Sri Lanka’s Economic Meltdown Triggers Popular Uprising and Political Turmoil


By
Alan Keenan

Sri Lanka is embroiled in nationwide protests amid deepening economic woes and increasing political volatility. In this Q&A, Crisis Group expert Alan Keenan analyses the implications of the crisis, which could have lasting political and economic effects.

What has been happening in Sri Lanka?

Protests, which had been building from late February in response to Sri Lanka’s worst economic crisis in nearly 75 years of independence, have now morphed into a nationwide uprising. Protesters are demanding the resignation of President Gotabaya Rajapaksa and removal of the Rajapaksa family from politics.

The protest wave gained momentum as the results of the government’s financial and economic mismanagement became increasingly visible amid rapidly disappearing hard currency reserves and widespread shortages. As prices of petrol and other basic commodities spiked, and imported goods became more expensive and harder to find, the public expressed its growing frustration through ad hoc protests and nightly vigils in middle-class neighbourhoods. Average Sri Lankans are furious at the collapse of living standards and government ministers’ repeated statements betraying indifference to the immense hardships they are facing. Popular anger grew after the president addressed the nation on 16 March, refusing to accept any responsibility for the economic problems, and a special All-Party Conference on 23 March produced no solutions to the crisis.

Organised in large part through social media, including under the banner of #GoHomeGota, protesters have shifted from calling on the president to resign to calling for the whole Rajapaksa family – including the prime minister and former president, Mahinda Rajapaksa – to exit politics. They are also demanding thorough investigations into the alleged large-scale corruption and political crimes widely attributed to the ruling family and their associates. Since 9 April, thousands of peaceful protesters have been continuously camped outside the president’s offices in central Colombo. While the Rajapaksas’ reputation for political repression had earlier deterred many protesters, growing anger seems to have overcome fear.

The evening of 31 March was a turning point for the protest movement, as large crowds gathered near Gotabaya’s private residence. Protesters marched directly up to the president’s well-guarded house, chanting their demand that he leave office. Police efforts to disperse the crowd with tear gas and water cannons only fuelled discontent. The clashes saw security forces assault journalists and arrest more than 50 demonstrators, some of whom were reportedly tortured. Public outrage at police violence and the deployment of troops deepened the shift in public mood against the Rajapaksas. In the protesters’ eyes, the family, which has been at the core of the nation’s power politics since 2005, is the central cause of Sri Lanka’s woes and no longer credible as the protectors of the country’s Sinhala Buddhist majority.

On 1 April, in an effort to prevent planned future protests, the president declared a state of emergency, followed by an island-wide curfew and a shutdown of social media networks. He lifted these measures within days, but even before he did so, protest organisers had found ways around the social media ban. Demonstrations on 4 April saw tens of thousands in the streets in multiple locations, with some protesters beginning to link the government’s economic mismanagement to the Rajapaksa family’s alleged corruption and other crimes, starting with Gotabaya himself.

Amid the tumult, the entire slate of government ministers resigned on 3 April. It was a coordinated move, allowing Gotabaya to appoint a new four-member cabinet, still headed by his brother Mahinda as prime minister. Gone from office were two other Rajapaksas – Basil, who as finance minister had been a lightning rod for popular anger, and Namal, Mahinda’s son and heir apparent, who had been sports minister. The loathed Central Bank governor, Ajith Nivard Cabraal, also resigned.

The president then called on the opposition to join a “national unity” government, but there were no takers, and his political stock continued to plummet. On 5 April, more than 40 allied lawmakers withdrew support from the governing coalition led by Gotabaya’s Sri Lanka Podujana Peramuna party (SLPP), putting its parliamentary majority in doubt. In response, Gotabaya said any group of parties that could assemble a majority was invited to form a new government, but so far none has tried to do so.

The emergence of a broad-based popular movement against autocratic rule is for many Sri Lankans a welcome change in a country traditionally divided on ethnic and religious grounds. The situation is volatile, however. Political paralysis could lead to even deeper economic collapse or more serious social unrest. Authorities could in turn use the turmoil to justify violent repression and an even larger role for the military in governance.

