Sri Lanka in Turmoil: An Old-School Economic Crisis

The unfolding economic, political, and social crisis in Sri Lanka has distinct echoes from the past. Not just the Asian financial meltdown of 1997-98, which savaged the economies of Korea and Southeast Asia, but from a region far away from Sri Lanka – Latin America, where a series of failures in the 1980s led to debt defaults and skyrocketing inflation, setting back social progress for a generation. With Sri Lanka also reneging on its foreign debt obligations, the first Asian country to do so since Pakistan’s lapse in 1999, the parallel with Brazil and Argentina is evident.

The island nation’s path toward economic restoration will require more than a simple fix of its monetary and fiscal balance sheet, the objective of negotiations underway with the International Monetary Fund (IMF). Just as Indonesia and Brazil emerged afresh from their crisis spells in the 1980s and 1990s, Sri Lanka needs a major reset which will reposition the country away from the political blunders and excesses of recent years. The question is whether the political class and a pliant business community can rise to the challenge.

Wickremesinghe, who has also assumed the finance portfolio, must quickly deliver tangible economic and social benefits well before he too incurs the wrath of the street. The prime minister has four immediate priorities – secure emergency food and fuel supplies, negotiate an economic restoration program with the IMF and international donors, tackle Sri Lanka’s chronic foreign debt problem, and restore public trust in government. The food and fuel crisis that the country is facing is due to a combination of self-inflicted pain (the decision by the previous prime minister Mahinda Rajapaksa, who resigned on May 9, to ban the imports of chemical fertilizer, for example, which led to a sharp fall in domestic output) and an upsurge in global food prices due to the pandemic and Russia’s invasion of Ukraine. India, Sri Lanka’s giant northern neighbor, has provided an estimated US$3.5 billion credit line, with the World Bank and other bilateral donors also chipping in.

A devalued Sri Lankan rupee will prohibitively increase the cost of importing food, fuel and other essentials. The prime minister has to sell a difficult austerity package to his citizens, with no immediate prospect of a return to stable economic conditions. Adding to Sri Lanka’s woes is the negative global economic outlook, with the World Bank projecting global growth to be trending sharply lower (3.8 percent in 2022 compared with a robust 5 percent in 2021).

Sri Lanka might find some relief by renegotiating its foreign debt obligations, but talks are at a standstill after the country failed to pay US$78 million in interest payments on two sovereign bonds earlier in May. The country’s overall foreign debt stands at US$51 billion, an estimated 10 percent of which is owed to China. International media coverage, however, has overwhelmingly focused on the Chinese debt dimension, a resolution of which will have to be part of an overall debt relief package for the country.

Since the pandemic, the G20 has established a common framework for debt treatment, to allow heavily indebted countries and their creditors (private and public) to establish a viable path forward. While the framework has primarily focused on African nations and progress has been slow, there is a clear, compelling case for the inclusion of Sri Lanka in the process. This will enable Sri Lanka’s largest official creditors to agree on how and when the debt will be repaid.

A final point about restoring public trust, which has evaporated in the last few months. Faced with the prospect of a lost decade of low growth and diminishing economic opportunity, Sri Lankans have targeted their wrath at the political elite by torching their property and taking to the street in unprecedented numbers. The president, who declared an emergency on May 6, has refused to resign, despite public protests calling for him to step down. Prime Minister Wickremesinghe is the nation’s man of the moment and has a historic opportunity to reverse decades of neglect in public policy and erosion of trust in institutions. But besides money, the country is running out of time.