On Wednesday, the Sri Lankan Parliament elected Ranil Wickremesinghe as the republic’s interim president. Mr Wickremesinghe, who on Friday appointed Dinesh Gunawardena as prime minister, is a career politician whose legislative career, going back to 1977, spans the making of the country’s current economic crisis. As an economic depression now takes hold, the same policies that he is likely to impose will further undermine the economy. Indeed, policies of austerity are making an unprecedented collapse even worse. Alternative approaches of relief, public distribution and self-sufficiency are sorely needed to cushion people from the devastation. Such alternatives may also provide clues to other developing countries in line to default on their sovereign debt, and which are facing potential crisis dynamics like those in Sri Lanka.
Sri Lanka was the first country in South Asia to pursue economic liberalisation in the late 1970s. This meant devaluing the rupee, curtailing food subsidy and social welfare more broadly, and generally opening the country to trade and financial liberalisation. With the onset of the global debt crisis in the early 1980s, other developing countries followed with structural adjustment programmes. The International Monetary Fund (IMF) and World Bank experimented with Sri Lanka as the front runner. They facilitated a massive infusion of donor aid. But as its current account and fiscal deficits ballooned with unrestrained imports and state expenditure on infrastructure projects, international agencies began demanding austerity. This created a political and economic crisis in the early 1980s.
With the breakout of civil war in 1983, successive governments pursued further market reforms including privatisation, but with some caution. They did not want to undermine their political base for wartime mobilisation. After the government’s victory against Tamil separatists in 2009, it accelerated the process of liberalisation. It drew in greater inflows of global finance for mega infrastructure projects and speculative investment in urban real estate. This process culminated in the accumulation of tremendous debt stock in the form sovereign bonds – and eventually the default on its sovereign debt in April this year.
The mainstream policymaking consensus within Sri Lanka now argues that the government must pursue an agreement with the IMF to support restructuring its debt and set it back on the path of growth. The IMF has offered recommendations such as floating the rupee, raising interest rates, freezing state expenditure on projects and increasing energy prices. The government has already implemented many of these policies. Experts hold on to the belief that if Sri Lanka can pass a debt sustainability analysis by demonstrating a commitment to fiscal reform, it will receive a seal of approval from the IMF. This would allow the country to negotiate with creditors, including private bondholders, to restructure its significant external debt. The green light from the IMF and solvency through debt restructuring would supposedly enable Sri Lanka to access temporary financing from regional powers such as China, Japan and India, and eventually access new loans from international capital markets.
This rosy analysis of the way forward recommended by mainstream analysis over the past six months, however, is now coming under critical scrutiny. The reality of global economic headwinds and tremendous disruptions within the country signal a much longer crisis. The global rise in interest rates, led by the US Federal Reserve, will undermine the inflow of capital and raise the cost of capital for developing countries. Meanwhile, rising global prices for food, fuel and other essential inputs are aggravating the ongoing breakdown of the market in Sri Lanka.
In this context, an austerity-driven policy approach that is supposedly designed to lower inflation is, in fact, making the crisis worse. The policy reset in Sri Lanka this year is raising prices to prohibitive levels and undermining people’s income and livelihoods through further reductions in spending. Private capital is withdrawing from the economy while public expenditure is frozen, resulting in a sharp overall reduction in national production. Sri Lanka’s economy could contract by one tenth this year alone. The mainstream approach of macroeconomic stability for the country through an IMF agreement, which entails austerity to address the country’s twin deficits, will accelerate the downward economic spiral.
The reality is that Sri Lanka’s economy will take a very long time to recover. As with the fall-out of the last great global crisis, during the Great Depression of the 1930s, alternative forms of development rooted in a more egalitarian vision of society could eventually take hold. But right now, the immediate priority is the food system. Sri Lanka is already facing food shortages and could possibly experience famine without immediate relief.
The government must pursue immediate stimulus in food production, particularly as farmers are abandoning their fields due to the ill-advised fertiliser ban last year and the shortages of fuel and inputs this year. Addressing this crisis requires spending for agriculture combined with public distribution. The latter needs strengthening, after the decades-long dominance of market-oriented policies led to its neglect.
The shortages of foreign exchange are likely to continue. In response, the state must take over the external sector and prioritise Sri Lanka’s foreign earnings to purchase essential goods for both production and consumption. With the failure of the market, due to hoarding amidst limited supplies of imports, such goods must be distributed through the public distribution system. This will ensure the continuation of the critical export sector and its foreign earnings, in addition to sustainable local food production to avoid a food crisis and pave the way to self-sufficiency in the food system.
Sri Lanka is caught in the clutches of an economic depression. This is the worst time for policies of austerity. Instead, the government should redistribute wealth, borrow locally and spend in rupees to revive people’s livelihoods and income streams. It must subsidise producers to ensure that production is maintained. With Sri Lanka, like many other developing countries, likely to continue to face tremendous hardship over the next few years, citizens must be adequately prepared for the long road to recovery.
A new global economic crisis is in the making. Ruling in the belief that the market alone will eventually fix these problems would be foolhardy. Now more than ever, the state needs to take responsibility for the future of its citizens. There is no real path to political and economic stability except through the stabilisation of people’s livelihoods and strengthening the food system.