For the time being, Sri Lanka is stuck in a political standoff: the president refuses to resign, even as his parliamentary majority is in question, while the opposition has failed to develop a coherent plan for removing him or for ruling the country if he leaves. Even if Gotabaya resigns, it is not clear that opposition parties are ready to take on the responsibility of seeing Sri Lanka through the economic crisis, given that international creditors are certain to impose conditions for further lending that will force painful sacrifices on average Sri Lankans, making whoever is in power unpopular.
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Just how bad have things become for average Sri Lankans?

Sri Lankans across the island are increasingly desperate. Skyrocketing prices – due to the scarcity of imported goods, low recent crop yields and a 60 per cent drop in the Sri Lankan rupee’s value since mid-March – have made even basic commodities unaffordable for many families. The risk of widespread food insecurity and malnutrition is growing. High prices have hit the poor and day labourers particularly hard, but shortages of key food items, cooking gas and petrol have affected the middle class badly, too. The misery is worsened by daily power outages up to twelve hours long, with power plants lacking the imported fuel they need to generate electricity and water levels in hydroelectric reservoirs low due to drought. Lack of reliable power forces many businesses to shorten their hours. Medicines and medical supplies – virtually all imported – are getting hard to find, with doctors and medical trade unions warning that the health system could fall apart.

Although no stranger to natural and manmade disasters, Sri Lanka has never faced this kind of economic and political meltdown. Even through 30 years of war, it maintained a relatively high standard of living in most parts of the country, with a functioning, if increasingly threadbare welfare state. The economic pressures and rapid decline in living standards are traumatic for all but the wealthiest Sri Lankans and lie at the core of the nearly universal anger at the government.

Meanwhile, the possibility that the crisis spirals into a humanitarian emergency looms as Sri Lanka’s lack of money threatens to cripple economic activity and undermine its shaky banking system. On 12 April, the Central Bank announced it was suspending repayments of foreign debt in advance of negotiations with the International Monetary Fund (IMF) and other outside creditors. In effect, the announcement begins the process of Sri Lanka’s first-ever default, although some economists and investors are nevertheless welcoming it as a long overdue acknowledgment of how critical the situation has become.

Even if the government is able to reach a deal with the IMF to avoid an “unstructured default” (ie, one that occurs outside a deal with creditors and the IMF) and the downward spiral that could ensue, Sri Lanka’s economy and living standards will take years to recover.

What is driving the economic crisis?

Sri Lanka’s economic disaster has deep roots: the country has long lived beyond its means – borrowing too much and taxing too little – and produced below its potential. But the Rajapaksa administration’s gross negligence on economic matters since it came to power in November 2019 has significantly aggravated the island’s chronic problems.

At the heart of the crisis is the lack of hard currency needed to service the country’s huge foreign debt and to purchase the imported goods that Sri Lankans rely on, including much of their food and medicine, and all of their fuel. Foreign reserves have long been low, but the COVID-19 pandemic made things worse by almost entirely interrupting tourism, one of the country’s largest sources of foreign currency. Meanwhile, Sri Lanka’s international debt obligations have steadily grown, in part because of costly infrastructure projects financed with Chinese loans that must be repaid even though the projects have yet to pay economic dividends, and the need to finance chronic budget deficits generated by a large public sector and low taxation rates. With debt increasingly composed of high-interest commercial loans and sovereign bonds held by international creditors, Sri Lanka needs to repay another $4-6 billion in 2022 alone, but has less than half a billion in usable dollar reserves.

The previous government (2015-2019) made modest progress toward fixing Sri Lanka’s chronic problems, but its efforts were quickly reversed after Gotabaya’s election. In early 2020, just before the COVID-19 pandemic started affecting the economy, the new administration introduced massive tax cuts that sharply reduced government revenue and garnered lower credit ratings that eliminated its ability to borrow on the international market. In an effort to keep inflation under control, the government spent large amounts of its dwindling hard currency reserves to prop up the Sri Lankan rupee’s value. To save hard currency, the president also banned the import of chemical fertilisers in April 2021, forcing farmers to adopt organic methods overnight, without resources or training. As result, agricultural yields plummeted, farmers got poorer and the government was forced to import more food.
Gotabaya’s authoritarian, centralised and non-transparent decision-making is central to the crisis. Surrounded by cronies and oblivious to criticism, his administration rejected repeated calls for a course correction as the crisis deepened. Defying expert opinion, the president and his Central Bank governor initially refused to enter into negotiations with the IMF to arrange a financial package that could win international creditors’ confidence and allow for the restructuring, and reduction, of Sri Lanka’s debt. Instead, throughout 2021 and the first quarter of 2022, the government arranged a series of short-term currency swaps and credit lines from China, India, Bangladesh and others. These were merely stopgap measures, failing to address the fundamental problems and in fact adding to Sri Lanka’s total debt.

