The Sri Lankan catastrophe persists with no signs of respite. The terrible economic crisis has sparked an unprecedented mass protest that followed the Sri Lankan government’s default on its external debt obligations in April 2022. The previous Prime Minister, Mahinda Rajapaksa, had to flee his Colombo residence and take refuge in a naval base in Trincomalee to escape mass anger. Mahinda and his family had been in firm control of the country since he took the reins of the Sri Lanka Freedom Party (SLFP) in 2005. His public image was bolstered after waging the war against the Tamil minority, and especially the Liberation Tigers of Tamil Eelam (LTTE), in 2009.

His downfall was as remarkable as his rise. In the eyes of an observer, “the family took complete control of the island nation and then frittered it all away rather spectacularly.” It seemed, temporarily, that the Prime Minister’s brother and President, Gotabaya Rajapaksa, would quickly meet the same fate. However, in an attempt to divert mass rage, the President invited Ranil Wickremesinghe, the former prime minister and leader of the United National Party (UNP), to become prime minister, even though the UNP registered its worst defeat in the last parliamentary elections. Gotabaya Rajapaksa also called on the military to suppress the protests and incarcerate the key organizers.

While the momentum of the protests has been slightly subdued due to a combination of such factors, the anti-Rajapaksa demonstrations continue, as do protests against austerity and rising costs.

What took off as an economic crisis has transformed into a social crisis. The main roots can be traced back to the state’s terrible economic mismanagement following the implementation of neoliberal policies. This has created serious financial and fiscal deficits that the ruling elites are finally unable to conceal. A 2019 working paper of the Asian Development Bank (ADB) classified Sri Lanka as a “twin deficits economy.” According to the report:

Sri Lanka is a classic twin deficits economy. Prevalence of twin deficits implies fundamental economic imbalances. Twin deficits signal that a country’s national expenditure exceeds its national income, and that its production of tradable goods and services is inadequate. Such economies can be beset by high levels of debt, a heavy reliance on foreign capital inflows, a steady depreciation of its currency, and high interest rates. Sri Lanka has suffered balance of payments (BOP) crises at regular intervals (…) It has had 15 arrangements with the International Monetary Fund (IMF) in 52 years during 1965–2016—an indication of the frequency of the crisis. Sri Lanka’s economy demonstrates a high degree of macroeconomic volatility, evidenced by its frequent BOP crises.

This crisis was exacerbated by Mahinda Rajapaksa’s 2019 electoral pledges to cut taxes, in order to woo sections of the middle classes. While the tax cuts had their own impact on the state purse, the pandemic had further crippling effects on the economy. Remittances from the country’s expatriate labor force declined and the tourism industry faced a virtual shutdown. While the island nation faced difficulties in earning hard currencies, the credit rating agencies began their downgrading. As a result, at a certain point, the doors of the international capital market were effectively shut. The government’s borrowing capacity—dependent on the approval of these agencies—took a beating and foreign exchange reserves crashed by more than 70 per cent in less than two years.

Over the past few years, Sri Lanka’s foreign debt has been sitting on a powder keg. It only needed a spark to explode. The pandemic and the ensuing lockdown was that spark. The government defaulted on April 12. Foreign exchange reserves declined from $7.65 billion in 2019 to $2.03 billion in February. Such a huge foreign exchange deficit has led to high inflation across the country. In January / February, the inflation rate was 16.8%. In April, the National Consumer Price Index rose 33.8 per cent year-on-year. That’s more than six times the 5.5 percent inflation of a year earlier. Annual food inflation stood at 45.1 per cent. Consequently, the prices of everything from rice and pulses to petrol and diesel have touched the sky.

The government has been trying to knock at the doors of the IMF to find a way out of the current crisis. It has already applied for a loan of $4 billion, which it intends to use for debt repayments. However, the IMF doesn’t lend its helping hand that easily. Moreover, even if borrowing from the IMF might seem like the easiest way out, two major questions remain. Can the debt crisis be resolved with further borrowings? And does the Sri Lankan crisis contain any lessons for the countries in the periphery?

Historical examples of new loans helping a country to come out of a debt crisis are rare. In the past, Sri Lanka has rampantly borrowed from the international market to build various mega infrastructure projects. However, the revenue generated from these projects was much below the estimates, and many of them turned out to be white elephants. This resulted in an unprecedented increase of total debt.

For example, Sri Lanka borrowed $1.26 billion from China between 2006 and 2015 to build the Hambantota port. Initially the interest rate was 1% and 2%, but later it increased to 6.3%. However, the port suffered losses from its opening in 2010, as there was practically no traffic due to its proximity to Colombo port. Unable to cope with the debt, Sri Lanka leased 75% of the port to a Chinese state-owned company for 99 years for $1.12 billion.

In another instance, the Sri Lankan government took a loan of $1.4 billion to build the Colombo Port City project, which mainly includes casinos, green zones, and real estate. There have been serious environmental concerns with the project as it was done by filling up a part of the sea. Moreover, the planned income from all these projects could not be achieved until 2020. This resulted in an unprecedented increase of debt. Currently, the country is deprived of urgent and vital imports due to the shortage of foreign currency.

While the government’s preferred solution lies in borrowing again from the IMF, the costs of these loans are going to be huge for the working people of the country. Such loan conditionalities would mean an additional increase of the indirect tax and a reduction of priority sector subsidies, such as energy. Currently, indirect taxes contribute to 85% of the total tax earnings by the Sri Lankan government. The new loan agreement will see a sell-off of public assets at throw away prices in order to restore “fiscal stability.” It would also mean freezing state expenditure on salaries, employment creation and social security. A “market-determined and flexible” exchange rate would lead to greater fluctuations of the Sri Lankan rupee.

Negotiations with the IMF are under way, but it will take months to get that assistance…

While the idea of ​​”financial aid” as the ultimate protector is universally accepted, there is a heavy price to pay for it. A better option, in the interest of the population, would be to suspend the debt payments and renegotiate bonds in the international market, as Ecuador did between 2007 and 2009.

Sri Lanka is currently mired in a deep humanitarian crisis. Borrowings and bilateral loans from various lenders, including the World Bank and the IMF, need to be scrapped. At the very least, loan repayments need to be immediately suspended and the interest on the outstanding loans need to be canceled. International financial institutions, including the IMF and the World Bank, are not keen on a permanent solution, but they are very keen to keep the problem alive by re-lending to Sri Lanka. This also applies to other lenders – India, the US, EU, Japan and China.

The Sri Lankan government needs to stop repaying loans and spend the precious foreign currency on the basic needs of the people. As the country has been going through an extraordinary situation, the government can use arguments from international law to suspend its debt obligations, such as “fundamental change of circumstances,” “state of necessity” and “force majeure.”

While the current problem can be arrested by suspending debt repayments and levying property and wealth taxes on the rich, Sri Lanka needs the political will to come out of this crisis. It should set up a Citizens’ Debt Audit Committee to determine the necessity of any subsequent borrowing. The committee should also look into past contracts in order to identify the illegitimate part of the debt that has to be repudiated. Such action, followed by a progressive redistribution of wealth and income, could be a way out for Sri Lanka and all other countries of the periphery suffering from a similar fate.