In late June, Sri Lanka’s prime minister Ranil Wickremesinghe announced that the country’s
economy had “collapsed.”
There was no money left to pay for imports of necessities like food, fuel and medicine,
and the country was seeking help from neighboring countries and the IMF.
Wickremesinghe, who had taken office in May, emphasized the monumental scale of the task
the country faced in turning around an economy he said was heading for “rock bottom.”
Sri Lanka is going through its worst economic crisis since it gained independence from Britain
almost 75 years ago.
Protesters have been on the streets for the last five months, furious about the economic
mismanagement, the corruption, the authoritarianism, and the nepotism of the Rajapaksa brothers
who've dominated Sri Lankan politics for decades.
In July, videos emerged on social media showing people taking over the presidential palace.
We saw protestors in palace bedrooms, at the palace gym and swimming in the palace swimming
pool.
The sheer scale of the protests, and the anger of the population prompted Gotabaya Rajapaksa,
the president at the time to flee the country on a military jet to the Maldives and later
to Singapore where he turned in his resignation by email.
Sri Lanka’s economic collapse has been blamed on the Rajapaksa brothers, for borrowing heavily
to build Chinese-backed projects, for their corrupt mismanagement of the economy and for
their ill-considered policymaking, which included a ban on fertilizer imports in 2019.
When Gotabaya Rajapaksa resigned, MPs replaced him with the Prime Minister Wickremesinghe,
who I mentioned earlier a man protestors hated so much that they burned his house down a
few weeks ago.
With its foreign currency reserves depleted, Sri Lanka, a nation of 22 million people,
has run out of money to import fuel and other necessities, leading to queues miles long
at petrol stations and daily power cuts.
The fuel shortage has put people out of work and forced the country’s schools, offices
and companies to close.
People have been asked to work and attend school remotely, but a lack of IT infrastructure
and reliable power make this impossible for most.
Sri Lankans are skipping meals and lining up for hours every day to try to buy the scarce
supplies that they need.
This is a harsh new reality for a country that had a growing and comfortable middle
class, until the latest crisis enveloped them.
The country's official inflation rate is reported as being just under 55% but one estimate from
Johns Hopkins University estimated inflation at over 130 percent in March.
In such a situation, citizens are seeing their wealth evaporate into thin air.
According to the FT, roughly half of Sri Lankans will be classified as poor by the end of the
year, a shocking reversal for a country that was until recently classified as upper-middle
income.
While demonstrators accused Gotabaya Rajapaksa of mismanaging the economy, the president’s
older brother Mahinda Rajapaksa, who had previously been a president and prime minister of the
country, accused the citizens themselves of deepening the nation’s financial plight.
“Friends, every second you protest on the streets our country loses opportunities to
receive potential dollars,” he said in a broadcast in April.
The Economy Sri Lanka’s economy was until recently growing,
it took off after the nation’s brutal civil war ended and tourists discovered how beautiful
the country is.
Lonely Planet listed it as the top tourist destination of the year in 2019.
Its main economic sectors are tourism, tea export, clothing and agricultural products.
Additionally, remittances from overseas employment, especially in the Middle East, contribute
significantly to the economy, bringing in badly needed foreign exchange.
Industrialization increased the importance of sectors like food processing, textiles,
telecommunications, and finance to the economy over time, and Sri Lanka was listed as the
second wealthiest country in South Asia - just behind The Maldives in terms of GDP per Capita.
So, what went wrong?
Well, there’s not just one factor to blame for the problems Sri Lanka faces today.
Instead, a number of internal and external issues hit the economy all at once over the
last few years which contributed to the economic collapse that we see right now.
Unfortunately, there is a long list of other highly indebted countries around the world
today who might find themselves in a similar situation, having to choose between subsidizing
essential goods for their populations and paying their creditors.
We will talk about those countries in just a moment.
Sri Lanka's long standing high debt and large civil service have for a long time contributed
to very high budget deficits.
Additionally, the countries focus on domestic goods – things like the construction sector
- instead of export growth—only increased Sri Lanka’s trade imbalance.
Sri Lanka now imports $3 billion dollars more than it exports every year, and that is part
of the reason that it’s run out of foreign currency.
Tourism was a key sector of the Sri Lankan economy, but the Easter bombings in 2019,
and the global pandemic which struck in 2020 combined to halt this key industry which had
been counted on to bring a lot of foreign currency into the economy.
Gotabaya Rajapaksa promised, when he was elected, that he would deliver a “prosperous nation.”
His main approach to achieving this was through instituting the largest tax cuts in Sri Lankan
history.
Rajapaksa cut both VAT and income taxes in 2019, The tax cuts were later reversed, but
only after creditors downgraded the country, blocking it from borrowing more money while
its foreign reserves were sinking.
In an extremely controversial move, he banned the use of and the import of synthetic fertilizers,
in a bid to become the first country in the world to fully adopt organic farming.
Now, while this ban was also quickly rolled back, only a small amount of synthetic fertilizer
made it to farms in time and crop yields were severely affected.
The lack of fertilizer led to a significant drop in tea production, an important export.
Rice production – a food staple in the country - plummeted too, forcing the government to
spend $450mn of foreign reserves on rice imports.
With the country's revenues slashed and credit rating falling, the government struggled to
refinance its foreign debt.
