Sri Lanka has suffered severe damage. With disruptions to one of its largest export streams of tea facing a nearly 18 per cent decrease in its production, it is clear that a great deal needs to be done for Sri Lanka to restore its nation.
Speakers Mr Brian Lee Shun Rong, Mr Devadas Krishnadas and Dr Gunter Dufey at an event titled “The Economic, Financial and Political Crises in Developing Nations”, jointly presented by The International Affairs Society (IAS) and Economics Society (SIMES) bring the discussion of this crisis to the table. The speakers shared their insightful perspectives on the underlying problems Sri Lanka had which eventually led to its rapid spiral into crisis.
Sri Lanka’s downfall is something that other developing nations struggling to stay afloat in today’s political and economic climate, should pay close attention to. Otherwise, Sri Lanka’s situation may just be a sinister foreshadowing of their fate. These are three major areas that countries should avoid to prevent themselves from committing the same mistakes.
- The Piling of Foreign Debt
The piling of foreign debt is one of the biggest causes of Sri Lanka’s collapse. Its debt-to-GDP ratio is 111 per cent, which means that it owes a lot more money than it is able to bring in. In 2019, the Asian Development Bank flagged this problem, mentioning that the “country’s national expenditure exceeds its national income and that its production of tradable goods and services is inadequate”.
The causes of this can be traced to the arguably irresponsible decisions made by its political leaders. A research paper written by Research Analyst at the Institute of South Asian Studies (ISAS) Ms Namrata Yadav, alongside Distinguished Visiting Research Fellow Mr Vinod Rai, highlights how Sri Lanka’s present situation is not one “created by a single misguided policy”, but “caused by policies gone wrong at the hands of populist jibes by consecutive governments”. With heavy borrowing of funds from international lenders like China and the United States (US) to aid the country’s post-civil war reconstruction, alongside the tax cuts enforced by former President Gotabaya Rajapaksa in 2019, the country ran low on public revenue when it needed it the most.
Sri Lanka has a long history with the International Monetary Fund (IMF). Since 1965, the country has required a total of 17 interventions from the world’s “financial crisis firefighter”. However, considering how the IMF’s economic reforms as prerequisites for lending are often counterproductive for economies, Sri Lanka working with the IMF for extensive bailouts does not seem to be a promising way of sustainable economic development.
In a research paper titled “Institutions and Foreign Direct Investment (FDI): evidence from developed and developing countries” authored by Kamran Abbas, Samina Sabir and Anum Rafique, it is highlighted that multinational corporations (MNCs) will avoid “every type of threat” that discourages the inflow of FDIs —substantial, lasting investments made by a company or government into a foreign concern. In other words, such MNCs would avoid engaging in FDIs “in cases of political instability due to high risk” and would rather invest in risk-free countries.
Considering how Sri Lanka has amassed approximately US$48730.71 million (S$66804.20 million) in external debt to date, it, therefore, comes as no surprise that a country so deeply buried in financial debt would scare off potential investors and international businesses to its market. This could lead to grave repercussions for Sri Lanka as the introduction of these stakeholders is pivotal for its economic development.
Another area in which countries need to be cautious to prevent the excessive buildup of foreign debt is trade deficits. High trade deficits refer to a country’s imports exceeding its exports during a given time period. In such cases, it is not uncommon for countries that run trade deficits to take up loans from wealthier nations like Sri Lanka did to progress in an increasingly competitive global landscape. However, the problem lies when the loans they take up are significantly greater than their ability to financially pay them off.
A country is said to have unsustainable debt when the growth and stability of its economy are jeopardised by the accumulated debt. This can be extremely dangerous as it can cause a country to fall behind in fulfilling its financial obligations, lose market access and face higher borrowing rates.
In the case of Sri Lanka, it is no longer able to support its citizens because of its state of debt and bankruptcy. The inflation rate has risen to 61 per cent as of November 2022, leaving Sri Lankans struggling to afford their basic daily necessities like food and medication. Countries should therefore be cautious of the extent to which they take up such loans, since it could result in the build-up of unsustainable debt and subsequently bankruptcy.
What countries can learn from Sri Lanka in this instance is to better manage the taking up of loans and running of trade deficits to ensure the country has measures and infrastructures in place to help strengthen its economy in order to support these financial choices. This can be done through the redirection of national savings towards more long-term productive investments as well as the restructuring of its unsustainable debt.
- Low Revenue to GDP Ratio
Sri Lanka’s dwindling earnings and extremely low revenue-to-GDP ratio is another situation other countries should avoid. GDP refers to Gross Domestic Product— a measure of the monetary value of final goods and services produced in a country in a given period of time.
The graph above depicts the extent to which Sri Lanka’s revenue-to-GDP ratio has been affected over the years. The sharp drop in total revenue as a percentage of GDP from 15 per cent in 2019 to about nine per cent 2021 shows just how quickly the county spiralled out of control.
In an article titled “Sri Lanka: Why is the country in an economic crisis?”, Ayeshea Perera from BBC News brought to light how the country’s lack of attention on exports and focus on imports led to it running out of foreign currency; which plays a critical role in enabling cross-border trade, investments and financial transactions. With the number of imports amounting to US$3 billion (S$4.11 billion), up to US $2.73 billion (S$3.74 billion) more than its exports every year, the country’s foreign currency reserves are sinking to an all-time low.
