The Sri Lanka paradox

Shortage of food and medicines, rationing of fuel, and load shedding of electric power, made the daily life miserable for almost everyone except the elite class

The key to avoid such a gruesome situation is good governance and equitable sharing of the benefits of growth where the majority of the population rather than a narrow elite class derives the benefits. Self aggrandisement and maximisation of personal and familial interests by the elites to the exclusion of others are no longer acceptable to a more informed, urbane, and educated youthful population of this day and age. Corruption and nepotism have to be contained and pomp and protocol given up by adopting simple and austere lifestyle. Basic public services have to be delivered while rule of law has to be observed with cheap and expeditious justice available to every one

Sri Lanka has long been admired by development economists, international financial institutions, and public intellectuals for leading South Asia in all economic and social indicators. Per capita income of $ 3,853 in nominal terms (almost twice as much as India’s) and $ 12,850 in PPP dollars, poverty headcount (measured at $ 1.90 per day) less than 1% of the population and multidimensional poverty of 16% placed the country ahead of every other country in the region. The country was the first one to pursue economic liberalisation as early as 1977 by introducing less restricted foreign trade and investment regime compared to the three large economies in the region. 

The ratio of Exports of Goods and Services to GDP reached 23.1%. As a matter of fact in 1977 the aspirational goal for the country was to become Singapore of South Asia, a place which has since been taken over by Dubai. The long protracted civil war that lasted almost 30 years was a serious setback in translating this vision into fulfilment. After the war ended in 2009 the country resumed the path of recovery and recorded a gradual, slow but stable growth until 2019. 

With the highest ranks in the region on Human Development Index, Human capital Index, Hunger Index, and population growth rate of 1.1%, 100% enrolment and completion rates in primary and secondary schools with gender parity, literacy rate of 92%, average years of schooling of 11.1 years (almost twice that of Bangladesh), and life expectancy of 77 years, the country has piled an impressive record better than any of its neighbouring countries. The same is true in respect of immunisation rate, maternal mortality rate, access to safe drinking water, basic sanitation services, stunting rate (17%) and undernourishment limited to only 7% of the population. Electricity is available to 100% of the population. Military expenditure had come down to only 1.9% of GDP freeing up resources for infrastructure and social sectors. 

Thus from an economist perspective most of the ingredients for steady inclusive growth and broad based social and economic development were present. Sri Lanka graduated to become a middle income country in the early 2000s. In brief, “Sri Lanka has more happiness, less hunger, better human development, less wealth inequality, and better gender equity” than India, Pakistan or Bangladesh. 

The question then arises as to why we are observing a paradox where the conventional development indicators all look promising but the people of this well-placed country had to suffer within a very short period miserable conditions in the form of high inflation, shortages of food, fuel and medicines, electricity outages for hours, high unemployment, sharp drop in farm incomes, closure of many small businesses and a precipitous decline in their living standards. The state of desperation against living conditions was so intense that a widespread grass root unorganised spontaneous movement against the ruling class forced the President to abandon and flee the country. The wrath of the people was so severe that another member of the family couldn’t board the plane as the other passengers won’t allow that to happen. 

An objective analysis would separate the external factors that impinged upon this dismal state of affairs from the domestic policy failures and lapses, economic mismanagement and poor governance. Of course, the devastation created by the civil war had imposed a huge cost to both physical and social infrastructure. More importantly, the war fractured the society and divided them into ethnic and religious groupings. The pandemic of COVID-19 did interrupt recently gained economic momentum as a negative growth rate of 3.6% was recorded in 2020. 

Lockdowns and the 2019 bombing of the churches in Colombo dried up the tourist traffic—a major source of foreign exchange earnings and also provider of direct and indirect employment in the country. The recent Russian-Ukraine war and the aftermath of the sanctions against Russia led to a spike in the global commodity prices of food, fuels, and fertilisers. The lockdown in China did disrupt the supply chains with its attendant consequences for developing countries. Thus unfavourable external conditions did contribute to the adversity faced by the country. 

Greater damage by domestic policy and governance failures than external factors

Although empirical evidence to determine the relative contribution of external vs. domestic factors is not available the consensus view of the analysts and observers appears to postulate that greater damage was done by domestic policy and governance failures rather than the external factors. Mahinda Rajapaksa who came to power in 2005 and stayed as President until 2015 was followed by his brother Gotabaya from 2019-2022. Thus the Rajapaksa family ruled the country for all these years except a short period of four years during which Sirisena held the office of the President. 

