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Sri Lanka’s economic crisis explained

After a month of intense civilian-led protests over Sri Lanka’s deteriorating economy, President Gotabaya Rajapaksa agreed to appoint a new council on Friday to lead the formation of an interim government. The resolution would create an all-party coalition in Parliament and remove the control 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, worth an estimated $50 billion, for the first time since the country gained independence from the British in 1948.

Signs of Sri Lanka’s impending economic crisis became increasingly apparent during the last two years of the Covid-19 pandemic as food prices soared and power blackouts increased in frequency. Sri Lanka currently has about $7 billion in total debt due this year.

Many attribute Sri Lanka’s economic crisis to the mismanagement of its finances by successive governments through mounting foreign debt and continued investments in infrastructure. The Rajapaksa administration also implemented sweeping tax cuts in 2019, cutting the value-added tax (VAT) rate, the tax levied on imports and domestic supplies, from 15% to 8%, contributing to a decline in the country’s income.

The president’s older brother, Mahinda Rajapaksa, is expected to be ousted as prime minister as part of a deal brokered by former President Maithripala Sirisena, who defected with dozens of other members of the current president’s ruling party in April in protest of poverty. the Rajapaksas. ruler.

But the power struggle in the country may have sown discord between the two brothers, which could exacerbate their political impasse. On Friday, the Associated Press reported that a spokesman for the prime minister did not immediately confirm the removal of the elder Rajapaksa, saying the prime minister would announce such decisions in due course.

The country continued to accumulate external debt without sufficient income

A big part of Sri Lanka’s economic problems is its mounting foreign debt, mainly to finance its aggressive turn to infrastructure development under former President Mahinda Rajapaksa, Rajapaksa’s older brother and a two-time prime minister. With its finances already bleeding, Sri Lanka has secured major investment loans from state-owned Chinese banks to finance its infrastructure projects, including a controversial port development in the Hambantota district.

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

Over the past decade, Sri Lanka has racked up $5 billion in debt to China alone, accounting for a large chunk of its total foreign debt, according to the BBC. Sri Lanka’s bloated debt to China and the failure of the Hambantota project are often held up as an example of the “debt book diplomacy” that China has pursued over the past two decades.

Some believe that China has extended that approach to currency diplomacy through its ambitious Belt and Road Initiative (BRI), a global infrastructure project that involves Chinese investment in infrastructure developments in parts of the world. Asia, Africa and Europe which is then repaid, as part of China’s bid to increase global influence as a growing economic power. Some 139 of the world’s 146 countries, including Sri Lanka, have joined the China BRI project. While an infrastructure project on such a global scale may provide some economic benefits to participating countries, the BRI has inevitably become a strategic way for China to gain political influence with economically vulnerable countries in the Asia-Pacific region. . At least 16 countries involved in the BRI project have been saddled with billions of dollars of debt that China then leveraged, according to independent analysis by the Harvard Kennedy School for the US State Department.

About 22 percent of Sri Lanka’s debt is owed to bilateral creditors, institutional investors from foreign governments, according to CNBC. Neighboring India has sought to increase its bilateral cooperation with Sri Lanka in part as an attempt to secure its influence in South Asia over China. India recently provided Sri Lanka with a $1.5bn credit line to overcome the country’s fuel crisis, plus another $2.4bn through a currency swap and loan deferral since January.

As the country racked up foreign debt, its tourism sector, previously a $44 billion industry and a main source of income for the island, took successive hits. In 2019, tourism suffered after a series of church bombings killed nearly 300 people, including some foreign nationals.

The following year, the Covid-19 pandemic brought tourism and other major sectors to a halt, causing a global economic downturn. Although Sri Lanka saw an increase in the number of foreign visitors last year, the ongoing pandemic combined with Russia’s invasion of Ukraine, both main source nations of tourism for Sri Lanka before the conflict, continued to slow the recovery of the industry.

The worsening of the crisis triggered mass protests

The country’s problems intensified in March when the Sri Lankan government announced a daily 13-hour power cut as a way to save energy amid the ongoing crisis. Without enough power, many were unable to do their jobs as the economic crisis continued, leading to mass riots. Thousands of Sri Lankans took to the streets in the weeks after the power cut to protest the country’s growing crisis.

On April 1, President Rajapaksa declared an emergency as unrest grew. saw protesters clash with police. The entire cabinet of the Sri Lankan government resigned in protest shortly after the emergency law was implemented, causing Rajapaksa to repeal the law. Among those who resigned was Sports Minister Namal Rajapaksa, another member of the Rajapaksa family and the president’s nephew.

With political unrest growing and no solution in sight, Rajapaksa’s rivals began calling for a no-confidence motion against his administration.

“We are confident that we have the numbers and we will present the motion at the appropriate time,” opposition lawmaker Harsha de Silva told CNBC. Hoping to placate critics, President Rajapaksa tried to form a new unity coalition under his leadership, but failed to gain support. In April, the government also announced that it would temporarily suspend foreign debt payments, marking the first time Sri Lanka has defaulted on foreign loans since independence.

Experts had been warning of a possible dire situation in the country’s finances for some time. When the country defaulted, the government had been negotiating a rescue plan with the International Monetary Fund, which had assessed its accumulated debt as unsustainable.

“The government intends to continue its discussions with the IMF as quickly as possible with a view to formulating and submitting to the country’s creditors a comprehensive plan to restore Sri Lanka’s external public debt to a fully sustainable position,” the Ministry said. Finance in a statement. .

In a meeting with cabinet officials a week later, President Rajapaksa acknowledged his government’s role in the country’s declining economy. Specifically, the president said that the government should have approached the IMF sooner for support in addressing its ungovernable foreign debt and that they should have avoided a ban on importing chemical fertilizers that was meant to preserve Sri Lanka’s foreign exchange holdings, but instead The change hurt their agricultural production.

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

Now, Sri Lanka’s future hinges on whether the president’s proposed government changes will placate his growing opposition long enough for an IMF solution to arrive. However, Sri Lanka’s finance chief Nandalal Weerasinghe has stated that a long-awaited deal could still be months away.