In order to avoid falling into a similar situation as Sri Lanka, other countries should ensure that they are able to maintain a high revenue-to-GDP ratio. This can be enforced by maintaining a balance in the number of imports and exports that the country produces. Imports are important as they are able to provide a country with goods and services that they may not be able to obtain locally. Exports are equally, if not more important for a country’s economy as they can stimulate domestic economic activity by creating employment opportunities and opportunities for collaboration with other nations.
- Lack of Free Trade Agreements
Free trade agreements (FTAs) are legally binding international treaties between two or more partner trading countries that seek to promote trade by reducing barriers in areas such as goods, services and investments. The main merits of FTAs include a significant reduction of tariffs and encouraged collaboration between countries. With significant reduction in tariffs, countries will be more inclined to purchase products due to the lower costs of obtaining these goods. This brings about increased economic growth for both countries as the buyer is able to save costs since products are sold at a reduced price while the seller is able to profit off the sale of larger amounts of inventory. Theoretically, this dynamic allows for a win-win situation for both parties involved in the free trade agreement.
The figure above, obtained from a research paper titled The US-Singapore Free Trade Agreement: Effects After Five Years, written by D. Nanto, showcases the scale in which a country can benefit from being involved in FTAs. The revenue collected post-FTA increased greatly from US$16.6 billion (S$22.76 billion) to US$22.3 billion (S$30.57 billion) in 2009, proving that engaging in these agreements can bring great productivity to an economy. It can be concluded that FTAs strengthen and increase a nation’s foreign reserves as it facilitates the inflow of economic activities through imports and exports.
In Sri Lanka’s case, gross official foreign reserves have been falling steadily from the middle of 2019 to 2022. This decline is caused by several factors including the sudden hit of a global pandemic as well as the new governance under the Rajapaksas. Compared to other states like the US which have been able to secure more stable economies through their engagement in FTAs, Sri Lanka could have done the same.
Sri Lanka is a large nation and has substantial potential as to what it can offer to the trade industry.
With vast access to natural resources, the country has a natural advantage in terms of goods it can produce for exports and thus generate income from. Currently, 52 per cent of the total exports from Sri Lanka are from garments and textiles, 18 per cent from tea and the other 30 per cent from natural products such as spices, gems, rubber and fish. Sri Lanka has chosen to use its natural resources as its main source of its exports but there is definitely more that can be done to expand the range of products and even services for export.
Mr Devadas highlighted that Sri Lanka could learn from Singapore, for it has been successful in leveraging the benefits of the trade industry. Having forged a strong network of 27 implemented agreements from a myriad of countries; including China, Korea, Australia and the United Kingdom (UK), Singapore has been able to secure revenue by expanding its market for its goods and services to these partners.
“We have focus. That focus was growth.”, Mr Devadas emphasised, adding that this was what Sri Lanka lacked, for it mainly believed in its “strong legacy investments, prevalently agriculture”.
Despite the lack of natural infrastructure and resources to be able to export agricultural products, Singapore was still able to generate large revenue from exports by playing to the strengths of its strong workforce and offering quality products such as machinery and transport equipment, accounting for up to 43 per cent of all exports.
In other words, Sri Lanka would have the potential to benefit significantly if it were to involve itself in more FTAs with other nations. It is crucial for nations to diversify their income streams and bring their attention to exporting goods outwards to yield greater returns.
What Now for Sri Lanka?
Sri Lanka was not able to set in place the measures they direly needed in order to keep their country progressing due to their lack of forward thinking. A country would need to have reserves and plans set in place in case any unforeseen circumstances disrupt the nation. Financial reserves are an antidote to difficult and unexpected situations and provide a buffer for countries to recover from any form of calamity.
An exemplification of this would be Singapore’s response to COVID-19. The country drew S$42.9 billion worth of past financial reserves, allowing the country to stay afloat and provide the necessary support for its citizens during this unprecedented time.
Vietnam is another such country that was able to maintain its economy albeit the spread of a pandemic. In fact, the country’s economy expanded by 2.9 per cent during the pandemic— one of the highest in the world. Their success was in part due to the resumption of domestic activities and impressive performance in exports, especially in high-tech electronics, which was in demand as many people across the globe turned to remote working.
Unlike nations like Vietnam, quick economic recovery for Sri Lanka still remains a pipe dream. Sri Lanka still has a long way to go and it will require many years of work to undo the damage caused by past political parties.
The state in which Sri Lanka is in today is an extremely devastating one and has regressed beyond an economic crisis, tipping the nation into a humanitarian crisis. With fuel and medicine shortages, extremely rapid food price inflation, with a record of 90 per cent, and the closure of schools, the country is struggling to be able to provide the basic necessities for its people. Sri Lankans are left facing the brunt of the political system that has failed them.
Other developing nations can and should use Sri Lanka’s negative experiences as critical lessons that can be extracted, examined and improved on to prevent themselves from facing such calamity in the near future as with proper management and governance, a country can save themselves from impending economic; or worse, humanitarian crises.