The question then arises as to why we are observing a paradox where the conventional development indicators all look promising but the people of this well-placed country had to suffer within a very short period miserable conditions in the form of high inflation, shortages of food, fuel and medicines, electricity outages for hours, high unemployment, sharp drop in farm incomes, closure of many small businesses and a precipitous decline in their living standards. The state of desperation against living conditions was so intense that a widespread grass root unorganised spontaneous movement against the ruling class forced the President to abandon and flee the country

Having been successful in bringing the civil war to an end the family mobilised their support among the majority Sinhalese population which empowered the President to concentrate powers in his own hands with little checks and balances. The Prime Minister, the Cabinet and the Legislative assemblies existed but had little control on what the President was doing. Mahinda started spending generously on huge infrastructure projects some of them of questionable economic value—the most notorious that is cited widely in the wrong context of the Chinese assistance program—was the port of Hambantota near his home town. That was not the only one but many others followed. The family ruled the country for 13 years more than Chandrika Kumaratunga and Jayewardene who each held the office for 11 years.

Gotabaya went out of the way by appointing Mahinda Rajapaksa as the Prime Minister, another brother as Finance Minister and other brothers held Cabinet positions and a dozen of top officials including the head of SriLankan Airlines among other relatives in the Rajapaksa family. This brazen act of nepotism along with allegations of systematic corruption and enormous wealth accumulation, transfer and acquisition of assets abroad by the family members at a time when the ordinary citizens were facing economic difficulties was the first trigger of widespread resentment. 

The second trigger was when taxes were cut, interest rates reduced, new commercial loans taken, and money supply expanded. Personal income tax, corporate tax and value added tax rates were reduced, threshold levels raised and sectoral exemptions granted generously leading to revenue losses exceeding 2% of GDP on an already narrow tax base. As a consequence of these tax cuts, and exemptions one million taxpayers got excluded from tax payments while for others the burden was considerably reduced. As a result of these uncalled for tax cuts, Revenues/GDP ratio slipped from 13.5% to 7.7% of GDP in 2021 while at the same time Expenditure/GDP ratio was allowed to escalate to 20.3% from 18.8%.

Government subsidies and grants rose to 30% of Government spending. Consequently the fiscal deficit jumped to 12.6%. The automatic fuel pricing mechanism was discontinued raising fiscal losses of the State owned enterprises. Fiscal imbalances were financed by resorting to excessive borrowing from the Central Bank which resorted to printing the high powered money. Money supply increased by 42% in nine months as Rs. 588 billion were printed in the first quarter of 2022 on the top of 1,225 billion in the preceding year. 

Sri Lanka recorded a rapid increase in Public Debt/GDP ratio to 119% from 42% over a few years. Access to international capital market was lost, export earnings plummeted, import payments swelled up due to global price increases prompting depletion of foreign exchange reserves to critically dangerous levels. Export earnings from tourism which was $ 4.4 billion in 2018 or 5.6% of GDP dipped to 0.8% of GDP. Remittances started drying up too shrinking from $ 612 million in April 2021 to $ 205 million by February 2022. Petroleum prices tripled from $ 40 a barrel to $ 120 in a short span of time making it almost difficult for the Government to find the resources to place orders for replenishing or building stocks. As FDI was channelled mainly to cater to domestic market demand the profits were repatriated in foreign exchange further putting pressure on current account. 

It is pertinent to mention here that contrary to popular misperception China has only 10% share while International Sovereign bonds account for 50% of the total external debt of Sri Lanka of $ 51 billion. The ratio of External Debt to GDP has risen from 30% to 42.6%. As the country fell into middle income category it was no longer eligible to secure concessional loans from the multilateral institutions and bilateral creditors and therefore the terms and conditions of the loans were market determined and depended on sovereign rating by credit rating agencies. Once the ratings were downgraded, roll over of sovereign bonds through new placements became difficult. Rajapaksa and his brothers were reluctant to approach the IMF as they considered the conditionalities required would be unacceptable politically. The country had no other option but to default on its external service payments of $ 7 billion for the rest of 2022 against reserves of only $ 1.9 billion. 

The third trigger was the decision to ban the imports and use of chemical fertilisers and transition to organic fertilisers. This unwise decision has cost the country a fortune because two-third of the population depends on agriculture directly or indirectly. The output of the country’s staple diet rice sank precipitously by 20% and rice had to be imported at a time when the world prices were high, the country was short of foreign exchange and the Sri Lankan rupee was depreciating. Domestic rice prices to consumers recorded a hike of 50% in seven months. 

