Sri Lankan economic and political crisis

• Sri Lanka’s latest political crisis, who governs the nation?
• Poor economic indicators adding to the nation’s woes

Sri Lanka is currently embroiled in a political crisis, which is no lesser than a battlefield for the attainment of power. This political flux is the culmination of a power struggle between the country’s ruling coalition, which is currently headed by the President Mr Sirisena and the Prime Minister Mr Wickremesinghe. It was way back in 2015 that these two politicians from rival parties and contradictory ideologies came together to oust Mr Rajapaksa, the country’s former President (2005-2015). However, thereafter, this union soon turned bitter and lasted for just about three and a half years.

The former president is hailed as a hero by few people in the country’s Sinhalese ethnic majority as he was credited for ending the 26-year long civil war and the defeat of Tamilian ethnic minority rebels back in 2009. He, however, has faced flack by the international community on corruption, war crimes as well as nepotism. It is a known fact that Mr Sirisena is trying to get back Mr Rajapaksa to power as the country’s Prime Minister.

On October 26^th, 2018, Sirisena stripped Wickremesinghe’s powers as the PM and instated Rajapaksa hoping that he would convince enough MPs to join his government. Although, the new amalgamation failed and on November 09, 2018, Mr Sirisena abruptly dissolved the Parliament and called for snap elections in January 2019. A move that seemed to defy the Sri Lankan constitution or more specifically the terms of its 19^th amendment; a legislation which came into force in 2015 and limited the powers of the President quite significantly. This move was vehemently opposed by Mr Wickremesinghe, members of the ruling party, other supporters including the public as well some Buddhist monks. This also garnered a strong condemnation from foreign diplomats based in Colombo, who urged that the democracy and constitution should be respected. While Mr Sirisena cited a clause for justification of his move, which was a general clause in the Constitution. The petitioners, who challenged President’s act argued that a clause in the 19^th Amendment states that the Parliament cannot be dissolved until after four and a half years of elections, unless and until two-thirds of the Parliament members vote for the same.

In a further twist of events, on 13^th of November, the Supreme Court overturned the President’s dissolution move and stalled preparations for snap elections. The court will hear petitions against President’s decision on 3^rd and 4^th of December.

This political drama has done no good for the Sri Lankan economy, which was already reeling under several signs of distress, a stagnant GDP growth rate, declining FDI, declining reserves, slowing exports and staggering debt to the GDP.

The Sri Lankan economy started exhibiting signs of a distress as early as 2013. A widening current account deficit, slowing growth, low forex reserves were weighing down the rupee. It is an export-oriented economy and took a hit when exports started falling, both as a percentage of the GDP as well as in dollar terms, this further strained the country’s reserves. For example, Sri Lankan exports fell significantly from 33.3% of the GDP (2000) to a mere 12.7% of the GDP (2016). The economic crisis manifested around 2012-13 when the economy registered a slowdown in its growth, dipping significantly from the growth registered immediately (temporarily) after the war years. In addition, the country’s currency was kept artificially high by a supply of dollars in the market from the exchequer, with already scanty reserves. As the forex reserves were funded by borrowings and not through earnings, these soon fell to diminishing levels, thereby, depriving the market of any more dollars. On the contrary, imports kept ballooning up and lead to a widening trade deficit, which ranged around US$10 bn. Sri Lanka attempted to tackle this partially by using the remittances from abroad, in order to cushion a part of the gap. When this also fell short, the country borrowed more funds to fill the remaining gap. It reached a situation of falling revenues, widening trade deficit and therefore, lack of funds to pay off maturing debt stocks, this compelled the government to increase its borrowing.

In essence, the present-day government inherited a debt-laden economy, although it does not seem to have tackled the issue too well either. Macroeconomic factors continue to show a sign of distress with a staggering level of debt still persistent and continues to be a major cause of concern for the nation. In fact, with a BOP or Balance of Payments crisis in 2016, Sri Lanka was bailed out by the IMF, which allowed the country to draw down a three-year bailout package worth US$1.5 bn.

Furthermore, Sri Lanka’s foreign debt more than doubled to US$18.6 bn (2009), which was up from US$9 bn (2000). However, this only worsened and skyrocketed to the staggering US$42.9 bn (2014) and was reported to be approx. US$46.6 bn (2017).

Estimates suggest that the country’s debt service costs will be approx. US$4.2 bn next year (2019) with nearly US$15 bn due to mature between 2019-22. The debt service cost is also expected to rise given the country’s depreciating currency. Rajapaksa borrowed heavily from China in an attempt to rebuild the country after 26 years of civil war that ended in 2009. It is publicly known that Rajapakse relied heavily on China to finance grand infrastructure projects, but many of these ended up becoming a burden on Sri Lanka's US$87 billion economy. Approximately 80% of Sri Lankan government’s revenues go towards debt servicing cost. Moody’s, warned that policy uncertainty could potentially hurt investor sentiment, thereby, making it difficult for Sri Lanka to refinance the debt that matures as early as next year (2019) at an affordable rate.

Albeit the loans were taken during Rajapaksa era that eventually thrust the country into the debt, the decision to give strategic control of a southern port to China was taken by the then presiding PM, Wickremesinghe after the port lost money and was eventually sold to a state-owned Chinese firm in a debt-to-equity swap on a 99-year lease. On similar lines, an international airport named after Rajapakse also ended with the same fate, with its revenue insufficient to meet the requisite salary bill. Addedly, China is involved in the funding of several other major infrastructure projects such as the Central Expressway, Colombo Port City as well as the Norochcholai coal power plant. These external debts from China have alarmed the international community with many terming it as a debt trap.

In nominal terms vis-à-vis 2% (September 2017) the LKR or the Sri Lankan Rupee has depreciated by 10% (September 2018). This, in conjunction with a significant external debt stock of 60% of the GDP, which makes the country highly vulnerable to currency depreciation. In a study by Nomura, which covered 30 countries and was conducted last month, Sri Lanka topped the list with a likelihood of currency crisis owing to significant refinancing needs to give the high short-term debt (US$7.5 bn) coupled with modest forex reserves.

While the political drama will further unfold with the hearing in the Supreme court next month, it is yet to be seen who will finally retain the post of the Prime Minister. In conclusion, it can be stated that none of these events made a positive impression on the market already plagued with myriad issues.