Now, before we discuss the foreign debt, let me quickly tell you about today’s video
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Now, there were other big problems in Sri Lanka too.
The Rajapaksa family had been borrowing money for years and spending it on white elephant
projects.
Lotus Tower, the tallest communications tower in South Asia was built at a cost of $105
million dollars in the capital city Colombo.
It was supposed to be used for communication, observation and other leisure activities.
It was ceremonially opened in 2019 but remains out of operation today.
It stands as a monument to malinvestment in the country.
There was also a monorail project proposed at a cost of 1.3 billion dollars which luckily
never began construction as it would have been almost as wasteful a project as the Las
Vegas loop.
– Well, maybe quite not that bad…
A deserted four lane highway in Sri Lanka leads to Hambantota, the home region of the
Rajapaksa family where an unused convention center, a massive international airport and
a thirty-five thousand seater cricket stadium which has hosted less than three games a year
since it was opened in 2011 sit.
All are empty and rotting away in the heat.
There is also a $3.1bn port, which was financed by China and is now controlled by Beijing
after the Sri Lankan government incurred heavy losses and gave up on funding it in 2017.
These projects were all built using money borrowed from China as part of the Belt and
Road initiative and have now become a burden to the nation.
The issue is not just the unpaid debts, but the ongoing cost of maintenance required to
preserve any value these white elephant projects may still have.
Newspapers in Sri Lanka claim that “20 percent” of the money borrowed went as kickbacks - being
“paid as commissions” to the Rajapaksa family and their associates.
The family borrowed heavily overseas to spend lavishly in their home region of just 600,000
people and it appears that they spent the money on projects that would make them and
their associates rich rather than benefit the overall economy.
Political corruption is a huge problem for the country, as not only did it play a role
in squandering the wealth of the nation, but it also complicates any possible financial
rescue for Sri Lanka.
Any assistance from the IMF or World Bank would come with strict conditions to make
sure the aid isn’t mismanaged.
The final two blows to the Sri Lankan economy came from external events.
Russia’s invasion of Ukraine caused energy, food and fertilizer prices to skyrocket.
The highest inflation in 40 years in the United States caused the Federal Reserve to hike
interest rates aggressively.
These two events made conditions particularly difficult in emerging markets like Sri Lanka.
The war in Ukraine meant inflation in Sri Lanka, and higher rates in the US pushed up
borrowing costs worldwide and drove the US dollar higher.
This means that any trade invoiced in US dollars is more expensive and dollar-denominated debt
is more difficult to service.
Sri Lanka defaulted on its debt in May, having chosen to use its remaining foreign reserves
to pay for staples rather than to pay creditors.
OK, So, what happens when a country defaults?
Well, “The Paris Club” is an informal group of creditor nations that meets each
month – in Paris - to find workable solutions to payment problems faced by debtor nations.
Their process of restructuring debt which was established in the 1950s typically falls
under what is known as “The Common Framework”, where the negotiation is held in an open and
transparent manner and the creditors coordinate their engagement with the debtor country and
all agree to the same terms of a debt restructuring – which involves some form of debt relief.
China, however, is not a member of the Paris Club, and has a different way of dealing with
countries who are having trouble meeting their debt service obligations.
Sri Lanka, like many emerging markets owes a lot of money to China, who accounts for
around 10 percent of the country’s foreign debt.
The other big bilateral lenders are Japan and India followed by the Asian Development
Bank.
It is difficult to know the exact amount owed to China as they don’t disclose their deals.
The World Bank estimates that around the world, almost a quarter of emerging and developing
countries’ external debt is owed to China, and they have been so far reluctant to restructure
any of it.
Sri Lanka’s debt talks will be closely watched as a test of how Beijing works with creditors
who are in distress, as they have made a lot of emerging market loans, which are under
strain due to rising inflation and the fallout from the war in Ukraine.
I covered that in my last video.
Sri Lanka’s default has left many investors wondering who the next sovereign borrower
to go into restructuring will be.
Foreign investors have been pulling money out of emerging markets for five straight
months now.
This is the longest streak of withdrawals on record.
It highlights how recession fears and rising interest rates are shaking developing economies.
Beyond Sri Lanka, there is a long list of vulnerable countries.
More than 20 of whom have foreign bond yields over 10 per cent.
Spreads on foreign bonds issued by Ghana, for example, have more than doubled this year
as investors price in a rising risk of default or restructuring.
Pakistan, Ghana, Egypt, and Tunisia are all in rescue talks with the IMF right now.
The severity of the crisis means that Sri Lanka is seeking $1.5bn from its biggest bilateral
lenders — China, India and Japan — in bridge financing so that they can resume imports
of badly needed fuel.
Sri Lanka needs large-scale, long-term economic restructuring.
And for that to happen, the government will have to negotiate a working deal with China
as the IMF is not going to give Sri Lanka money just so that it can be used to pay off
its debt to China or any other entity.
The Chinese government is aware that cutting any deal with Sri Lanka will mean that other
countries that owe them money will expect similar deals.
And Beijing obviously would rather not set a precedent on this.
China will most likely have to work with Sri Lanka and other lenders, especially once there
is a new government in place, as China will want to cultivate goodwill and maintain influence
in a strategically important country and probably won’t want to be seen as exacerbating Sri
Lanka’s problems.
If you found todays video interesting, you should watch my recent video on the weaponization
of the US Dollar.
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See you again soon, bye.