Export earnings from tea also dried up as the industry suffered losses of $ 425 million further harming the balance of payments position. Other essential food items such as wheat, sugar, and milk powder also suffered output decline and the demand for foreign exchange increased to import these commodities. The sharp fall in rural incomes and erosion in the purchasing power of the urban consumers of food and other agricultural products created a lose-lose situation for everyone instead of the traditional winners and losers arising from public policy interventions. Depreciation of currency by 75% in March to June skyrocketed import costs adding to inflationary pressures. The speculators, taking cognisance of the depleting reserves, entered the market to hoard foreign exchange and intensified the pace of the downward movement of the parity rate. 

Corruption and reckless spending and borrowing

It would be fair to add that the period 2015-19 was also characterised by allegations of corruption and reckless spending and borrowing. So it was not only the Rajapaksas but systemic corrosion of body politic by the elites that has contributed to the present state of affairs. The cumulative effect of all these arbitrary, populist flawed policies and mismanagement, nepotism, greed and wealth accumulation by the ruling classes combined with adverse external economic circumstances resulted in massive increases in prices and shortages of the essential goods and services. Shortage of food and medicines, rationing of fuel, and load shedding of electric power, made the daily life miserable for almost everyone except the elite class. Headline Inflation on year to year basis hit a record high of 54.6% in June 2022 as a result of imported inflation, supply shocks, fiscal profligacy and loose and accommodating monetary policy. 

The misery faced by the citizens brought together for the first time in the history of Sri Lanka all segments of the divided population—Tamils, Sinhalese, Muslims, Christians – together on a single platform to pursue a single point agenda i.e. get rid of those who had inflicted this misery. This social cohesion precipitated the popular uprising, the occupation of the Presidential palace, the resignation and fleeing of Gotabaya from the country. The majoritarian rhetoric and authoritarian nationalist stance that the Rajapaksa family had exploited for their advantage for over a decade did not help them when the chips were down. 

The Arab spring uprisings in the Middle East in the 2010s, the abrupt exit of Ashraf Ghani from Afghanistan after the Taliban take over and the fleeing of an otherwise strong man in Sri Lanka should open up our eyes to some bitter truths. In this world of instant communication and social media the rulers ought to be careful not to antagonise the masses to the point where their patience threshold reaches its brim and they have no other option but to mobilise themselves spontaneously but ruggedly to ventilate their pent up emotions against those who have abused power for their own, family and cronies benefits. 

At that time the distinctions arising from ethnicity, language, sect, region, gender all disappear and the wrath is so fierce that the soldiers, policemen and law enforcing agencies are hesitant to take coercive measures against the agitating masses not because of the huge numbers, but out of empathy with the agitators as they themselves are facing identical conditions. 

The key to avoid such a gruesome situation is good governance and equitable sharing of the benefits of growth where the majority of the population rather than a narrow elite class derives the benefits. Self aggrandisement and maximisation of personal and familial interests by the elites to the exclusion of others are no longer acceptable to a more informed, urbane, and educated youthful population of this day and age. Corruption and nepotism have to be contained and pomp and protocol given up by adopting simple and austere lifestyle. Basic public services have to be delivered while rule of law has to be observed with cheap and expeditious justice available to every one. 

Accountability of public office holders needs to be ensured. Merit, performance and competence rather than loyalty, familial relations or political connections should be the guiding principles for choosing the individuals running the Government organisations. Sound economic management should not be sacrificed for the sake of short-term political expediency. These essential elements of Good Governance and management are the only guarantee that the countries would enjoy peace and prosperity and the leaders earn the respect and confidence of the citizens. 

In the end, some food for thought for all of us in the development community who have become passive consumers of a plethora of global indices of all kinds that have gripped our minds. Single issue advocacy groups and international agencies with specific mandates —both inter governmental and NGOs—have found that a quantitative measure such as an Index is a persuasive tool as it confers a lot of respectability for their messages. In most cases a partial positive correlation is asserted between the value of their particular index and general economic betterment. The Sri Lanka paradox—a vivid example of star performer on many of these global indices gone sour—raises serious question about the veracity, authenticity and credibility of these indices which have become a commonplace tool for comparative country analysis and policy actions.

(The writer is a Pakistani banker and economist who served as the Dean of the Institute of Business Administration (2008-2016) and the Governor of the State Bank of Pakistan (1999-2006). He was Advisor to Prime Minister Imran Khan for Institutional Reforms and Austerity, in office from 2018 to 2021 and is also the former Director of the World Bank.)