Sri Lanka’s Economic Crisis Explained

After a month of intense civil protests against Sri Lanka’s deteriorating economy, President Gotabaya Rajapaksa agreed to appoint a new council on Friday to guide the formation of an interim government. The resolution would create an all-party coalition in parliament and break the grip of the Rajapaksa family dynasty that currently rules the country. At stake is the economic future of the country, which is in shambles after defaulting on its mountain of foreign loans – estimated to be worth $50 billion. for the first time since the country gained independence from Britain in 1948.

In the last two years of the Covid-19 pandemic, signs of an impending economic crisis in Sri Lanka have become increasingly clear Food prices rose and power outages increased in frequency. Sri Lanka currently has approximately US$7 billion in total debt due this year.

Many attribute Sri Lanka’s economic crisis to successive governments’ mistreatment of its finances through mounting external debt and continued infrastructure investment. The Rajapaksa administration has also implemented it 2019 sweeping tax cutswhich lowered the Value Added Tax (VAT) – the tax levied on imports and domestic deliveries – from 15 percent to 8 percent, contributing to a drop in the country’s revenue.

The president’s older brother Mahinda Rajapaksa is expected to be removed as prime minister as part of a deal brokered by former President Maithripala Sirisena, who joined dozens of other members of the ruling party in April in protest at the Rajapaksa’s poor incumbent President had defected to rule.

But the country’s power struggle may have sowed discord between the two brothers, which could exacerbate his political impasse. On Friday, the Associated Press reported A spokesman for the prime minister did not immediately confirm the elder Rajapaksa’s removal, saying such decisions would be announced in a timely manner by the prime minister.

The country continued to accumulate foreign debt without sufficient revenue

A large part of Sri Lanka’s economic woes is its mounting external debt, namely funding its aggressive turn to infrastructure development under former President Mahinda Rajapaksa, Rajapaksa’s older sibling and two-time prime minister. With its finances already bleeding, Sri Lanka took out large investment loans from Chinese state-owned banks to fund its infrastructure projects, including a controversial port development in Hambantota district.

The Sri Lankan government justified the Hambantota project as turning their economy into a bustling commercial center comparable to Singapore. However, the project was riddled with corruption and stalled, and Sri Lanka eventually hand over control of the port as collateral to China after it failed to repay its loans.

In the last ten years, Sri Lanka has accumulated a $5 billion debt to China alone, which according to the BBC accounts for a large part of its total external debt. Sri Lanka’s bloated debt to China and the failure of the Hambantota project are often cited as examples of the “debt-book diplomacy” China has engaged in in recent decades.

Some believe China expanded this approach to monetary diplomacy through its ambitious Belt and Road Initiative (BRI), a global infrastructure project that includes Chinese investments in infrastructure developments in parts of Asia, Africa and Europe, which will later be repaid as part of China’s bid growing economic power increase global influence. About 139 out of 146 countries in the world, including Sri Lanka, have joined the Chinese BRI project. While an infrastructure project of such global scale can bring some economic benefits to participating countries, the BRI has inevitably become a strategic avenue for China to gain political influence in economically weak countries across the Asia-Pacific region. At least 16 countries involved in the BRI project were saddled with billions of dollars in debt, which China then leveraged, one said independent analysis from the Kennedy School at Harvard for the US Department of State.

above 22 percent of Sri Lanka’s debt is owed to bilateral creditors — institutional investors of foreign governments — according to CNBC. Neighboring India has sought to expand its bilateral cooperation with Sri Lanka, partly in an attempt to secure its hold on China in South Asia. India recently extended a $1.5 billion line of credit to Sri Lanka to help shore up the country’s fuel crisis, in addition to another $2.4 billion through a currency swap and loan deferral since January.

As the country racked up foreign debt, its tourism sector – before a $44 billion industry and a major source of income for the island – was successively hit. In 2019, tourism suffered as a result a series of bombings of churches Almost 300 people lost their lives, including some foreigners.

Over the next year, the Covid-19 pandemic halted tourism and other key sectors, leading to a global economic downturn. Although Sri Lanka has seen some increase in the number of foreign visitors over the past year, the ongoing pandemic has combined with Russia’s invasion of Ukraine – both nations leading sources of tourism for Sri Lanka before the conflict – continued to slow the industry’s recovery.

A worsening of the crisis triggered mass protests

The country’s problems escalated in March when the Sri Lankan government announced a 13-hour daily blackout to conserve energy amid the ongoing crisis. Without adequate electricity, many were unable to do their jobs as the economic crisis continued, sparking mass unrest. Thousands of Sri Lankans took to the streets in the weeks following the blackout to protest the country’s deepening crisis.

On April 1, President Rajapaksa declared the state of emergency as unrest grew saw protesters clash with police. The entire Sri Lanka Government Cabinet resigned in protest not long after the implementation of the emergency law, Rajapaksa arranged for the law to be repealed. Among those willing to resign was Sports Minister Namal Rajapaksa, another member of the Rajapaksa family and the President’s nephew.

With political unrest mounting and no solution in sight, Rajapaksa’s rivals began calls for a vote of no confidence in his government.

“We are confident that we have the numbers and that we will bring the motion in at the right time,” said opposition MP Harsha de Silva told CNBC. Hoping to appease critics, President Rajapaksa attempted to form a new unity coalition under his leadership, but received no support. In April, the government also announced a temporary suspension of payments on foreign debt, marking the first time Sri Lanka had defaulted on foreign loans since independence.

Experts have been warning of a possible dire situation in the country’s finances for some time. When the country defaulted, it was the government Negotiations on a rescue plan with the International Monetary Fund, which had deemed its accumulated debt unsustainable.

“The Government intends to continue its talks with the IMF as expeditiously as possible to formulate a comprehensive plan to restore Sri Lanka’s external public debt to a fully sustainable position and present it to the country’s creditors,” the Ministry of Finance said in a Explanation.

At a meeting with cabinet officials a week later, President Rajapaksa accepted his government’s role in the country’s declining economy. In particular, the President said the government should have turned to the IMF earlier for assistance in dealing with its unruly external debt and that they should have avoided the ban on imported chemical fertilizers, which was meant to preserve Sri Lanka’s foreign exchange holdings but instead its agricultural ones production affected.

“In the last two and a half years we have faced major challenges. The Covid-19 pandemic as well as the debt burden and some mistakes on our part,” Rajapaksa said.

Now Sri Lanka’s future depends on whether the president’s proposed change of government will appease its growing opposition long enough for a solution to be reached by the IMF. Sri Lankan Chief Financial Officer Nandalal Weerasinghe has stated that such a hoped-for deal is possible be months awayHowever.

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