Austerity measures on trial in Sri Lanka’s first election since economic collapse

• The economy will be the key issue for voters in Sri Lanka’s upcoming presidential election, set against a backdrop of geopolitical rivalry

By Dr Chietigj Bajpaee

When Sri Lanka heads to the polls on 21 September in the country’s first presidential election since its 2022 economic meltdown, the economy will be the key issue for voters. The election will serve as a referendum on the difficult austerity measures imposed on the country’s road to recovery.

 Sri Lanka underwent a sovereign default in April 2022 as its foreign exchange reserves ran out and public debt stood at more than $83 billion, half of which was owed to foreign creditors. Soaring inflation at close to 70 per cent and commodity shortages triggered large-scale unrest that ultimately unseated President Gotabaya Rajapaksa from power.

 In 2023, the government of Interim President Ranil Wickremesinghe secured a $2.9 billion bailout from the IMF – the 17th in the country’s history.

 Sri Lanka has been on the road to recovery since then with lower inflation and borrowing costs and a strengthened Sri Lankan rupee. This has been facilitated by higher than anticipated growth, a revival of the country’s tourism industry, and a string of structural reforms aimed at reining in public spending and raising tax revenues. Debt restructuring measures with bilateral lenders including India, China, Japan and France have also helped attract additional financing from the World Bank and the Asian Development Bank.

 Nonetheless, Sri Lanka continues to face several economic challenges. Between 2019 and 2023 poverty levels more than doubled with over a quarter of the population living below the poverty line. Sri Lanka holds the world’s highest interest payments to government revenue ratio and the grace period on bilateral loan repayments will expire in 2028.

 There are multiple reasons for Sri Lanka’s economic distress. China is its largest bilateral creditor and the country has become synonymous with the narrative of China’s ‘debt trap’ diplomacy. Claims over China’s opaque lending practices and predatory economic activities gained momentum when Beijing secured a 99-year lease for the Hambantota port project in 2017 after Colombo was unable to service its debt obligations.

 But this narrative fails to take into account the damage done by economic mismanagement and unwise policies put in place by previous Sri Lankan governments. These have included tax cuts, subsidy increases, and debt-fuelled infrastructure spending that worsened the country’s fiscal position, as well as a ban on fertilizer imports that led to an increase in food imports.

 Nor does it take account of external factors, such as the COVID-19 pandemic and the 2019 terrorist attacks on churches and hotels, which crippled Sri Lanka’s tourism industry.

 Geopolitical fault lines

There is also a geopolitical angle to developments in Sri Lanka. Regular visits by Indian and Chinese naval vessels illustrate Sri Lanka’s importance in the geopolitical rivalry between the two countries –and this has policy implications.

 For instance, delays in the release of the second tranche of an IMF loan to Sri Lanka last year was attributed to China’s stalled approval of a debt relief framework. This was fuelled in part by China’s reluctance to join the official creditor committee that is co-chaired by India (alongside Japan and France), preferring instead to discuss debt relief efforts with Sri Lanka bilaterally through its Exim Bank.

 While governments in Sri Lanka – and across South Asia – tend to oscillate between pro-India and pro-China rhetoric, in reality, they cannot afford to alienate either country. In January 2024, the Sri Lankan government declared a moratorium on foreign research vessels, amid concerns over visiting Chinese ships – but there are already plans for this ban to be phased out to reaffirm Sri Lanka’s geopolitical neutrality.

 However, there will be differences depending on who wins the election. For instance, one of the presidential candidates, Anura Kumara Dissanayake who is aligned with a coalition of left-leaning parties, has pledged to cancel an Indian wind power project if he is elected amid claims it challenges Sri Lanka’s ‘energy sovereignty’.

 China and India are also not the only major powers with interests in Sri Lanka. In 2023, the US International Development Finance Corporation announced a commitment of half a billion dollars to support the development of a deepwater shipping container terminal in the Port of Colombo. Such projects aim to dilute China’s economic influence and reaffirm Sri Lanka’s geostrategic importance along vital maritime trade routes in the Indian Ocean.

 Key challenges await new president

There are more than three dozen candidates in the upcoming presidential election but the four key candidates are the incumbent, Ranil Wickremesinghe; centre-left Sajith Premadasa; Namal Rajapaksa, the son and nephew of former presidents Mahinda and Gotabaya Rajapaksa; and the aforementioned Dissanayake.

 While Wickremesinghe has been credited with stabilizing the economy, the six-time former prime minister is unpopular for the tax and electricity price hikes that have accompanied the government’s austerity measures, as well as his affiliation with the previous Rajapaksa government where he served as prime minister. In August 2023, the country’s supreme court found him guilty of ‘arbitrary and unlawful’ conduct in the postponement of local body elections that were scheduled to take place last year. 

  With Wickremesinghe seen as the face of the country’s IMF bailout and other candidates pledging to soften the terms of the debt restructuring framework, there is a risk that the country’s economic reform trajectory could shift under a new president. While no candidate will seek to exit the IMF bailout or abandon the government’s market-friendly economic policy framework, a winner with a weak mandate may complicate decision-making. A key watchpoint will be the next budget that will be unveiled after the election.

 Beyond its economic challenges, Sri Lanka is still recovering from the devastating impact of the three-decade civil war that ended in 2009. The brutal conduct of the war combined with the ethnic Sinhalese nationalism of President Mahinda Rajapaksa’s government undermined reconciliation efforts with the country’s minority Tamil population. The ability of the next president to facilitate such a rapprochement will be hampered by Rajapaksa’s party (SLPP) holding the largest number of seats in parliament.

 Ultimately, leading Sri Lanka out of its economic woes will require policy consistency. Over 70 laws have been enacted over the last two years, covering such areas as anti-corruption and public debt management. Changes to this legislation could signal reform fatigue and undermine debt restructuring efforts – and could jeopardize access to IMF funds.

 Sustained implementation of structural reforms, meanwhile, coupled with continued improvements to the country’s remittance inflows and tourism sector will help facilitate additional capital inflows.

 Importantly, sustained reform momentum must be underpinned by Sri Lanka’s continued geopolitical neutrality amid tensions between its key economic partners India and China. (Source: https://www.chathamhouse.org/2024/09/austerity-measures-are-trial-sri-lankas-first-election-its-economic-collapse)

 

(The writer is Senior Research Fellow for South Asia, Asia-Pacific Program.)