Why has this situation emerged in Sri Lanka? Could this have been prevented?

The origin of the crisis can be traced back to the economic development policy strategy adopted by the Mahinda Rajapaksa administration from 2005. In this policy, the export sector was not given the due recognition it deserves. Instead, development was to be attained by promoting the domestic economy. As a result, GDP, mainly due to domestic investments for producing goods and services for domestic consumption increased faster than the growth in exports. Accordingly, the share of exports in GDP, which amounted to 26 per cent in 2005, fell to 15 per cent in 2010 and further to 12 per cent by 2021.

At the same time, Sri Lanka borrowed from the international financial markets by issuing sovereign bonds and from China for unsolicited projects. This increased the debt servicing commitments. These projects did not generate the required foreign exchange earnings to support the balance of payments and debt repayments. This led to multiple macroeconomic ailments. Growth was slowed from above 9 per cent in 2012 to 2.3 per cent in 2019. In this backdrop, Gotabaya Rajapaksa who was elected president in 2019, adopted certain economic policies which were erroneous. Income tax and value added tax were cut drastically causing a revenue loss of about 4 per cent of GDP for the government. Chemical fertilizers and pesticides were banned to convert the country’s agriculture to organic farming overnight. It led to a decline in the agricultural production by about 45-50 per cent.

The rising government expenditure was financed mainly by borrowing from the banking system leading to an explosion in the money stock by about Rs 4 trillion during the 27-month period from January 2020. It led to inflation on the domestic front and pressure for the exchange rate to depreciate on the external front. Instead of allowing the rupee to depreciate gradually, the Central Bank tried to keep it at an artificial level of Rs 200 per US dollar. The corollary was a sharp decline in the foreign exchange flows to the country creating a shortage within the formal banking institutions. A lucrative and dynamic black market instantaneously sprang up with a margin as high as Rs 50 over the fixed exchange rate of the Central Bank. Foreign reserves began to fall making it difficult to continue with the normal import program and service the foreign debt.

The resultant shortage of goods in the market created long queues for fuel, cooking gas, medicines, and food items. When the reserves fell to a very low level, the Central Bank could not hold on to the artificial exchange rate and had to allow it to have a free-fall. The government announced that it will not service the external debt and instead add to the principal with a view to restructuring the same. The crisis could have been avoided had Sri Lanka sought a loan facility from IMF and allowed the exchange rate to depreciate gradually. Hence, the crisis is a manmade crisis.

What do you think was the main reason behind this situation?

As explained above, the main reason had been the erroneous economic policies adopted by all the government since 2005. This was aggravated by the policy follies of the Gotabaya Rajapaksa government. It refused to seek IMF support, allow the exchange rate to fall gradually, increase government revenue by going back to the tax system that existed prior to 2019, and desist from borrowing from the banking sector.

How would you rate the role of corruption in leading up to this eruption of violence and break up of public trust?

Sri Lanka’s corruption perception is high as revealed by the Corruption Perception Index compiled by Germany based Transparency International. In this index for 2021, Sri Lanka is ranked at 102 out of 180 countries and its overall score had been at 37 out of 100. This was a deterioration of Sri Lanka’s corruption perception level as well as ranking from 2020. In that year, Sri Lanka had scored 38 out of 100 and been ranked at 94.

Because of this poor performance in corruption perception, Sri Lankans widely believe that political leaders of all hues are corrupt and have amassed a massive amount of wealth outside the country. The country’s corruption watchdog cum bloodhound, Bribery or Corruption Commission too has contributed to this belief through its past action. Almost all the cases it had filed against top political leaders of the present government were withdrawn by it claiming that there was a procedural error in filing. That is, when they were filed, it claimed that not all the members of the commission had approved of such filing but there was no any attempt by the commission to re-file the cases after correcting the procedural errors.

The public, specifically the youth, have been angry at this and as a result agitating for justice. The sudden eruption of violence could be attributed to this anger.

Did the country's economists and politicians had any idea in advance? Did they advise the government?

The country’s economists, not necessarily the politicians, had been warning all the governments since 2005 about the possible collapse of the economy. These governments include the Mahinda Rajapaksa administration from 2005 to 2014, the good governance government from 2015 to 2019 and the Gotabaya Rajapaksa administration since then. However, only scanty attention was paid by policy makers and as a result, the conditions began to deteriorate finally leading to the present economic collapse.

Was it a political and institutional failure? Do you think that the institutions work properly?

Sri Lanka’s institutional system is weak. An attempt was made to strengthen them in the 19^th amendment to the constitution passed in Parliament in 2015. In this amendment, several independent institutions were set up in accordance with the needs of good governance. These institutions covered such areas as bribery and corruption, national procurement, judiciary, police and public services, to mention but a few. However, this was reversed in 2020 by the 20^th Amendment to the constitution by which all powers were vested with the President. That was why they failed to rise against the abuse of power by the President after 2020.

Did Sri Lanka fall into any international trap?

I do not think so, though there are some sections in society which believe this.

Sri Lanka's economic crisis has now turned into political violence. What is the way out for this debt-ridden nation?

A large section in society, especially the youth rose against the government throughout the country. But they all were peaceful protests. However, after those who had been protesting in front of the official residence of Mahinda Rajapaksa and the office of the President Gotabaya Rajapaksa were attacked by mobs brought to Colombo by the supporters of the prime minister, the agitations turned violent forcing the government to introduce emergency laws. Now Sri Lanka is a boiling pot and can explode at any time.

Sri Lanka's three main income sectors - readymade garments, tea and tourism - are in crisis. Tourists may be further discouraged from visiting the country after the violence. What do you think needs to be done to boost up these sectors?

All the economic sectors, not necessarily hospitality and apparels, have been in crisis today. Immediately, foreign exchange is needed to maintain the country’s import of essential items like fuel, cooking gas, medicines, and foods. That had been partly funded by India by offering trade credit amounting to $1.5 billion, and China providing a SWAP of 10 billion yuan that can be used to import goods from China. This has been inadequate given the enormity of the country’s balance of payments problem. Plans are afoot now to seek IMF support. But it will take some 6 months to materialize and it is necessary to have a bridging financing facility immediately.

What will xthe status of Sri Lanka's relations with South Asian countries, especially with Bangladesh and India be? Will there be a crisis of trust?

Sri Lanka had been maintaining cordial and friendly relations with all the South Asian countries. Special support was given by India by providing loans and trade credit amounting to about $ 2.5 billion. They were very helpful. Bangladesh through the Bangladesh Bank provided a SWAP facility of $ 150 million which the country used for making essential imports. Though they were far from adequate, the support given at the time of need is appreciated by all Sri Lankans.

China still remains silent on the Sri Lankan crisis. How will the bilateral relationship between the two nations shape up in the future?

China has now visited the new prime minister Ranil Wickremesinghe and pledged its support. Hence, to say that China has been on the sideline is erroneous. Since China is a main creditor holding about 10 per cent of the central government credit, it is a force too important for Sri Lanka to ignore.