The making and masking of Sri Lanka’s debt crisis

17 May by Matt Withers


Sri Lanka is in the grip of its worst economic crisis since Independence. Behind recent headlines, the Covid-19 pandemic has exposed structural problems that were decades in the making. The origins of today’s foreign exchange crisis are rooted in the colonial plantation sector, failed industrial policy, and the façade of stability afforded by migrant remittances.

There are numerous immediate causes for the sovereign debt Sovereign debt Government debts or debts guaranteed by the government. crisis, some of which are certainly attributable to the economic mismanagement of the Rajapaksa and Sirisena governments. Heavy international borrowing, excessive spending on largely uneconomical infrastructure projects, populist tax reforms, and misguided agricultural policies have all contributed to Sri Lanka’s inability to weather the economic consequences of the pandemic.

Fixation on these interventions has lent support to a simplistic belief that Sri Lanka’s macroeconomic problems would disappear under a liberal market economy. Amid the chaos and deprivation of recent weeks, free-market think-tanks have espoused a tired ensemble of neoliberal reforms – spanning fiscal austerity, monetarism, privatisation of state-owned enterprises, and freer trade – as a pathway to recovery. Yet in the absence of any compelling examples of economic development guided by the invisible hand of market forces and extensive evidence to the contrary, calls to embrace International Monetary Fund IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
(IMF) loan conditions ignore deeper structural problems that have primed the economy for the crisis.

When Sri Lanka gained independence in 1948, its export sector was dominated by plantation cash crops – mainly tea, rubber, and coconut. With rubber prices buoyed by the Korean War and tea prices spiking shortly after, Sri Lanka enjoyed a brief period of relatively favourable terms of trade. These terms were sufficient to run a surplus and amass foreign exchange reserves, but the opportunity for industrial development was eschewed in favour of food subsidies, agricultural investment, and a liberal import regime.

Declining terms of trade and the political intractability of welfare spending quickly exposed Sri Lanka’s over-reliance on the primary sector. The International Labour Organisation (ILO) observed that “apart from Burma, Ceylon was the only country in Asia earning less foreign exchange in 1968 than in 1958”.

The lack of resolution to Sri Lanka’s first foreign exchange crisis ensured the inevitability of the current one. Throughout the 1960s and 1970s, jarring shifts between ideologically opposed regimes lurched the economy from autarky to partial liberalisation and back again, without achieving an effective industrial policy.

The 1977 election of the J.R. Jayewardene Government heralded a turning point, with new legislative powers used to usher in a sweeping liberalisation of the economy. Having famously declared: “Let the robber barons come!”, Jayewardene dismantled import controls, floated the currency, deregulated the banking system, and created export processing zones for garment manufacturing.

While limited foreign direct investment did come in, gross domestic product GDP
Gross Domestic Product
Gross Domestic Product is an aggregate measure of total production within a given territory equal to the sum of the gross values added. The measure is notoriously incomplete; for example it does not take into account any activity that does not enter into a commercial exchange. The GDP takes into account both the production of goods and the production of services. Economic growth is defined as the variation of the GDP from one period to another.
(GDP) and export growth did not. The garment sector steadily created a new stream of low value-added export revenue, but not enough to offset burgeoning imports or the economic repercussions of civil war. As of 2020, Sri Lanka’s export profile remained dominated by primary and low value-added goods with poor terms of trade.

Crucially, the Jayewardene Government also removed restrictions on international migration, facilitating Sri Lanka’s relatively late entry into the Gulf labour market and laying the foundations of the “remittance economy”. Rapid growth in aggregate remittances from low-wage domestic and construction workers provided foreign exchange receipts to cushion the trade deficit and create some macroeconomic stability. The employment “fix” of temporary migration and the foreign exchange buffer of remittances has enabled Sri Lanka to endure poor terms of trade and evade the industrialisation question for decades.

But this was only possible if migration continued apace. The gradual collapse of the remittance economy has arguably been the most destabilising shock of the pandemic. Remittances accounted for almost 10% of GDP in 2019. While various explanations have been given for their unexpected resilience during 2020, there was a precipitous collapse in 2021. If current monthly values are annualised, remittance receipts for 2022 will total $ 2.4 billion – just half of 2021 earnings. With workers returning and annual departures significantly reduced, an inevitable strain has been placed on already limited employment opportunities in both rural and urban areas.

The unprecedented shock of Covid-19 has exposed the instability of Sri Lanka’s economy and the absence of an endogenous engine for employment, exports, and growth. Stripped of the veneer provided by migration and remittances, these underlying structural constraints have been laid bare for the first time since the 1977 pivot to economic liberalisation. These are problems that another laissez-faire turn will not fix. Just as the “open economy” oversaw deteriorating terms of trade as high standards of living were propped up by the poorest, embracing IMF reforms will do the same now.

What Sri Lanka needs is a robust industrial policy capable of generating employment, diversifying export production, and building value into the local economy. This is a challenging task, and now is not the time for the Government to take its hands off the steering wheel.




Source : Morning Lanka

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