The economic crisis has left deep traces

Dinuka Liyanawatte / Reuters

Sri Lanka's economy has recovered from the deep crisis two years ago. But corruption, legal uncertainty and a lack of foreign investment are calling the recovery into question. The number of poor people has more than doubled.

Sri Lanka's economy has seen the worst. After the dramatic crisis two years ago, which quickly led to the collapse of the economy, the situation has stabilized again. Gasoline is available again, supermarkets are full, and inflation was only 2.4 percent in June. Thanks to the International Monetary Fund (IMF), which approved a loan of three billion dollars in March 2023, the state's finances have improved. President Ranil Wickremesinghe, who will be re-elected in September, sold the recovery as a great success for his government.

But the slump has left deep scars. “The economic crisis is devastating, even if it is hardly visible on the streets of Colombo,” says Iromi Perera, who heads the Colombo Urban Lab think tank in Sri Lanka's capital, which deals with urban development and social security. “Since August 2022, food has become 90 percent more expensive. Electricity now costs three times as much, and electricity prices are the highest in South Asia. Those who are self-employed or on daily wages are particularly affected.”

While day laborers used to borrow money to earn a higher income, the crisis forced them to sell tuktuks or motorbikes, says Perera. Today they borrow money to pay rent or buy food. The lower and middle classes are bearing the brunt of the debt crisis. As a result, the number of people below the poverty line has more than doubled from three to seven million between 2019 and 2023.

In January 2024, the official poverty line in Sri Lanka was 17,014 rupees, the equivalent of about 50 francs a month. Today, about one in three Sri Lankans lives on less than 50 francs a month. Plantation workers, for example, earn less than three francs per working day. When the government wanted to increase the daily wage to just under five francs in May, tea producers claimed that such a high wage would drive them into ruin.

President Rajapaksa has plunged the country into crisis

The economic recovery remains at risk and memories of the crisis are still fresh. It began with the bloody attacks by Muslim extremists on Easter Sunday 2019, which left more than 250 people dead and brought vital tourism to the island to a standstill. The presidential elections in November of that year brought to power Gotabaya Rajapaksa, the younger brother of former President Mahinda Rajapaksa, who ruled the country from 2005 to 2015.

After the Islamist attacks, Sinhalese voters demanded a strong president, and the hardliner Gotabaya promised security. As Secretary of the Ministry of Defense, he had waged the war against the Tamil separatists with ruthless severity. Tens of thousands of Tamil civilians were killed in the final phase of the civil war in 2009. But Gotabaya had little political experience and surrounded himself with dubious advisors.

After the election, the president announced far-reaching tax cuts. VAT fell from 15 percent to 8 percent, and other taxes were raised entirely. The budget deficit rose from 9.6 percent of gross national product in 2019 to 12.2 percent in 2021. National debt grew from 87 to 106 percent of gross national product in the same period. Because the printing presses were subsequently turned on, inflation reached up to 70 percent in 2022.

A popular uprising broke out and Gotabaya Rajapaksa had to flee the country in July 2022 and submit his resignation. Parliament elected Ranil Wickremesinghe, a former prime minister and long-time politician, as the new president. According to the constitution, he can remain in office until the end of his five-year term. He will now have to face the voters on September 21. His chances of re-election are slim.

The population has paid a high price

This is also because the majority of the population paid a high price in the crisis. Wickremesinghe also made the middle class pay. The VAT was raised from 8 to 18 percent. Income tax increased and the number of taxpayers increased significantly. As a result, members of the middle class also slipped below the poverty line. Last but not least, the state coffers were rehabilitated at the expense of pensions. The result is significantly lower pensions for state employees.

According to the Asian Development Bank, the economy of the South Asian island state shrank by 7.8 percent in the crisis year of 2022 and by a further 3 percent in 2023. The bank now expects moderate growth of 1.3 percent for 2024. At the same time, debt remains high. Cumulative domestic and foreign debt was around 81 billion dollars at the end of September 2022, but was over 100 billion at the end of March 2024.