After more than a year of resistance, Gotabaya announced on 16 March that his government would enter into negotiations with the IMF. By then, the situation had grown truly dire, with currency reserves down to dangerously low levels and the government struggling to pay for even the most essential imported goods. Two weeks earlier, the IMF had issued a statement outlining the reforms needed to win its financial support. These include a long series of austerity measures, from budget cuts to income tax and VAT increases, an end to inflationary money printing by the Central Bank, phasing out import restrictions, stopping government interventions aimed at stabilising the rupee, and “growth-enhancing structural reforms”, which will likely include the sale or partial privatisation of state-owned companies.

On 6 April, the president appointed a committee of three respected economists to handle talks with the IMF. It will face a daunting task. In addition to negotiating with the IMF on the details of long-term structural reforms, the committee, together with the finance ministry and Central Bank, will need to arrange urgent “bridge financing” from international agencies to inject short-term liquidity, convince creditors to allow a pause in debt payments, and prepare a range of legislation to increase taxes and cut non-urgent public spending. With currency reserves dangerously close to zeroing out, speed is of the essence. While the Central Bank’s 8 April doubling of interest rates and subsequent suspension of debt repayments shows that some in the government now seem to understand the urgency of the situation, there is little in the administration’s record to inspire confidence about how it will handle the challenges ahead.

The government is due to start talks with the IMF on 18 April and has announced that it needs $3-4 billion in support from external lenders for the remainder of 2022. To secure agreement from the fund on such a large amount will likely take months, but it might deploy emergency financing (most likely in the tens of millions) as a stopgap, likely in coordination with the World Bank, which has said it is considering emergency assistance. Whether the IMF acts quickly will likely depend on how serious the Sri Lankan team seems about reforms, how dire the situation continues to look on the ground, and how eager the IMF is to avoid rattling the global markets that see Sri Lanka as a bellwether for a string of future potential defaults across the developing world.


What is the way out of the political crisis?

Despite the vigorous protest campaign demanding his resignation, President Rajapaksa appears determined to cling to power, especially as public calls to hold him and his family accountable for alleged corruption and other crimes grow louder. Various parties in the opposition are developing plans to remove him or trim his powers, but it is proving to be a challenging undertaking. One possible road to removal is impeachment – a complex effort that requires a two-thirds majority in parliament. The bloc most likely to attempt it is an awkward grouping of the main opposition Samagi Jana Balawegaya (SJB), former Rajapaksa supporters, the leftist Janatha Vimukthi Peramuna (JVP), and smaller Tamil and Muslim parties. But they are still far from meeting the required threshold.

Another approach that may present fewer procedural obstacles, proposed by SJB leader Sajith Premadasa on 5 April, would be to amend the constitution to strip the presidency of its executive powers and transfer them to the prime minister and cabinet, who would be accountable to parliament. A draft bill giving effect to this approach, formulated with a view to past supreme court rulings in order to avoid the need for approval by referendum, is reportedly ready to be tabled at the next parliamentary session on 19 April. If the amendment is approved – which would also require two-thirds support and take three to four weeks – Gotabaya would have the choice to remain as a ceremonial president or to resign. Under this scenario, whatever new parliamentary majority and prime minister emerged would then face the challenge of negotiating with the IMF to win support from the fund and begin restoring investor confidence, before likely calling fresh elections.

To increase political pressure on Gotabaya to resign and be in a stronger position to win a vote on amending the constitution, the main opposition party, the SJB, plans first to call for a no-confidence vote in the hopes of then forming an interim coalition government it will lead. It had earlier hesitated to do so, uncertain that it has the votes and also well aware it could struggle to set policy with Gotabaya still in office given the enormous powers the president enjoys (and which he significantly reinforced though a constitutional amendment after coming to power). The SJB also knows that governing under Gotabaya, even briefly before his removal, could taint it by association and damage it politically, especially given the unpopular decisions any government will need to make to stabilise the country’s financial situation. The SJB’s hesitation, and its failure to communicate to the public a clear strategy for removing Gotabaya and addressing the immediate economic crisis, appear to have provided space for the Rajapaksas to regroup partially. Other parties, including those formerly in government, are floating rival plans.

