• header EFSAS

EFSAS Commentary

Sri Lanka needs urgent solutions to its economic crisis but China’s tardiness has nixed hope of a December IMF bailout


The political and economic crisis that engulfed Sri Lanka early this year has not faded away quite as dramatically as international concern, overtaken by other momentous events such as those in Ukraine and Taiwan, seems to have done. Sri Lankans continue to be burdened by the worst economic crisis they have ever witnessed, and many have been plunged into poverty. Despite this, several tax hikes are on the anvil even as the cost of living is on a steep upward curve. Popular resentment is still simmering across the country and has only been subdued through force by the army. That discontent looks set to boil over yet again. Evidence of this was on display on 27 October, when after a fairly sustained period of relative quiet, several thousand members of civil rights groups, trade unions and students came onto the streets of Colombo to protest against the economic situation and the heavy handed suppression of previous demonstrations. The Trade Union Coordination Centre (TUCC), which brings together trade unions and prominent figures who led the earlier protests that removed former President Gotabaya Rajapaksa, was at the center of the protests.

Rajapaksa’s successor Ranil Wickremesinghe, who took over on 21 July, immediately declared a state of emergency and granted sweeping powers to the military, which resulted in a series of crackdowns targeting protesters and the arrest of several protest leaders. In August, the United Nations (UN) urged Wickremesinghe to end the crackdowns, describing them as a “misuse of emergency measures”. After a period of wait-and-watch following the crackdowns, Al Jazeera’s Minelle Fernandez believes that the protesters are frustrated as there seems to be “no let-up” in the ongoing economic crisis. She said, “The cost of living is soaring, food inflation is topping 90 percent, and people are really, really struggling”, adding that “people are now coming out once again, and the reason for that is there seems to be no let-up. A few months ago it was just beginning to make itself felt at the household table but now most households are really struggling”.

As a consequence of a series of disastrous economic decisions compounded by corruption, the pandemic, and the war in Ukraine, Sri Lanka found itself earlier this year without any foreign currency reserves to import essential items, including food, fuel and medicines. In April, it defaulted on its foreign debt. The country was hit by severe fuel, food and medicine shortages, crippling debt, negative growth, skyrocketing inflation, and dwindling foreign exchange reserves. All of these problems have persisted till date. To make matters worse, inflation, elevated fuel prices, and shortage of food supplies continue to plague many countries. While the economy is improving in Sri Lanka, the top drivers – tourism, remittances and exports – are not likely to return to pre-pandemic levels anytime soon.

Food shortages, blackouts and school closures have become the norm for the island’s 22 million people. Many have warned that it is children bearing the brunt of the crisis. Food inflation has continued to rise, hitting a record 94.9% in September, according to the Colombo Consumer Price Index, meaning that parents have been unable to afford even basics such as rice and lentils, while vegetables and meat have become unaffordable luxuries for many households. As the Guardian pointed out on 28 October, with 90% of people relying on State handouts, child malnutrition has soared across Sri Lanka. According to Save the Children, two-thirds of families are now struggling to feed themselves, while UNICEF’s regional director for South Asia, George Laryea-Adjei, said that “children are going to bed hungry, unsure of where their next meal will come from”. In Sri Lanka’s poverty-stricken regions in the north, parents have started leaving their children in care homes as they can no longer feed them. The Guardian quoted an official working in child protection as revealing that “more and more parents are leaving their children in children’s homes because of financial issues … I have personally met parents who say that they can’t provide for their children anymore”.

Medicine shortages also remain a cause for serious concern. Despite international lending agencies and bilateral partners, especially India, pumping in emergency credit, the health sector is still short of over 150 essential drugs. Dr. D.R.K. Herath, Deputy Director General of the Sri Lankan Health Ministry’s Medical Supplies Division, lamented that “We are trying our best to maintain an optimum level of supplies, but there is a shortage”The Hindu reported that drugs used for treatment of cancer were in short supply, and that shortage of medical devices and reagents used for laboratory tests and investigations were substantial. Over 80 % of Sri Lanka’s medical supplies are imported. In 2021, the island nation imported more than $800 million worth of pharmaceutical products, a large proportion of which came from India, which has been a major supplier of essential drugs to Sri Lanka.

In Foreign Policy’s weekly South Asia Brief of 6 October, Michael Kugelman of the Wilson Center took a closer look at the international response to the crisis in Sri Lanka and noted that in recent weeks Colombo’s new government had settled in and received help from bilateral and multilateral donors. He elaborated, “Since Sri Lanka’s economic crisis began, it has received emergency assistance from Japan, a currency swap offer from Bangladesh, and humanitarian aid from the European Union. The United States announced last month that its total assistance to Sri Lanka during its crisis had exceeded $90 million. The World Bank has repurposed funds from current financing projects to provide essential goods. And in September, Colombo reached a preliminary agreement with the International Monetary Fund (IMF) on a $2.9 billion assistance package. Sri Lanka has also benefited economically from regional rivals China and India jockeying for influence in the country, even if Colombo would want to avoid getting dragged into their competition. India has provided nearly $4 billion in assistance and is negotiating a future debt restructuring plan and a credit line of $55 million for badly needed imports of fertilizer”. Kugelman felt that ideally, the assistance Sri Lanka has received so far will eventually buy it more time to pursue “other stopgaps, such as debt relief measures and additional aid packages”.

