Sri Lanka is undergoing a severe economic crisis and is at the risk of devolving into a failed state. The country's foreign reserves are fast depleting, falling from $5 billion in 2019 to 1.8 billion in 2021, despite high inflation and a debt-to-GDP ratio of 110 per cent. From health to defence, the nation is attempting to reorganise its affairs. Meanwhile, other speculations about the origins of the crisis have evolved, ranging from Covid to debt-trap diplomacy. The debt trap of China and Covid is marketed as the source of the crisis. They are, however, only a catalyst; the debt trap sponsored the cause, and Covid was the spark that ignited the fire. The root cause of the crisis lies at the heart of the country. The country's people were persuaded to offer legitimacy and authority to an aristocratic political system Using the identity crisis and insecurity. This mechanism triggered the Butterfly and Domino effect.
The root cause of Sri Lanka's economic crisis and all of the other problems that the nation has been dealing with for decades is the country's identity crisis and sense of insecurity. There are two dominating factions in the country: the Sinhala Buddhists and the Tamil Nationalists. Non-ethnic differences separate the two groups; they are also split along religious and linguistic grounds. The majority of Sinhala nationalists feel unhappy with sharing their territory with Tamil nationalists, who are ethnically, religiously, and linguistically distinct from them. Similarly, the Tamil Nationalist minority feel insecure about sharing their territory with the majority. This sense of vulnerability ultimately resulted in the civil war that lasted for decades and ravaged the nation. The same uneasiness that led to the present economic catastrophe also convinced the nation's people to provide legitimacy and authority to an aristocratic political system, as the insecurity of the majority had done before. The country's populace was convinced to provide legitimacy and power to an aristocratic governmental structure to preserve their interests.
This autocratic political system is reflected via the Sri Lanka podujana peramuna and the New Democratic Front, both endorsed by the Sinhala majority in the country's political institutions. As a result of this unavoidable support, the nation's political structure was transformed from democracy to aristocracy. Sri Lanka was classified as a "flawed democracy" by the Economist Intelligence Unit in 2019. In the aftermath, the nation was plagued by corruption, widespread exploitation, and repression of minorities, among other things.
Sri Lanka's troubled political structure and its geographic location on the Indian Ocean exposed it to foreign threats. The most serious of these threats came from financial reserves, particularly from China. China has poured a large quantity of money into Sri Lanka to aid the country's growth and development. However, the political system of Sri Lanka, which was plagued by corruption, was unable to translate the flood of riches into productive assets. Consequently, the nation found itself in a financial trap with a dual deficit. As is customary in the west, China is being held responsible for the present economic crisis to prevent the expansion of the Chinese financial arm.
A Hypothetical scenario to demystify the conspiracy of the Debt Trap diplomacy. The board of directors of an infrastructure development firm, a public limited company, successfully raised funds for a highway building project. Rather than constructing the highway, they diverted the funds to personal spending and investments. Initially, the firm paid the bank interest using funds from its shareholders-funded reserves. However, after the covid, the shareholders were handicapped making them impotent to replenish their reserves. Consequently, the reserves dwindled, and the firm was unable to pay the interest due to the corporation's inability to generate income from the funds, interest and principal accumulated. Naturally, the bank will need the collateral that was pledged.
Who is to blame in this case: the bank, the company's directors, or the shareholders who disregarded checks and balances to satisfy their personal interest . China is the bank in this scenario, the Sri Lankan government serves as the board of directors, and the Sri Lankan people serve as shareholders. Thus, the Sri Lankan people failed to establish checks and balances on their representatives due to their drugged condition of insecurity, forcing the country or firm into bankruptcy and forcing it to sell its assets to banks and other foreign investors. Furthermore, According to Reuters, China is responsible for just 10.8% of the country's debt; 47% of the country's debt is financed by market borrowing, particularly international sovereign bonds (ISB).This capital-market borrowing is unconditional, with interest rates that are quite high and payback periods that are much shorter.
The coronavirus served as the ignition source for the fire. Sri Lanka was heavily reliant on its tourist sector, which accounted for 10% of its GDP. Following the corona, international travel limitations wiped off the industry. To add fuel to this fire, the Sri Lankan government made efforts to promote organic farming by prohibiting the use of chemical fertilisers; this measure, implemented during a period of economic and social distress, had a detrimental effect on domestic food production and limited the export of cash crops, mainly tea. Sri Lanka was the second biggest exporter of tea, and Ceylon tea is often regarded as the most sought-after brand globally. Organic farming practices lowered tea and other cash crop yields, limiting export capacity and revenue. On the other hand, the decline in food output necessitates the importation of food crops, putting further strain on the country's currency reserves, which are already reduced due to interest payments. Finally, massive tax cuts, a campaign commitment, and a failed effort to revive the economy brought the nation's economy to a standstill.
Finally, to determine what steps the nation should take to exit the situation. Sri Lanka's debt must be restructured quickly and a debt management programme implemented. Both with the IMF's financial and technical assistance and the austerity measures. Due to the IMF's massive involvement, Sri Lanka has evaded the IMF's intervention for a lengthy period, including the people and government. However, if the nation is to survive, this intervention is necessary, and it is the best course of action. Additionally, Sri Lanka needs professional engagement from the IMF to turn its debts and new investment into profitable and developmental assets. The International Monetary Fund (IMF) has helped several countries, including India, get back on their feet after a similar predicament. Under the International Monetary Fund (IMF) guidance and support, India launched the 1991 LPG reforms, which resulted in the country's economic turnaround.
*Haridass Sankar is a professional with M.A. in International Relations, established software engineer and an aspiring political analyst.
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