Sri Lanka’s current economic crisis is rooted in its long dalliance with IMF-imposed conditionalities and has been aggravated by the Rajapakse government’s quixotic organic farming adventure. Without a course correction, more misery is in store for the country.
Sri Lanka is in the news for all the wrong reasons. Its economy has been in a crisis owing to a serious balance of payments problem. Its foreign exchange reserves are depleting rapidly. The country is unable to repay past debts. It is becoming increasingly difficult to import several essential consumption goods, such as food, fuel and fertilizers. Domestic agricultural production has fallen. Hunger and malnourishment are rising. Inflation ruled at 17.5 per cent in February 2022.
Given the manufacture of narratives in our times, a dominant explanation for the crisis in the mainstream media centres around the so-called “debt-trap” that China is accused of having set for Sri Lanka. However, China’s share in Sri Lanka’s total foreign debt was less than 10 per cent in 2020. Sri Lanka borrowed more through international sovereign bonds and from Asian Development Bank and Japan than from China. The China-centred analysis draws from a Western campaign and is essentially aimed at obscuring the central role of several domestic and international agents, especially the International Monetary Fund (IMF), in the making of the Sri Lankan crisis. A composite understanding of the roles of all these agents is necessary to understand the predicament the island economy finds itself in today.
British colonialism was instrumental in entrenching a new cropping pattern in Sri Lankan agriculture, which was aligned to demands in the European market. The British introduced tea, coffee and rubber in the uplands, where large numbers of Tamilian workers were brought in to work as indentured labourers. At the time of independence in 1948, a third of Sri Lanka’s gross domestic product (GDP) came from the exports of these primary commodities.
Such a classic lock-in of the economy as an exporter of primary commodities was difficult to wriggle out of after independence. Foreign capital continued to control the plantation sector, and much of the profits from plantations were drained out of the country. As the cropping pattern failed to diversify, Sri Lanka relied considerably on the import of essential food items like foodgrain, pulses, milk and sugar. Unsurprisingly, then, industrial capital accumulation, too, was stifled. Thus, the country was dependent on imports in non-agricultural consumer goods too. Over time, the inability of the post-war Sri Lankan economy to escape from the rigidity of this economic structure within the global capitalist milieu was to become its bane.
Until the second half of the 1950s, the Sri Lankan economy enjoyed a trade surplus owing to rising primary commodity prices. The rising tax revenue from export crops allowed Sri Lanka to invest in free education, free primary health care and a subsidised food rationing system. Because of these early investments, Sri Lanka became one of the outliers in the development literature with admirable social sector indicators even at low per capita income levels.
However, once the Korean war eased, things became difficult. As commodity prices fell, exports fell too, but imports kept rising. Sri Lanka walked into a serious balance of payments crisis by 1965-66. It was in this situation that the IMF first entered the scene with a loan tagged with its inevitable conditionalities. The country was forced to cut its budget deficit, slash subsidies, follow a tight monetary policy and reduce taxes on private and foreign capital. In the late-1960s, the currency was devalued by 20 per cent, a dual exchange rate regime was introduced and imports were liberalised.
The IMF’s reform package was partially reversed in the first half of the 1970s by the Left-leaning Sirimavo Bandaranaike government. This government pushed for land reform, nationalised industries and increased social-sector expenditures. International organisations such as the World Bank and the IMF criticised Sri Lanka for the policy shift, which led to much external hostility towards the Bandaranaike government. In 1973, the oil shock led to a major drain of foreign exchange reserves. Social expenditures had to be maintained, industrial growth was stagnant, external perception was hostile and essential consumer goods had to be imported. These conflicting features could not be reconciled by the ruling coalition, and it finally collapsed in 1977.
NEOLIBERALISM IN SRI LANKA
In 1977, a United National Party (UNP) government led by J.R. Jayawardane took office. The UNP government inaugurated the embrace of neoliberalism—the “open economy”—in Sri Lanka. Its aim was to build “a free and just society”; following Milton Friedman, free society was seen as inseparable from a free economy. Towards this goal, Jayawardane obtained three major IMF loans: for 1977-78, for 1979-1982 and for 1983-84.
As part of these loans and the attendant conditionalities, Sri Lanka consented to another economic reform programme consisting of a set of recommendations that later crystalised into the “Washington Consensus”. The programme included exchange rate liberalisation, rupee depreciation, abolition of price controls, slashing of food subsidies, restraints on wages, tight monetary policy, encouragement to private enterprises and more foreign aid.
