BackSri Lanka is a warning against irrational government policy
A government that carries on with irrational measures over real reforms merely deepens the misery caused by faulty policy
PremiumA tragedy is unfolding in Sri Lanka. Citizens must queue for food and pharmaceuticals, vehicle owners cannot fill their tanks, and there have been rolling power outages. The economy is paralysed, and because the country’s debts are unsustainable, it cannot borrow. The country is suffering the world’s worst economic crisis since World War II.
The situation is so dire that millions of people have taken to the streets. The former president has fled the country and its parliament has elected a new, but unpopular, replacement. If all goes smoothly (a big if given the events of recent weeks), the International Monetary Fund (IMF) can come to Sri Lanka’s aid with a rescue loan package— allowing for the purchase of essential imports—and a programme to achieve sustainable fiscal, monetary and exchange-rate policies.
Sri Lanka’s plight serves as a lesson to other governments. When a country’s economic problems are plainly turning insurmountable, postponing a reckoning through various piecemeal measures will only make matters worse in the end.
For years, Sri Lanka was a ‘donor darling’, owing to its relatively high standard of living, good social services and robust economic growth. In the first half of the last decade, it boasted a 6.5% average annual growth rate—one of the world’s highest— and very low population growth. Though economic growth slowed after 2015, it still averaged well over 3% through 2019.
But at the end of that year, a new government came to power and immediately announced a large tax cut. In both 2020 and 2021, the government ran a fiscal deficit of more than 10% of GDP. The annual inflation rate rose from an average of under 5% in previous years to 39.1% in May, and then to 54.6% in June.
Worse, even with inflation already accelerating, the government announced in the spring of 2021 that it was banning all chemical-fertilizer imports. Predictably, rice production fell by 20%, tea exports fell to their lowest level in more than two decades, and more than one-third of the country’s farmland was left fallow.
The covid pandemic came on top of these self-inflicted wounds, causing a sharp decline in tourist revenues, which then deepened Sri Lanka’s foreign-exchange shortage and further curtailed its ability to purchase imports. By late 2021, the situation was spinning out of control; and in May, the government defaulted on its foreign debt.
Now, Sri Lanka cannot obtain essential inputs to restart its economy until it has restructured its debt and installed a working government. Reworking the country’s debt will be unusually complicated because a significant portion is owed to China, which does not participate in the multilateral Western-led restructuring exercises for overly indebted sovereign borrowers.
Again, the lesson for other debt-distressed nations is clear. While a country’s economic authorities can delay some of the consequences of ill-advised policies for a while through import rationing and prohibitions, price controls, fiscal deficits, foreign borrowing and printing money, the music eventually will stop. When a government’s only remaining choice is to implement serious reforms or pursue desperate and economically irrational measures, doing the latter will merely deepen the misery and human suffering caused by the earlier policy mistakes.
Had Sri Lanka approached the IMF late in 2021 (or even earlier) and implemented the painful reforms needed to rein in inflation and reduce its current-account and fiscal deficits, at least six months of suffering could have been avoided. The country’s external debt would not have risen quite so high and the road to recovery would not have been quite so long. More to the point, the country’s descent into complete political chaos might have been avoided altogether.
Since the start of the covid pandemic, the global community has appropriately been directing more attention to the plight of heavily indebted developing countries, with the G-20 rolling out a Debt Service Suspension Initiative that extended some $13 billion of relief to 48 countries in 2020-21, but that was just a drop in the bucket relative to actual needs.
Worse, there has been very little differentiation between countries whose underlying economic policies were sustainable and those whose policies would have become unsustainable without reform, even in the absence of covid. Lending to a country in the latter category without ensuring that it has or will implement sustainable economic policies is not doing it any favours. On the contrary, such ‘support’ merely postpones the day of reckoning and leaves it with an even higher debt-service burden when the time comes.
Policymakers in other economically struggling countries should take heed of Sri Lanka’s tale. The lessons can be paired with those from Brazil, which, following its 2002 debt crisis, quickly adopted the necessary policy reforms and went on to enjoy years of sustained growth after that. Back then, Brazil too had a choice between swift painful action to create the conditions required for recovery, and denial and delay to put off the inevitable. Its leaders proved wiser than those who have since high-tailed it out of Sri Lanka.
(Anne O. Krueger is a senior research professor of international economics at the Johns Hopkins University School of Advanced International Studies, and a former World Bank chief economist)
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
