Sri Lanka is, in the words of its own president, “bankrupt”.
FEBRUARY 2: The Indian Ocean nation defaulted on its sovereign debt in May 2022, plunging the country into economic and political chaos.
The Colombo government secured a $2.9 billion (£2.4 billion) International Monetary Fund bailout in principle the following September.
But the cash will not be released to Sri Lanka until its sovereign creditors in China and India first agree to a restructuring of the billions of dollars of bilateral debt owed to them.
Despite optimism last month that such a deal was imminent, it has yet to materialize, and Sri Lanka’s economic agony and the suffering of its people continue.
However, even if the bailout cash begins to flow in the coming weeks or months, that will not mark the end of Sri Lanka’s economic reconstruction program, just the beginning.
Because it is widely accepted that Sri Lanka’s economic model is in need of a fundamental overhaul.
In the years after the savage end of the government’s 25-year war against separatist Tamil Tigers in 2009, Sri Lanka benefited from a kind of financial “peace dividend.”
The government at the time successfully attracted large inflows of foreign investment, not only from foreign governments like China, but also from private international bondholders.
These financial flows boosted internal economic growth, but at the cost of growing imbalances.
The national economy grew constantly less competitive internationally in these years. And while exports continued to rise between 2000 and 2018, from $6.5bn to $19.4bn, over the same period they plummeted as a share of the economy, from 39% to 23%.
Even before the pandemic struck in 2020, ripping out the heart of the island’s lucrative tourism industry, Sri Lanka’s trade deficit, the gap between its imports and exports, was already over 6% of GDP.
That imbalance is one reason why default hit Sri Lanka so hard: it suddenly found itself without the means to generate the foreign exchange needed to import vital supplies of food and fuel.
Ranil Wickremesinghe, who assumed the presidency after the discredited and maligned Gotabaya Rajapaksa fled the country in July 2022, has made it clear that Sri Lanka’s path to recovery must involve addressing the imbalance at its source and, in particular, boosting the exports.
“We have to transform ourselves into a highly competitive export-oriented economy,” he told local business leaders last year.
“There is no other way out. We are a country with 22 million inhabitants. We have to find markets abroad.”
So the big economic question hanging over Sri Lanka is: can this be done? Can the country trade its way back to prosperity?
Traditionally, Sri Lanka’s major exports have been agricultural, beginning with cinnamon, which attracted European settlers in the 16th century. Today, tea is still the main export product.
But the tea sector is still reeling from a disastrous 2021 ban on fertilizer imports by the previous government, which reduce yields by one fifth.
Looking ahead, increasing agricultural productivity is an obvious avenue for policymakers to explore.
However, many companies in the tea sector present themselves as “artisan” producers, with the leaves still plucked by hand as they were two centuries ago, when the British Empire began planting. And many farms still use archaic processing equipment.
Adding to this, Roshan Rajadurai, general manager of Pedro’s farm in Nuwara Eliya, says his workers are resisting new, more efficient harvesting methods.
He wants to move to a model in which pickers and their families are given individual sections of the plantation to harvest themselves, and they set their own hours, rather than working in large traditional work teams for fixed daily hours.
It’s a reform that Rajadurai says has been shown to increase yields where it’s been adopted, but he says collectors are resisting.
“If we don’t, I think with rising costs and the static prices we get in world markets for our product, I don’t think we can be sustainable in the long term,” he warns.
Textiles, which make garments for Western brands, are another major source of exports for Sri Lanka.
But this, even more than tea, relies heavily on imported raw materials and fuel, the price of which has skyrocketed in the wake of the pandemic and Russia’s invasion of Ukraine.
Those prices should come down this year, but the reality is that tea and textiles, while likely to always be important, are unlikely to push Sri Lanka very far up the global export value chain.
So what else could Sri Lanka export?
What is surprising is that when talking to politicians and analysts in Sri Lanka, as Newsnight did in January, there is very little sense of a grand plan.
Unlike other Asian nations like Malaysia or Vietnam, which have seen a big state push into electronics manufacturing, there is not a strong sense that one hears of a particular sector where the country can and should gain an advantage.
The area closest to a possible national champion is probably that of port services.
The county’s central bank governor, Nandalal Weerasinghe, says Sri Lanka’s geographical location, at the center of the Indian Ocean shipping lanes, offers the opportunity to be a major “transshipment” hub.
“Ports and logistics is where the potential exists for them to promote exports,” he says.
It is estimated that one third of the world’s bulk cargo, and two thirds of its oil, are transported via the Indian Ocean.
But perhaps the absence of a clear national plan doesn’t matter as much as getting the basics of economic policy right.
In the midst of last year’s crisis, the government removed the currency peg, resulting in the rupee’s value halving against the US dollar. Some think that keeping a floating exchange rate will ultimately help boost exports.
“[In the past] we didn’t allow it to depreciate or adjust according to market forces, which has basically discouraged exports,” says Roshan Perera, of the Advocata think tank, and a former head of the central bank.
Another area to reform identified by the World Bank is, ironically, to liberalize imports and dismantle tariffs. These duties make many imported goods and products more expensive, which benefits domestic producers, such as those in the retail and construction sectors.
global trade
Sri Lanka is considered to be one of the most protected economies in the world in terms of import duties on consumer goods.
The argument is that liberalization could attract more foreign investment, which will help make the country’s industries more efficient and export more.
The question is whether, despite the change of president last year, there is enough political space for Wickremesinghe to dismantle trade barriers, which will inevitably draw opposition from powerful local vested interests.
The optimistic case is that last year’s shock will provide an impetus for such painful reforms and give Sri Lanka at least a fighting chance to emerge from the worst economic crisis in its history.
