Amin as a yardstick for brutality. “Sri Lanka made it easy for us because it ran out of foreign reserves,” said a London-based emerging markets investor who has a stake in Sri Lankan bonds. “I don’t know of any other country that has said they have no dollars left — it’s simply insane.”
A CRIPPLING CYCLE
This economic fall from grace has been long in the making. For years, economists and seasoned observers had warned about the strategically-located country living beyond its means. The indicators included decades of twin deficits — both current account and fiscal — and low taxes drained to support a bloated and inefficient public sector. But the economic managers of successive governments dismissed such indicators in the same way they ignored calls to reform loss-making state-owned enterprises in order to satisfy their political masters. Other markers of a troubled economy, such as rushing to the IMF for a bailout, which Sri Lanka has done 16 times prior to the latest round, put it second only to Pakistan for IMF lending in Asia, were treated with a similar contempt. So the collective macro-economic flaws amounted to this: an ominous cloud hovering over the country’s growth, which had evolved into a pattern of promising booms, resulting in poverty dropping, the middle class expanding and the country rising into the ranks of a middle-income country, and then sudden busts.
What happened in April 2022 was an economic collapse foretold: The country ran out of dollars to honor its external debt obligations. By the second week, foreign reserves had plummeted to an ignominious US$20 million — not even enough to pay for “half an hour of imports,” as one cabinet minister has since said. It was also insufficient to settle two foreign debts due that month for more than US$200 million. The sums were owed to private creditors who held the country’s international sovereign bonds. The announcement by the Rajapaksa administration of a sovereign default became official by May. This embarrassing milestone — the first sovereign default since it gained independence from British colonial rule in 1948 — affirmed the speed with which the Rajapaksa government squandered the US$7.6 billion in foreign reserves it had inherited after it swept to power in an electoral landslide at the November 2019 presidential polls.
The economic collapse, moreover, was self-inflicted. The signs were writ large for the US$81 billion economy by the end of 2021. Sri Lanka was shouldering US$47 billion in external debts by then. Of that, China accounted for 52 percent of the total bilateral debt, affirming its rise as the largest lender over a decade-long credit spree through Beijing’s policy banks. Japan, which had once been the leading development lender, came second, accounting for 19.5 percent, followed by India at 12 percent. But the bilateral lenders were overshadowed by the largest creditors: US$13 billion held by private investors in Sri Lankan ISBs, affirming the country’s appetite since 2007 to go to the international capital markets. And it was no secret that some of these external creditors had payments pending. The foreign debt bill Sri Lanka had to settle during 2022 was a formidable US$6.9 billion.
Yet finding dollars to pay foreign lenders had become a headache for Rajapaksa after the global ratings agencies began downgrading Sri Lanka’s standings to the level of junk. It followed sweeping tax cuts that Rajapaksa introduced after his presidential victory in November 2019, essentially worsening the country’s already perennial fiscal deficit malaise. The economic impact of the Covid-19 pandemic through 2020, the collapse of two sources of foreign exchange earnings — tourism and remittances from migrant workers — and the stubborn policy decision to maintain a low exchange rate for the rupee added to the nation’s woes. And in a desperate measure to save dollars, as some government policies backfired, Rajapaksa enforced an overnight ban, in April 2021, on imported chemical fertilizers. This precipitated the collapse of the agricultural sector — the mainstay of the rural economy.
So by the first quarter of 2022, Sri Lanka’s moment of reckoning was evident. The heavily import-dependent country was squeezed for scarce foreign currency to buy essentials such as food, fuel and pharmaceuticals, the main items among a longer list on which the country of 22 million people depended. It was only a matter of time before the inevitable: a spreading tide of economic misery that saw the once relatively comfortable and secure lives of thousands of households in urban and rural Sri Lanka wiped out.
The lack of dollars to pay for oil translated into lengthy power outages — 12 hours on many days — in homes, offices and factories. Vehicles would form kilometer-long lines for days and nights outside fuel stations to get limited supplies available. Reports of pharmacies running out of medical supplies and hospitals unable to deliver health services became the norm. Even stocks of candles dried up in some convenience stores.
These outward signs of economic collapse, however, were pooh-poohed by Rajapaksa’s cheerleaders. Nivard Cabraal, the then-governor of the central bank, was typical. When pressed by journalists about the country plunging into darkness due to power outages, he retorted by pointing to a few neon-lit signs in Colombo. When questioned about dwindling foreign exchange reserves, he shot back with the US$1.5 billion currency swap from the People’s Bank of China that helped boost the official dollar chest (but he kept concealed the strings that were attached, such as China’s central bank stating that the money could not be touched until Sri Lanka had reserves to pay for three months of imports, some US$5.1 billion). Cabraal also championed the need for “home-grown solutions” to solve the crisis rather than seeking a bailout from the IMF. Not surprisingly, his reputation as the financial mouthpiece of Rajapaksa rather than an independent central banker made him the butt of jokes within Colombo’s commercial banking circles. “He is in the wrong business trying to build castles in the air with his promises,” quipped a veteran commercial banker. “He should have pursued a career as a magician.”
