Sri Lankan economic crisis caused by egoistic elite


  • Opinion by Jomo Kwame Sundaram, Anis Chowdhury (Sydney and Kuala Lumpur
  • Inter Press Service

Chinese scapegoat

SL has just defaulted on its foreign debt for the very first time. Attributing the current predicament to a Chinese “debt trap” is another Cold War propaganda distraction – one of which we’ll no doubt be hearing a lot more.

In this fable, SL is a country caught in a debt trap due to white elephant projects put forward and financed by loans from China. Blaming SL’s debt crisis on Chinese loans is not only factually incorrect, but also hinders understanding of the origin and nature of the current crisis.

The SL government’s outstanding external debt amounted to US$35.1 billion in April 2021. Policy errors have reduced foreign direct investment (FDI), exports and government revenues, changing the worst-case foreign debt composition.

Debts to the Asian Development Bank (ADB), the World Bank, China, Japan and other bilateral lenders, including India, were about one-tenth each. Borrowing on the capital markets – 47%, or almost half – is mainly responsible for the unsustainability of the debt.

After all, borrowing from multilateral development banks – mainly the World Bank and ADB – and bilateral lenders usually takes place on favorable terms, while debt from commercial sources entails a higher interest rate.

Commercial loans usually have shorter maturities and are subject to stricter conditions. When government bonds or commercial loans mature, their full value must be repaid. The cost of external debt service increases accordingly.

As of April 2021, approximately 60% of SL’s debt had a maturity of less than ten years. US dollar-denominated debt stock rose sharply – from 36% in 2012 to 65% in 2019, while Chinese renminbi-denominated loans remained around 2%.

Adding government-guaranteed debt to state-owned enterprises, total loans from China amounted to 17.2% of SL’s total external debt obligations in 2019. Meanwhile, commercial loans grew rapidly from just 2.5% of external debt in 2019. 2004 to 56.8% in 2019.

The effective interest rate on commercial loans in January 2022 was 6.6% – more than double that for Chinese debt. Unsurprisingly, SL’s interest payments in 2021 alone accounted for 95.4% of declining government revenues!

Deep-seated problems

After the recession of 2001, SL recovered, before growth slowed again after 2012 and the pandemic contracted in 2020. SL also experienced premature deindustrialization, with industry’s share of GDP falling from 22% in 1977 to 15% in 2017.

Government tax revenues fell from 18.4% of GDP (average from 1990-92) to 12.7% (2017-19), reaching a pandemic low of 8.4% in 2020. Non-tax revenue – mainly dividends and public investment gains – decreased from 2.3% of GDP in 2000 to 0.9% in 2015.

SL’s export-to-GDP ratio has nearly halved from 39% in 2000 to 20% in 2010. This took a major blow during the pandemic, falling to 17% in 2020. As of 2000, the inflow of FDI into SL has been between 1.1% and 1.8% of GDP, before falling to 0.5% in 2020.

In the 2012-2019 period, the share of International Monetary Fund (IMF) Special Drawing Rights (SDRs) in SL’s debt stock decreased from 28% to 14%, while loans increased! SL’s debt crisis is clearly due to the policy choices of successive governments since the 1990s.

Crisis sensitive

In February 2022, SL had only $2.31 billion in foreign exchange reserves, too little to cover its $4 billion import bill and debt service obligations.

The 22 million people face 12-hour power outages and extreme scarcity of food, fuel and other essentials such as medicines. Inflation reached a record high of 17.5% in February 2022, while food prices rose by 24% in January-February 2022. But the economic crisis is not new to SL.

As a commodity producer – mainly exporting tea, coffee, rubber and spices – export earnings have long been volatile and vulnerable to external shocks. Foreign exchange earnings also come from ready-to-wear, tourism and remittances, but their share has barely grown in recent decades.

Since 1965, SL has obtained 16 IMF loans, usually on tough terms. The last was in 2016, worth $1.5 billion over 2016-19. The required austerity measures have put pressure on public investment, damaging growth and prosperity.

Two recent shocks made matters worse. First, bomb explosions at Colombo churches and luxury hotels in April 2019 drastically reduced the number of tourists by 80%, putting pressure on foreign exchange earnings.

Second, the pandemic has damaged not only economic activity but also foreign exchange reserves as it has often paid monopoly prices to get COVID-19 tests, treatments, equipment, vaccines and other needs.

Tax cuts galore

The ethno-populist policies of the Gotabaya Rajapaksa government – ​​which came to power in 2019 – have added fuel to the fires. He successfully mobilized the majority of Buddhist Singhala sentiments – against Tamils, Muslims and Christians – and sought political support by lowering taxes on the ‘middle class’.

His government cut taxes across the board, amassing just 12.7% of GDP in revenue in 2017-19 — one of the lowest shares among middle-income countries. With a loss of about 2% of GDP in revenues, the tax-to-GDP ratio fell to 8.4% in 2020.

SL’s VAT rate was reduced from 15% to 8%, while the VAT registration threshold was raised from one to SL 25 million rupees per month. Other indirect taxes and the pay-as-you-earn system were abolished.

The minimum income tax threshold was raised from SL 500,000 rupees per year to three million, and few made that much! Personal income tax rates were not only lowered, but also became even less progressive.

The corporate tax rate was reduced from 28% to 24%. With a 33.5% drop in registered taxpayers (corporate and private) between 2019 and 2020, SL’s tax base shrank.

For example, even a larger part of the population was exempted from direct taxes, increasing the popularity of the government, especially among the middle class. But tax cuts didn’t boost investment and growth — despite old claims by Ronald Reagan, Donald Trump and their “guru” Arthur Laffer.

Successive SL governments thus failed to increase tax collection, depressing government revenues. To finance budget deficits, they increasingly borrowed from international capital markets – at higher commercial rates, with shorter maturities.

When the government lowered tax rates and exempted most from paying income taxes, government revenues fell. Falling income and deteriorating creditworthiness forced the government to borrow more at a higher interest rate.

Faced with fiscal and exchange restrictions, the SL government declared a 100% organic farming nation in April 2021. Banning all fertilizer imports – ostensibly to promote ‘agroecological’ farming as part of a larger ‘green’ transformation – exacerbated the looming ‘perfect’ storm.

The policy was abolished in November 2021 and drastically reduced agricultural production, necessitating more food imports. Falling tea and rubber production also lowered export revenues, exacerbating foreign exchange deficits.

It is clear that the SL government met the economic challenges with ‘populist’ policy choices. Rather than addressing long-standing problems, it effectively pointed the way, exacerbating the inevitable collapse.

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© Inter Press Service (2022) — All rights reservedOriginal source: Inter Press Service

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