Any move to remove or sideline President Rajapaksa is likely to take weeks, if not months, and could fail entirely. Meanwhile, the prospect of an unmanaged default looms, with hard currency reserves likely to run dry within the next few weeks. Moreover, there is no guarantee of success in negotiations with the IMF and international bondholders, who will want to be assured that any likely government will make and sustain the reforms and other measures they insist on as a condition to any relief package. Against this backdrop, opposition parties will need to work with serving officials on an urgent basis to craft a consensus set of economic policies that can win over the IMF. They will need to cooperate closely with the new Central Bank governor, P. Nandalal Weerasinghe, and the committee of economists appointed by the president to manage the IMF negotiations.

Is there a risk political tensions could turn violent? Could the military be tempted to intervene?

Should the protests continue to grow or turn violent, perhaps following a banking collapse, some fear Gotabaya, known for his hot temper and his role in brutal counter-insurgency campaigns against both Sinhalese and Tamil insurgencies during his military and political career, might be willing to call in the military to crush them. So far, the government has been careful to cultivate an international image of moderation, and the military has denied any plans to intervene, but Prime Minister Mahinda Rajapaksa’s address to the nation on 11 April, in which he presented the protest movement as anti-democratic and hostile to the police and military, was widely interpreted as a veiled threat.

It is unclear how much support there would be in the army for a crackdown. On one hand, its top commanders – most notably the army head, Major General Shavendra Silva (sanctioned by the United States for credible allegations of war crimes), and the defence secretary, retired General Kamal Gunaratne – are known to be close to the president. On the other hand, while military personnel are paid well relative to other civil servants, the worse the economic crisis gets, the more they and their families will also feel its effects. They could be reluctant to turn their guns on protesters, especially those who are fellow Sinhalese. There is also evidence of fissures between the army and police, who are normally in charge of dealing with protests. In one incident – widely discussed on social media – police turned away unmarked army special forces motorcycle units sent in to intimidate protesters near parliament on 5 April. The army commander and defence secretary reacted angrily and ordered the chief of police to discipline the policemen involved.

What can foreign governments and multilateral agencies do to help?

Only Sri Lankans can solve the country’s crises, but outside powers and international institutions have an important role to play in reducing the risks of economic collapse and violence. In particular:

First and foremost, donors can provide urgently needed humanitarian assistance, particularly in the form of medicine and medical supplies. An Indian government credit line to buy fuel, food and medicine has been crucial, but with Sri Lanka’s hard currency resources diminishing further each day, more assistance in those same areas is immediately required to prevent a serious humanitarian crisis.

Secondly, to limit the risks of violent escalation, Sri Lanka’s democratic foreign partners should send strong messages to military leaders that any attempt to intervene in politics or to repress protest will do lasting damage to bilateral relations and could trigger targeted human rights and other sanctions of the sort that the U.S. has enabled under the Magnitsky Act.

Thirdly, support from the IMF (as well as the World Bank and bilateral donors) is essential to avoid a complete economic disaster. But it brings risks, too. Many critics of the president and his administration fear that a lifeline from the IMF, while easing pressures on average Sri Lankans, could provide breathing space to Gotabaya as well, allowing him and his family to restore themselves. In the event the political opposition mounts a successful impeachment or power-stripping effort along the lines outlined above, this concern will at some point become moot. But regardless of the Rajapaksas’ fate, the IMF should take steps to help ensure that any international bailout does not perpetuate the systemic weaknesses that have contributed to the current crises. To this end, the IMF should insist on reforms that can help rein in a bloated military, institutionalised corruption enabled by a lack of financial and political accountability, and systematic attacks on free media that make it harder to report on and challenge official malfeasance.

Whatever happens over the next few weeks and months, Sri Lanka’s recovery from the current crisis is likely to be difficult and could last years. If the Rajapaksas hold onto power, they will be governing an angry, restless populace without the public support needed to impose the painful measures Sri Lanka must take to restructure its international debt. If they do not, a string of unstable and short-lived governments is a distinct possibility, as few politicians will be eager to design or administer the new social and economic policies that creditors will require as part of any bailout package. Sri Lanka will warrant close international attention and support throughout the difficult years ahead.

Courtesy:International Crisis Group