Sri Lanka’s upcoming elections and ongoing negotiations will shape the nation’s economic future, requiring resilience and commitment to sustainable growth
Sri Lanka, once hailed for its economic potential, found itself plunged into turmoil as it grappled with a severe economic crisis in 2022. Months of shortages in essential goods like food, fuel, and medicine culminated in the unprecedented event of defaulting on foreign debt. The ensuing public outcry led to the ousting of President Gotabaya Rajapaksa, setting the stage for a turbulent period of transition and reform.
The consequences of default were dire, with ordinary citizens bearing the brunt of the crisis. Essential commodities became scarce, exacerbating the hardships faced by the populace. The specter of economic instability loomed large, casting a shadow of uncertainty over the nation’s future.
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In the aftermath of Rajapaksa’s departure, Ranil Wickremesinghe assumed office and immediately embarked on a path of austerity. Tax hikes and a crackdown on dissent became the hallmark of his administration’s response to the crisis. These measures, though necessary, stirred further discontent among the populace.
Nandalal Weerasinghe, the governor of Sri Lanka’s central bank, offered a cautious assessment of the nation’s economic trajectory. While acknowledging the stabilization achieved through tough reforms and IMF assistance, he cautioned against complacency, stressing the need for continuity in policy regardless of the governing administration.
Presidential Elections Loom: A Fork in the Road
The upcoming presidential elections, scheduled for September or October, present a critical juncture for Sri Lanka’s economic recovery. Wickremesinghe’s intention to seek re-election sets the stage for a heated electoral contest, with his rivals advocating divergent paths forward.
The competing visions of Wickremesinghe and his opponents highlight the underlying ideological rifts regarding economic policy. While the incumbent favors austerity and adherence to The International Monetary Fund (IMF) guidelines, his challengers advocate for a renegotiation of terms, tax reductions, and increased subsidies.
IMF’s role in Sri Lanka’s recovery cannot be overstated. The IMF bailout package provided a lifeline during the darkest days of the crisis, but the specter of policy uncertainty post-elections looms large. Any deviation from the agreed-upon reforms could jeopardize the progress made thus far.
Remarkable financial turnaround
The pivotal moment occurred in April 2023 when Sri Lanka took the strategic step of raising interest rates. Since then, commercial banks have successfully repaid or collected a significant amount of approximately $3.2 billion. This proactive approach not only bolstered the financial stability of the commercial banking sector but also demonstrated Sri Lanka’s commitment to fulfilling its financial obligations
Against the backdrop of a challenging financial landscape, Sri Lanka faced a default on its financial commitments in April 2023, leading to official arrears. By June 2023, these arrears had surged to a daunting $3.7 billion. However, commercial banks, showcasing their financial prowess and resilience, managed to repay loans and accumulate reserves totaling about $2.8 billion during this period.
A critical challenge arose from the need for banks to settle foreign credit lines, as counterparties were reluctant to renew existing contracts. Additionally, the government’s decision to repay dollar-denominated debt in rupees exposed banks to negative net open positions on their dollar deposits, compelling them to actively collect dollars.
Policy consistency crucial for sustaining economic progress
When policies are consistent and predictable, it provides stability and confidence for businesses, investors, and citizens, fostering an environment conducive to sustainable growth. Here are some areas where policy consistency is particularly important:
- To fully implement the ILO Declaration on Fundamental Principles and Rights at Work, a commitment Sri Lanka is legally bound to internationally, and to enhance compliance as a means of fostering economic and social development, including enhancing Sri Lanka’s competitiveness
- To put into action the National Employment Policy and the National Productivity Policy, with the aim of generating more and better employment opportunities for both genders and contributing to peace and reconciliation efforts
- To minimize the adverse social impacts of economic and legal reforms by advocating for suitable and gender-sensitive social protection measures and enhancing the management of occupational safety and health
- To empower tripartite stakeholders to engage in the formulation and execution of social and economic policies
The China Conundrum: Bilateral Relations and Debt
Sri Lanka’s relationship with China, its largest bilateral creditor, adds another layer of complexity to its economic recovery efforts. Negotiations for debt restructuring have been ongoing, yet no concrete agreement has materialized. The outcome of these talks will undoubtedly shape the nation’s economic future.
