Sri Lanka is currently midst of the worst economic crisis the island has seen since independence.
After food inflation reached over 30% in March, food shortages have become common, power cuts last up to 13 hours a day in some areas, and for the first time, Sri Lanka has defaulted on its international debt, forcing the government to approach the International Monetary Fund for assistance.
Anger over the deteriorating economic situation has pushed many Sri Lankans onto the streets to demand the resignation of President Gotabaya Rajapaksa and the government led by his brother, Prime Minister Mahinda Rajapaksa.
While the IMF considers how best to support Sri Lanka, policymakers in Washington should urgently step forward with a financial package that will not only provide desperately needed aid for ordinary Sri Lankans but help the U.S. meet some of its long-term strategic objectives in the Indo-Pacific.
The economic crisis is directly linked to Sri Lanka’s external debt, which has become unsustainable for several reasons.
In November 2019, the government cut both income taxes and the value-added tax, which, according to the IMF, led to a loss of revenue exceeding 2% of gross domestic product. Then, in April 2021, the government implemented an ill-advised ban on nonorganic fertilizers, which led to a decline in tea production, Sri Lanka’s highest-earning export. Several other policy decisions alienated key partners, including China, India and Japan.
To be sure, the pandemic put further pressure on Sri Lanka’s finances. Tourism was beginning to recover after the April 2019 Easter terrorist attacks, and Sri Lanka was expecting at least $5 billion in foreign exchange earnings from tourism in 2020, but then the entire industry shut down from April to November that year and generated only $650 million in revenue last year.
China’s zero-COVID strategy has not helped either. In 2019, 168,000 Chinese tourists accounted for 9% of all arrivals. But in 2021, that number dropped to 2,400, or about 1.2% of arrivals.
Then came Russia’s invasion of Ukraine, which not only caused oil prices to spike, adding to Sri Lanka’s current-account deficit problems but will likely put an end to the Russian and Ukrainian tourists that the country has become dependent on. In the first quarter of this year, Russia accounted for 13.2% of all tourists, while Ukraine accounted for 4.7% of tourists.
Political pressure is growing on the Rajapaksas to either step down or enact political reforms, and protests are unlikely to die down anytime soon.
The government has taken some steps to address the crisis, including appointing a new cabinet, acknowledging past policy mistakes and approaching the IMF for a rapid finance instrument, which is essentially a bridge loan.
Because Sri Lanka’s debt is unsustainable, it would be difficult for the IMF to issue such a loan until Sri Lanka implements a debt restructuring plan. Even if Sri Lanka is able to access IMF funds, it will still need a broader extended fund facility (EFF) program, which would be provided on a longer-term basis but come with more strings attached.
India, which has been at the forefront of efforts to support Sri Lanka, has championed the EFF program, as that would require tough political and economic reforms that would put Sri Lanka on a path to fiscal solvency.
For the U.S., there is no better time than the present to offer support to Colombo. While Washington’s current focus is on the Russia-Ukraine war, it must soon turn its full attention back to its strategic rivalry with China, where smaller states such as Sri Lanka will play an important role.
To counter China’s influence in Asia, Washington has already strengthened its relationship with India, and one of India’s key foreign policy objectives is to weaken Chinese influence over Sri Lanka.
Supporting Sri Lanka’s eventual EFF request will be a win-win for the U.S., as it will serve to strengthen its partnership with New Delhi by supporting its central foreign policy objective of maintaining regional primacy and counteracting Chinese encirclement.
Sri Lanka also presents an opportunity for the U.S. and India to work together to prevent the humanitarian crisis from worsening. One possible area of collaboration is food security.
Here, the U.S. and India can work together to identify what food products Sri Lanka urgently needs and what each can provide. Success here could be a template for the growing Quad partnership that includes Japan and Australia and lay the foundation for a potential Quad working group on food security.
Whatever help the U.S. ultimately gives, it should extensively publicize what it is doing to help Sri Lanka. In the past, U.S. policies have been derailed in Sri Lanka due to misinformation, such as a $480 million Millennium Challenge Corporation grant that was ultimately canceled by the U.S. after the Rajapaksa government said it did not want the funds.
Effective messaging about the help offered to Sri Lanka to alleviate the crisis would also set the U.S. up for a post-Rajapaksa-era, as American aid at a time like this will not be forgotten.(Nikkei)