India’s generous assistance to its beleaguered neighbour through loans, loan deferments, credit lines, and currency swaps, notably in the early months of the economic crisis, has not gone unnoticed. President Wickremesinghe has repeatedly acknowledged India’s timely assistance, and Opposition leader Sajith Premadasa said, “India has played a very crucial role, especially at this critical juncture…India has come forward and supported us”. Wickremesinghe, who met Indian Prime Minister Narendra Modi briefly during their visit to attend former Japanese Premier Shinzo Abe’s funeral in Tokyo last month, announced in Parliament after his return that he hoped to visit New Delhi to discuss Colombo’s economic crisis. He said, “We are continuing our talks with India. During my brief meeting with Prime Minister Modi in Japan, I conveyed my wish to visit New Delhi to brief them on our situation. Modi has always extended his support to us. I have always appreciated India’s assistance in our crisis. India will continue to extend their support in our rebuilding effort”.

India now is a key player in Sri Lanka’s debt restructuring process, a prerequisite to the Extended Fund Facility (EEF) of the IMF referred to by Kugelman above. The IMF has made it clear that financial support is dependent on the willingness of creditors to reach a collaborative agreement. IMF bailouts are generally guided by the country’s financing needs, its capacity to repay, as well as its past track record of using IMF resources. Given that this is Sri Lanka’s 17th IMF programme in seven decades, the organization is looking to use this crisis to push for long-term structural reforms by Colombo. Having agreed to the staff-level agreement for a $2.9 billion bailout facility over four years, the IMF has, accordingly, asked Sri Lanka to start debt restructuring with its creditors. India with 12% is in the third position in the list of Sri Lanka’s bilateral creditors behind China and Japan with 52 and 19%, respectively. President Wickremesinghe had earlier informed that Sri Lanka hoped to reach a common agreement with creditor nations, including Japan, China, and India. He had added that Colombo would only be able to secure an IMF assurance after reaching an agreement with the creditor nations and private lenders.

The problem for Wickremesinghe and the people of Sri Lanka is turning out to be China. As the New Delhi based think tank the Observer Research Foundation (ORF) noted last month, China’s preferred approach towards Sri Lanka’s economic recovery appears to be either to help through the framework of the Belt and Road Initiative (BRI) and its flagship projects such as Hambantota Port and Colombo Port City, or through advancing trade. In this regard, China is focused on trying to “speed up negotiations on a free trade agreement and strive to reach a deal at an early date, so as to inject strong confidence and stable expectations into economic and trade cooperation”. Whilst India and Japan appear willing to support Sri Lanka’s plans with the IMF, China has been persistent in its preference for refinancing over restructuring. Sri Lanka will not be able to get out of the present crisis without China’s willingness to help, which does not appear to be forthcoming.

As Shishir Gupta noted in his 3 November article in the Hindustan Times titled ‘China lets down Colombo in securing $2.9 billion IMF loan in December’, Sri Lanka is headed for major political turbulence as it is unlikely to be able to secure the much-needed IMF loan in December as its main debtor China was involved in the 20th Party Congress and was still to initiate a dialogue on debt restructuring. While the other debtors India and Japan had already initiated a dialogue with Colombo on debt reconciliation and restructuring, China could not find time for a supposed ally that it had already snared in a debt trap. India has already had two rounds of talks with Colombo and is in discussion with Japan to ensure that Sri Lanka gets early relief.

President Wickremesinghe on 31 October underlined his country’s predicament when he said, “Now, this is the process, we had to move. If we can move and come to an agreement by December, which means coming to an agreement by mid-November, and going up to the IMF Board in mid-December, we will gain a big advantage. However, I don’t know whether we can do it for the simple reason that in China the focus has started now after the party conference. However, we must aim to have it by January”. According to financial analysts based in Washington D.C., Sri Lanka will likely miss the December IMF deadline and will have to wait for March 2023 to secure the USD 2.9 billion EEF. In the meantime, the Sri Lankan debt is increasing further due to foreign exchange depreciation, deep recession, and a burgeoning fiscal deficit. Since the end of 2021, inflation had considerably eroded the real value of domestic debt.

The longer the Sri Lankan government is unable to provide relief to the average citizen, the more likely the prospect of protesters returning in numbers to the streets becomes, as does the possibility of the authorities being compelled to use the military to clamp down on the demonstrations. Kugelman feels that “The country still seems like a powder keg — susceptible to more mass protests — particularly if the public faces new austerity measures”. Also, if the government implements the strict economic measures mandated by the IMF, it risks further unrest in society. The 7 key elements of the IMF programme include major tax reforms to raise government revenue for fiscal consolidation; cost-recovery based pricing for fuel and electricity in order to minimize fiscal risks; an increase in social spending; data-driven monetary policy, fiscal consolidation, phasing out monetary financing, and strong central bank autonomy; restoring the market-determined and flexible currency exchange rate; ensuring a healthy and adequately capitalized banking system, while upgrading the regulatory standards; and fiscal transparency, public financial management and laws/policies to reduce corruption vulnerabilities. Given the IMF's stringent bailout conditions and China’s distinctly unsupportive approach, Sri Lanka’s road to economic and political recovery will probably be a long and arduous one.

Notwithstanding the stringent conditions attached to the IMF bailout, swift action on implementing the IMF programme is imperative to begin the Sri Lankan economy’s recovery process, but China’s hidden loans and BRI ambitions are likely to dampen the debt restructuring process and encourage further political instability and violence in which the people of Sri Lanka will be the eventual losers yet again.