The International Monetary Fund, which transferred the third tranche of the aid loan to Sri Lanka in June, noted on this occasion that the path back to sustainable debt was on a knife edge: “The maintenance of the reform momentum and the attempts at debt restructuring are crucial to put the economy on the path to lasting recovery and debt sustainability.”

Many of Sri Lanka’s problems are home-made

According to Sri Lankan-born economist Shanta Devarajan, many of the problems are home-made. In 1978, all levels of society benefited from the liberalization of the economy, but since 2000 trade openness has been declining, said the professor of international development at Georgetown University at a presentation in Colombo. A law from 1958 requires rice to be grown on large areas, even though the financial return is much lower than for other agricultural products.

The schools in Sri Lanka are so bad that even 60 percent of the lowest-income quarter pay for additional private lessons for their children, says the former World Bank chief economist for the Middle East and North Africa, Africa and South Asia. And the fight against poverty is mainly heard by core voters of the ruling party, but less than half of the families below the poverty line.

Because of the crisis, an additional 22 percent of households have gone into debt, bringing the total to 55 percent today. Economist Nishan de Mel, director of the think tank Verite Research, says: “Our problem is that the right people are not being taxed.” There are enormous injustices. In the 2022/2023 financial year alone, there were tax breaks totaling $3.2 billion. These tax gifts are often made out of self-interest and are accordingly linked to corruption.”

The change in visa issuance is a debacle

Corruption is omnipresent. Anyone who recently applied for a visa for Sri Lanka was informed on the relevant website that no more visas had been issued since August 2nd. In fact, during the summer months visas were only issued at the airport in Colombo. Until April, the state-run Mobitel was responsible for issuing electronic visas. The system was easy to use and worked perfectly. Mobitel charged a fee of the equivalent of one dollar per visa.

On April 17, however, a dubious consortium was suddenly given the task. The fee was now 25 dollars instead of one as before. The tourism minister said he had neither been informed nor consulted, but the minister responsible for public security claimed that the cabinet had approved the proposal. Apparently the consortium had originally promised to invest 200 million dollars to support the migration office with technical equipment and software. However, this was no longer mentioned in the contract.

After several lawyers filed complaints, the Supreme Court interpreted the contract. But since visas were no longer being issued except at the airport in Colombo, the travel agency association raised the alarm: arrivals had fallen massively and bookings were poor. The government then decided to take a liberating step and announced that from October 1, citizens of 35 countries, including Swiss and Germans, could enter the country without a visa. Since tourists complained about long waiting times at the airport, visa-free travel was put into effect immediately on September 2.

Corruption is the lubricant of politics

“In Sri Lanka, corruption has become the lubricant of politics,” says Nishan de Mel. “It would require extraordinary creativity and skills to survive politically without corruption. At the moment, there is no ambition to do that.” State-owned companies such as the electricity companies, the water supply, the railways and Sri Lankan Airlines are particularly suffering from corruption. As a result, they have accumulated billions in debt.

Corruption and legal uncertainty also mean that hardly any foreign money flies to Sri Lanka. “Until 2009, the war was the problem, but investors still have no confidence in the government,” says Nishan de Mel. Foreign direct investment would not only create jobs, but also an increase in knowledge and know-how.

According to Iromi Perera, the IMF is as much part of the solution as it is part of the problem. It does not prioritize promoting health and education, which are important for long-term development. This view is becoming increasingly popular in Sri Lanka. Nishan de Mel believes that the IMF should be more transparent in its analyses. Certain ways could be found to stimulate the economy that would also improve general social well-being.

Dissatisfaction with the IMF will also affect the West

Sociologist and economist Ahilan Kadirgamar is even more critical: “People are now waiting for the elections. They believe that these things will magically change. But in 2025 or 2026 they will find that things have not changed.” People had the impression that the West fully supported the IMF. There would inevitably be a backlash against the IMF for its austerity measures, which would also be directed against the West.

The lecturer at the University of Jaffna is pessimistic about the future. Discontent over economic development could easily lead to tensions in politics and be directed against the minorities, he warns. “At first the Sinhalese nationalists will blame the West, but eventually the polemics could polarize the country and turn against Tamils ​​and Muslims.”