South Asian geopolitics – India has the most at stake

Ranil Wickremesinghe took over as president of Sri Lanka in July 2022 when the country was in the middle of its worst economic and political crisis since independence in 1948. His predecessor, Gotabaya Rajapakse, had been forced out of power after facing mass protests prompted by 12-hour power cuts and persistent fuel and food shortages. The nation was bankrupt.

Wickremesinghe brought in the International Monetary Fund and has focused on reaching macroeconomic stability and driving tough but much-needed structural reforms. Today, as Sri Lanka embarks on its 17th IMF programme, it has a unique opportunity to restore stability and push forward sustainable growth. President Wickremesinghe should start by creating an independent central bank, restructuring state-owned enterprises, extending trade liberalization and improving the business climate.

As next year’s election looms, Wickremesinghe will be under pressure to embrace populist policies rather than pursue unpopular reforms

The mood is ripe for change as the fallout from the economic crisis has been felt by all the different ethnicities, religions and classes that came together last year to protest. But as the situation in Sri Lanka improves with inflation and interest rates coming down, the momentum for reform could slow. As Winston Churchill said, ‘Never let a good crisis go to waste’, advice Sri Lanka should take to heart.

At the peak of the economic crisis, there was virtually no opposition to the IMF or the need for reform, but opposition is beginning to grow. Many critics who were previously nervous to speak out are now more emboldened and the government will face challenges in implementing reform.

First, there is a lack of economic understanding in the population. This plays into the hands of politicians wanting to whip up opposition and put the government on the back foot.

Second, political instability can disrupt reforms. A stable government is needed to set the agenda for change and the president will face a challenge as a presidential election is due next year. The closer Wickremesinghe gets to the election, the more pressure he will be under from his party to embrace populist policies rather than pursue unpopular reforms. 4m Sri Lankans have slipped below the poverty line since the economic crisis began last year.

Third, implementing reforms can be tough in Sri Lanka due to its weak institutions. Implementing policy changes through a maze of bureaucracy can be difficult and time-consuming, which allows time for opposition to gain momentum.

The aim in addressing economic structural flaws is to promote long-term economic growth, reduce poverty and create a stable country. A lot is at stake for the country. Since the economic crisis began last year, an additional four million Sri Lankans have sunk below the poverty line in addition to the three million who were already there, which amounts to a third of the population.

Brain drain

One result of this has been an exodus of people leaving the country which is resulting in a brain drain. Human talent needed for the recovery is seeking opportunities abroad, which will have repercussions beyond this generation.

It also means that Sri Lanka’s crisis is affecting countries beyond its borders. Sri Lankans fleeing as illegal immigrants are a concern for countries as far away as Australia. But the biggest impact is being felt by India, which will only get worse if the economy collapses.

As an immediate neighbour, India has the most at stake in Sri Lanka’s recovery

Sri Lanka’s economic stability and growth are also important to its creditor nations such as China, Japan and India and to mostly western-based international sovereign bondholders. They are keen to see the implementation of the IMF programme so the economy can recover.

The country is also caught in the geopolitics played out between the United States, Europe and Japan on the one side and China on the other. But of all countries, India has the most at stake, as Sri Lanka is an immediate neighbour with a shared culture and history.

For change to happen, there has to be consensus not just between the political parties but among state institutions, religious establishments and trade unions. If not, the changes will not be sustainable.

A history of large deficits

Sri Lanka has a history of fiscal mismanagement resulting in large deficits. Populist policies which have included expensive subsidies have led to governments spending more than their revenue. A primary budget surplus has only been achieved four times in the 75 years since independence. Fiscal deficits have been largely due to debt and monetary financing better known as printing money.

An independent central bank which can focus on price stability is essential as current monetary policy has been politicized. If the central bank is not independent, it risks being used for political objectives such as printing money to fuel populist policies or keeping interest rates down at the risk of increasing inflation. The IMF programme places central bank independence as a key priority. 86% of Sri Lanka’s revenue went on paying salaries and pensions of state sector employees in 2021.

In 2021, Sri Lanka’s state-owned airlines reported losses of more than 1 per of Sri Lanka’s GDP, while the floor set by the IMF for social security spending is 0.6 per cent. In 2021, 86 per cent of Sri Lanka’s revenue went on paying salaries and pensions of state sector employees, which is unsustainable.

State-owned enterprises have a reputation of fostering corruption. Privatization of these organizations should be strongly considered. A few other options would be restructuring them, forming public-private partnerships or setting up a holding company like Temasek in Singapore.

If they are not restructured, Sri Lanka runs the risk of large fiscal deficits which will increase debt, raise inflation and inflict the opportunity cost of not being able to spend more on education, health and infrastructure. The main opposition to state-owned enterprises would come from trade unions as they see the state sector as their turf.

A small window to cash in

Sri Lanka ranked 99th on the World Bank’s ‘ease of doing business’ table. A one-stop investment window would be an ideal solution. Many businesses wanting to invest in Sri Lanka would prefer faster approvals and shorter setting up times to tax incentives. By not making it easier to conduct business, Sri Lanka runs the risk of losing out on investments to its regional peers.

While 70 per cent of international trade involves global value chains, Sri Lanka,
as one of the world’s most protected economies, has not been able to capitalize on this.
Sri Lanka only has three free trade agreements despite being uniquely positioned to be a trade hub.

By not utilizing its strategic location, Sri Lanka risks being left behind. With many countries in South Asia and Southeast Asia opening their economies, Sri Lanka has a short window to cash in on this.

Kabir Hashim

Former Minister of Public Development, Sri Lanka

Talal Rafi

Economist, Deloitte Economics Institute

Chatham house

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