Sri Lanka’s simmering political crisis is rooted in an economic crisis which has been aggravated by a recent financial crisis that saw the total depletion of its foreign reserves and defaulting foreign debt this year.
Sri Lanka has one of the oldest liberalized economies in South Asia. Economic liberalization began in 1977-78, ending a two-decade-old state-capitalist economy guided by a policy ideology of import-substitution industrialization. Liberalization was introduced when the import-substitution strategy reached a dead end. Although liberalization anticipated rapid economic growth through export-oriented industrialization propelled by FDIs and rapid expansion of the manufacturing industry, the ethnic civil war that began in 1983 slowed down any progress in export-led economic growth. Several waves of macro-economic reforms introduced after 1978 to accelerate export-oriented growth through further market liberalization made the Sri Lankan economy more and more integrated with the world economy. Even then, continuing social and political unrest, civil war, and political violence in the country could ensure only moderate economic growth.
Sri Lanka also has had a balance of payment difficulties since the 1950s and they became aggravated after the mid-1970s coinciding with the crisis of import-substitution growth strategy. Economic liberalization did not make many contributions to resolving the BOP crisis. Export of primary agricultural commodities as well as manufactured garments, tourism, and foreign remittances by Sri Lankan expatriate workers, began to constitute the three major sources of foreign exchange earnings. But there was very little diversification of the export economy to move away from the colonial plantation economy. There was no modernization and significant expansion of the modern manufacturing sector that was inaugurated in 1978-79, while the new entrants such as Bangladesh and Vietnam forged ahead. Plantation and peasant agriculture and fisheries sectors also remained stagnant in terms of modernization of production and processing. Reliance on increasing foreign exchange remittances by Sri Lanka’s migrant workers has been a poor compensation for the sluggishness of the modern manufacturing sector.
Then, after 2010, borrowings from external sources became the fourth, and most sought, source of foreign exchange. Since then, every successive government resorted to borrowing from the state as well as market sources to manage the growing foreign reserve crisis. Even after the civil war ended in 2009, no effort was made by the Sri Lankan government to address the sharpening debt crisis by taking steps to address the structural deficiencies of Sri Lanka’s externally-dependent economy. It is this failure to introduce structural reforms to the Sri Lankan economy by rapidly developing the productive sectors of the domestic economy – manufacturing, agriculture, fisheries, and plantations – that has ultimately led to the present economic crisis.
Sri Lanka’s debt crisis has also been worsened by weak economic governance and policy deadlocks. There was no critique of the neo-liberal reform path in policy circles. Sri Lanka’s economic policy-making bureaucracy, trained only in neo-classical economics, is notorious for accepting without any dissent or counter-thinking policy prescriptions proposed by the IMF and the World Bank.
There was also an unquestioned endorsement by the economic policy bureaucracy political agendas of ruling parties that eventually produced a regime of economic populism, spearheaded by a coalition of populist politicians and a docile class of economic bureaucrats. Its harmful consequences became particularly evident during 2019-2022 under President Gotabaya Rajapaksa who offered major tax concessions to the wealthy and business classes as a reward for political loyalty soon after he was elected. Only recently has this policy decision come under scrutiny on the assumption that it had directly contributed to the drastic depletion of government income.
At present, Sri Lanka is caught up in a trap made by multiple crises at economic, social, and political levels. The foundations of Sri Lanka’s economy are shattered. Rebuilding the economy will take years. In the meantime, managing the massive social crisis, produced by the economic crisis, will be a huge task with an economy that is more or less bankrupt.