There is much literature that details the havoc that the IMF programme wreaked between 1979 and 1983 (see G.A. Cornea, R. Jolly and F. Stewart, Adjustment with a Human Face, Clarendon Press, Oxford, 1987). Income inequality, which had fallen between 1970 and 1977, increased afterwards; the share of income of the bottom 40 per cent fell from 19.3 per cent in 1973 to 15.3 per cent in 1981-82. Real wages fell. As a share of total expenditure, social sector expenditure fell from 33 per cent in 1977 to 22 per cent in 1983. Public expenditure on health fell by 13 per cent between 1979 and 1983, as did public expenditure on food subsidy and the supplementary feeding programme. Food subsidy was substituted with food stamps, but the value of food stamps eroded rapidly with inflation.
The daily per capita calorie intake of the bottom 20 per cent of the population fell from 1,500 calories in 1978-79 to 1,370 calories in 1981-82. Malnourishment among children of age 6-60 months in rural areas rose from 6.1 per cent in 1978-79 to 9.4 per cent in 1981-82. Literacy rates among those between five and 14 years fell from 88 per cent in 1978-79 to 86 per cent in 1981-82. School avoidance rates for children in Classes 1 to 8 increased from 12.2 per cent in 1978-79 to 13.5 per cent in 1981-82.
The implementation of the IMF programme also happened in the background of two political shifts. Firstly, the government needed a diversion to shield it from the public anger over the rising economic hardships. Thus, it consciously promoted a brand of Sinhala chauvinism to create a divide between the Sinhala population and the Tamil minority. There was systematic discrimination against Tamil minorities and frequent attacks against them. Alongside, the demand for a Tamil Eelam emerged, and groups led by V. Prabhakaran ambushed and killed Sinhala soldiers. These complex political developments culminated in the July 1983 pogrom against Tamils and the start of the long civil war.
Secondly, there was also massive suppression of trade unions and Left movements that opposed neoliberalism. Authoritarianism received a boost when the parliamentary system was replaced with a presidential system. General strikes of workers were put down brutally, including through the mobilisation of defence reserves and the declaration of national emergencies. “The elephant has only shaken its trunk and not yet used its full strength,” threatened Jayawardane in one nationwide broadcast in response to a workers’ strike in August 1980. (The elephant was the UNP’s electoral symbol.)
THE POST-CIVIL WAR ERA
The long civil war that began in 1983 came to a violent end in 2009. It was expected that the economy would be set on a growth path with the onset of “peace”. However, history could not be shrugged off that easily. To kick-start the war-torn economy, the then President Mahinda Rajapaksa of the Sri Lanka Podujana Peramuna (SLPP) approached the IMF for a $2.6 billion loan in 2009. War requirements had kept fiscal deficits high, and capital flights after the global financial crisis in 2008 had drained Sri Lanka’s foreign exchange reserves. This was when the IMF loan was sought in 2009. Unsurprisingly, the IMF’s cardinal conditionality was rather straightforward: cut fiscal deficit to 5 per cent of the GDP by 2011.
There was, in fact, a spurt of GDP growth in the initial years between 2009 and 2012. However, the growth rates began to decline steadily after 2012, as global commodity prices began to fall. Export revenues slowed down even as the demand for imports, including of luxury vehicles, rose. Thus, on the one hand, the annual GDP growth rates nearly halved from 8.5 per cent between 2010 and 2012 to 4.5 per cent between 2013 and 2015. The investment rate fell from 39.1 per cent in 2012 to 31.2 per cent in 2015. The savings rate fell from 33.2 per cent in 2012 to 28.8 per cent in 2015. Yet, a counter-cyclical fiscal policy was ruled out, as the government’s hands were tied by the IMF conditionality to keep fiscal deficits in check.
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On the other hand, as foreign exchange reserves fell, a balance of payments crisis emerged. The country also struggled to repay its large infrastructure loans. This was the context in which the IMF entered the scene yet again in 2016. The new government that took power in 2016 approached the IMF for another US$1.5 billion loan for a three-year period between 2016 and 2019. The 2016-19 loan was the 16th loan that Sri Lanka received from the IMF since 1965-66.
THE NEW IMF LOAN
As with the previous 15 loans, the 16th loan carried familiar conditionalities. “The linchpin of the reform programme”, as the IMF termed it, was that Sri Lanka must cut its fiscal deficit from 6.9 per cent of the GDP in 2015 to 4 per cent of the GDP in 2018 and 3.5 per cent of the GDP by 2020. The IMF also asked Sri Lanka to mobilise more revenues through indirect taxes, such as the value-added tax (VAT) instead of infrastructure-financing through the levy of a Nation Building Tax (NBT), rationalise public spending, move from subsidies to direct cash transfers, reform public financial management and state enterprises, adopt inflation-targeting and a flexible exchange rate regime, and liberalise trade and investment.