Sri Lanka has officially announced a successful agreement with China to restructure $4.2 billion (£3.4 billion) of debt. This deal comes as part of Sri Lanka’s broader efforts to negotiate similar agreements with various creditors, aiming to unlock the next portion of a bailout package.
With a total foreign debt of $46.9 billion, over half of which is owed to China, its primary creditor, Sri Lanka’s ability to strike deals with all creditors is crucial for continued access to funds from a $3 billion bailout program with the International Monetary Fund (IMF). However, the disbursement of the next installment, valued at $330 million, has been on hold since last month due to a failure to reach an agreement between Sri Lanka and the IMF on disbursement terms.
How India helped Sri Lanka overcome economic turmoil
In 2023, as Sri Lanka and India commemorated their 75th year of diplomatic ties, New Delhi emerged as a key ally in Sri Lanka’s economic recovery. Amidst unprecedented economic turmoil, India swiftly provided over USD 4 billion in assistance, surpassing the IMF’s bailout. This support highlighted the enduring bond between the nations. Sri Lanka, acknowledging India’s crucial role, successfully navigated IMF negotiations, crediting India’s Finance Minister Nirmala Sitharaman.
Notably, Sri Lanka utilized the first tranche of the IMF bailout to repay Indian loans, showcasing India’s patience and generosity in aiding its neighbor’s economic challenges.
What’s the plan to tackle the crisis?
Recent agreements with both nations have allowed for the restructuring of these loans, extending Sri Lanka’s repayment schedule.
This development has facilitated an agreement with the International Monetary Fund (IMF) to provide Sri Lanka with a $3 billion loan, supplementing the $600 million loan granted by the World Bank in the previous year.
To manage its debt obligations, Sri Lanka’s government intends to generate revenue through the restructuring of state-owned enterprises and the privatization of the national airline. Additionally, in early 2023, the country implemented income taxes targeting higher earners, ranging from 12.5% to over 36%.
Furthermore, Sri Lanka has increased various taxes to finance essential purchases, such as fuel and food.
What ADB says
The Asian Development Bank cautioned that Sri Lanka’s recovery could face disruption due to sudden policy shifts following elections later this year, despite indications of economic stabilization. To address the government’s financial woes, President Ranil Wickremesinghe implemented tax hikes and reduced subsidies, supported by a $2.9 billion rescue loan from the International Monetary Fund. However, the ADB highlighted concerns that upcoming presidential polls, scheduled for October, could undermine the commitment to austerity measures.
Additionally, the ADB warned that any delays in restructuring Sri Lanka’s external debt could further impact the country’s economic prospects.
Despite Sri Lanka’s expectations of reaching a deal with foreign lenders, including China, its largest bilateral creditor, by the end of March, no agreement has been reached thus far. The ADB projected Sri Lanka’s growth to reach a modest 1.9 percent in 2024, following contractions in previous years.
The World Bank also expressed concerns, noting that the projected growth in 2024 would have limited impact on those still grappling with the aftermath of the crisis. According to the World Bank, over 5.5 million Sri Lankans, representing a quarter of the country’s population, were living below the poverty line of $3.65 per day.
Conclusion
As Sri Lanka tentatively emerges from its worst economic crisis in recent memory, the road ahead remains fraught with challenges. The outcome of the upcoming presidential elections, coupled with external factors such as IMF conditions and bilateral negotiations, will determine the nation’s ability to sustain its fragile recovery. In these uncertain times, steadfast leadership and a commitment to sound economic principles will be paramount in steering Sri Lanka towards a brighter future.