NOT WHAT HE CAMPAIGNED ON
But that dig aside, Sri Lanka’s economic meltdown resulted in a trail of grim statistics, some of which the country was spared even during its nearly 30-year civil war, which ended in 2009, and the December 2004 tsunami, the worst natural disaster in its modern history. The World Bank, for instance, has forecast that Sri Lanka’s economy will contract by 9.2 percent in 2022 and by 4.2 percent in 2023. On the humanitarian front, a clutch of reports by the Bank and UN agencies laid bare worsening poverty, hunger and malnutrition as a consequence of the shrinking economy, the collapse of the rupee since March, a wave of job losses, food shortages and galloping inflation. Year-on-year food inflation in August spiked to 84 percent, pushing many basic items, even the cost of an egg or a loaf of bread, beyond the reach of thousands of newly impoverished families.
The UN’s Food and Agriculture Organization and World Food Program warned in a September report that 6.3 million people were “facing moderate to severe acute food insecurity.” The United Nations Children’s Fund had raised the alarm the same month that over 5.7 million people, including 2.3 million children, were in dire need of humanitarian assistance. Those assessments were amplified by mushrooming anecdotes of children going to school hungry and fainting in class, and families surviving on one meal a day in cities and towns across the country.
Such accounts were pregnant with grim irony, too. After all, this rapid economic collapse was a far cry from what Rajapaksa promised the country’s Sinhalese-Buddhist majority, whose votes he wooed as an ultra-nationalist hardliner to win the November 2019 elections. The uber-Sinhala-Buddhist patriot ran on a two-pronged campaign: to assure security for the majority and to transform the country into an economic utopia. The former was buttressed by his image as a tough-talking technocrat, cultivated when serving as the defense secretary during the presidential term of his elder brother, Mahinda, under whom Sri Lankan troops finally defeated the separatist Tamil Tigers. His pledge to usher in an economic utopia was assured under his “Vistas of Prosperity and Splendor” platform.
Gotabaya’s November 2019 electoral triumph, built on the strength of the Sinhalese-Buddhist vote bank, was a landmark. It ended the conventional electoral math that had prevailed hitherto of a presidential candidate needing a share of votes from the country’s linguistic and religious minorities — Tamils, Muslims, Catholics and Christians — to triumph. With his win, Gotabaya, a former colonel, paved the way for the Rajapaksas, the country’s most influential political clan, to resurrect their grip on power and to pursue their dynastic ambitions. The 39-strong clan, with roots in a land-owning, rural milieu in southern Sri Lanka, has produced a prime minister, finance ministers, cabinet ministers, parliamentarians and, with Gotabaya, two presidents. It is a feat unrivaled in a culture brimming with political families and lingering semi-feudal traits.
PEOPLE POWER STRIKES BACK
But the Rajapaksa dynasty was undone by the unprecedented groundswell of public rage that erupted as the economy went bankrupt. From April through July, under the banner “Aragalaya,” the Sinhala word for “struggle,” tens of thousands of Sri Lankans poured onto the streets of Colombo and other urban pockets to vent their economic pain and destroyed livelihoods. It was a rare sign of unity in a country divided along linguistic, ethnic and religious fault lines. The protesters had the Rajapaksas in their collective sights. Consequently, the once seemingly invincible political clan came under a barrage of verbal barbs, with accusations of corruption and charges of fattening themselves at the expense of the people having the sharpest sting. By July, the public rage had triumphed with the successive resignations of Mahinda in May from the prime minister’s post, and Gotabaya in July from the presidency. It was a glowing moment for Sri Lanka’s first foray into people’s power.
Sadly, for now, that might be the only silver lining in an otherwise painful year of economic reckoning. The prospect of more economic angst, impoverished lives, a hand-to-mouth existence and having to survive on one meal a day in some homes has become the new normal. The only exception to that: Sri Lanka’s “one percent,” the wealthy elite.
Relief in 2023 is expected to flow only after the country gets its economic house in order. The final judges of such change — Is it sincere or deceptive? Is it credible or cosmetic? Are the economic reforms real or rhetorical? — will not be Sri Lankans. That role has fallen to outsiders, such as the IMF and foreign creditors. Sri Lanka has little bargaining power left. It forfeited its economic sovereignty when it fell off the debt cliff.
Source: Global Asia