The health of the Sri Lankan economy further deteriorated between 2016 and 2019. The rate of growth fell from 5 per cent in 2015 to 2.9 per cent in 2019. The investment rate fell from 31.2 per cent in 2015 to 26.8 per cent in 2019. The savings rate fell from 28.8 per cent in 2015 to 24.6 per cent in 2019. Government revenues shrank from 14.1 per cent of the GDP in 2016 to 12.6 per cent of the GDP in 2019. Gross government debt rose from 78.5 per cent of the GDP in 2015 to 86.8 per cent of the GDP in 2019.
Nevertheless, in its 2019 assessment, the IMF praised Sri Lanka for its “commitment to the… programme”, its “efforts to advance revenue-based fiscal consolidation, with a well-targeted 2019 budget” and for its efforts to “strengthen reserves, under greater exchange rate flexibility” and for following “a prudent monetary stance”. It agreed to extend the loan period by one more year, even as it advised the country to move forward with the larger structural reform agenda.
TWO SHOCKS AND A PANDEMIC
The year 2019 witnessed two further shocks to the economy. First, there were a series of bomb blasts in churches and luxury hotels in Colombo in April 2019 in which more than 250 people died. The blasts led to a huge fall in international tourist arrivals; tourist arrivals fell by 71 per cent in May 2019. The extent of decline gradually narrowed thereafter but remained significant at 47 per cent in July 2019 and 9.5 per cent in November 2019. According to a report in Al Jazeera, tourist arrivals fell by 18 per cent over the year. The slowdown in tourism imposed enormous strains on Sri Lanka’s foreign exchange reserves in 2019.
Secondly, a new SLPP government came to power in November 2019 led by Gotabaya Rajapaksa. The SLPP had made two major promises in its election campaign: one, that it would cut taxes and, two, that it would provide major concessions to farmers. In December 2019, taxes were slashed. In indirect taxes, VAT rates were cut from 15 per cent to 8 per cent. The annual threshold for VAT registration was raised from LKR 12 million to LKR 300 million. The Nation Building Tax, the PAYE tax and the economic service charges were abolished. In direct taxes, standard corporate income tax rates were reduced from 28 per cent to 24 per cent. The annual income threshold for waiver of personal income tax was raised from LKR 500,000 to LKR 3,000,000.
The impacts of these steps on government revenues were quick and evident. A report in Financial Times estimated the loss from taxes thus foregone at $2 billion or about 2 per cent of the GDP. Estimates of PublicFinance.lk, an independent public finance platform, showed that there was a 33.5 per cent decline in the number of registered taxpayers between 2019 and 2020. GST/VAT revenues almost halved between 2019 and 2020.
The COVID-19 pandemic arrived in early 2020 on the back of these two economic shocks. An already bad situation turned worse. Exports of tea, rubber, spices and garments suffered. Tourism arrivals fell further. Remittances also fell as Sri Lankan workers lost jobs in different countries. On the other hand, the pandemic necessitated a rise in government expenditures. The fiscal deficit exceeded 10 per cent in 2020 and 2021, while the ratio of public debt to GDP rose to 119 per cent in 2021.
EMBRACE OF PSEUDOSCIENCE
Fertilizers were among the many items of consumption that Sri Lanka was historically forced to import. As the pressure on foreign exchange grew during the pandemic, Gotabaya Rajapaksa received the advice that foreign exchange could be saved if there were no fertilizer imports. Thus, in April 2021, he announced that imports of all chemicals for use in agriculture would be banned from May 2021. The question of introducing organic farming had been a live topic in Sri Lanka for a while. A section of environmental activists and international groups, based on unscientific reasoning, had been urging Sri Lanka to shift completely to “organic farming”. In 2015-16, when Maithripala Sirisena was the President, the government initiated a three-year long national programme titled Wasa Wisa Nethi Retak, also titled expansively as “A Wholesome Agriculture – A Healthy Populace – A Toxin Free Nation”. The aim was to ensure the provision of food free of chemicals and toxins.
Sirisena’s policy on organic farming was opposed by agricultural scientists. They warned the government of the “danger of going back to the pre-green revolution era”, which could “drastically reduce the production of cereal as well as the other crops”. The scientists suggested that the more appropriate policy to follow would be to ensure Good Agricultural Practices (GAP). GAP is a validated concept in agricultural science. Sirisena, however, refused to heed the scientists’ advice. Yet, the programme did not go further than a fertilizer subsidy reform in 2016, where a price subsidy was replaced with a direct cash transfer payment to farmers.
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When he campaigned for power in 2019, Gotabaya Rajapaksa promised subsidised foreign fertilizers to farmers. But by 2021 he changed his views. Amid the pandemic, he revived Sirisena’s idea and decided to convert all of Sri Lanka’s agriculture into organic agriculture. Most agricultural scientists were excluded from the President’s group of advisers which designed the new policy; in fact, the group was populated with people with dubious credentials. Some among them argued that chemical use in agriculture was the cause for the rising incidence of chronic kidney disease in Sri Lanka even though peer-reviewed research failed to reveal any link between chemical farm inputs and kidney diseases. Kidney diseases were linked by scientists to “hard water in conjunction with fluoride present in many wells”. But such voices of reason were disregarded.
Another presidential adviser had once infamously claimed to have identified a self-generated rice variety that had fed the 10 giant warriors of the Sinhala King Dutugemunu of the Anuradhapura Kingdom between 205 BCE and 161 BCE. Agricultural scientists tested the claim and found that the grain was sorghum, not rice. Yet another adviser had claimed that glyphosate dissolves reservoir bunds. It was not surprising, then, that the adoption of advice from such a group turned out to be disastrous for the Sri Lankan economy.
FAILURE OF ORGANIC FARMING POLICY
To begin with, globally, the share of the total area under organic farming is only 1.5 per cent. Even in the European Union (E.U.), the share of total area under organic farming is only 9 per cent. Thus, to aim for a 100 per cent shift to organic farming in just one month was not just suicidal but plainly ludicrous.
Secondly, agricultural scientists had petitioned the government not to implement the new policy. In a letter to the President in May 2021, the Sri Lanka Agricultural Economics Association (SAEA) wrote that banning chemicals would adversely affect “food security, farm incomes, foreign exchange earnings and rural poverty”. They added that yields may drop by 25 per cent in paddy, 35 per cent in tea and 30 per cent in coconut if chemical fertilizers were banned. As no chemicals were available to spray against fungal leaf diseases, rubber production was also projected to fall by 15-20 per cent. In the long-run, average agricultural productivity may fall by 20 per cent leading to a contraction of the country’s GDP by 3.1 per cent, they warned.
The scientists’ fears turned prophetic. Sri Lanka has two agricultural seasons: the Yala (May to August) and Maha (September to March). When the ban on chemical imports was imposed in May 2021, the Yala season of 2021 had already begun. A good part of the requirement of chemicals for the season had already been imported, and there were prior stocks from the previous Maha season. Hence, Yala production in 2021 was not significantly affected. However, with no imports of chemical fertilisers and pesticides, production and productivity were significantly adversely affected in the Maha season of 2021-22. The IMF concluded in February 2022 that there was a “worse-than-anticipated impact of the chemical fertiliser ban on agricultural production”.
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According to Buddhi Marambe, an agricultural scientist, the productivity of paddy in the Maha season of 2021-22 was lower by 40-45 per cent compared with the previous Maha season of 2020-21 (see Buddhi Marambe, “The ‘Manmade Agriculture Disaster’ in Sri Lanka”, DailyFT, March 23, 2022). In maize, the production during the Maha season of 2020-21 was 415,000 MT and during the Yala season of 2021 was 50,000 MT. However, in the Maha season of 2021-22, the production of maize is expected to be just 60,000 kg. With skyrocketing maize prices, animal feed costs have risen sharply leading to inflation in the retail prices of meat.
In tea, the total expected production in 2021 was 320 million kg but the actual production was only 299 million kg. Between January and April 2021 (that is, before the import ban), tea production was 21 million kg higher than between January and April 2020. However, between October and December 2021, tea production was 12 million kg lower than between October and December 2020. Similarly, in February 2022, tea production was 20 per cent lower than in February 2021.
The organic farming policy had two other perverse outcomes. First, when productivity fell, there were widespread farmers’ protests. The government was forced to compensate farmers who faced a loss of productivity. Marambe notes that LKR 40 billion was paid to paddy farmers alone as compensation in the Maha season of 2021-22. However, the total expenditure planned for the import of chemical fertilizers for all crops for the full year of 2020 was only LKR 36 billion. Secondly, though Sri Lanka had come close to self-sufficiency in rice production by 2019, the total planned import of rice in 2022 was 300,000 MT from Myanmar and 1 million MT from China. Together, these imports constituted 54 per cent of Sri Lanka’s annual rice requirement.
The organic farming policy was finally withdrawn in November 2021, but not before it had imposed extraordinary costs on the Sri Lankan economy.
This, in essence, is an outline of the economic crisis that has engulfed Sri Lanka. It has had many elements to its evolution and development: historical imbalances in the economic structure; the external imposition of neoliberalism by the IMF; the shift to a right-wing, authoritarian political regime; and the official embrace of pseudo-science. Soon, Sri Lanka will be forced to approach the IMF for a 17th loan. This new loan is certain to come with new conditionalities. The IMF has already indicated that VAT rates may have to be raised but alongside a tighter fiscal and monetary policy—the hallmarks of classic IMF interventions. However, it has given no indications of any concession on past debts, without which Sri Lanka may just enter yet another vicious cycle of neoliberalism, which would only heap further misery on the people.
R. Ramakumar is Professor, Tata Institute of Social Sciences, Mumbai.