Worsening global economic conditions are going to hit developing countries the hardest.
Worsening global economic conditions are going to hit developing countries the hardest.
S ri Lanka had been a South Asian success story, at least on economic development. The island country, located off the southern coast of India, had endured a 26-year civil war that concluded in 2009, but by 2019 it had been elevated from a lower-middle-income country to an upper-middle-income country by World Bank classifications. Its GDP per capita, adjusted for purchasing power, is about double that of India, about the same as the poorer countries of Eastern Europe such as Ukraine and Moldova, and only slightly behind Brazil. Its largest city of Colombo had become a tourist destination. It’s not a wealthy country by any stretch of the imagination, but it was doing well for its neighborhood, and its 22 million inhabitants saw a dramatic improvement in their quality of life in the past decade.
On Monday, authorities were telling airlines to make sure they had enough fuel for return trips because they probably wouldn’t be able to refuel in Sri Lanka. On Tuesday, they began the process of applying for international food aid.
Benjamin Parkin wrote about how Sri Lanka went into default for the Financial Times. His in-depth piece is worth your time to read in full, but here’s the gist:
Sri Lanka this month defaulted on its overseas loans after missing interest payments on two $1.25bn sovereign bonds, the first country in Asia-Pacific to do so in more than two decades, according to Moody’s data. The latest estimates put the country’s total foreign debt at more than $50bn, with a $1bn bond maturing in July. President Gotabaya Rajapaksa’s government says it has all but run out of foreign reserves and fuel, relying on ad hoc shipments to top-up supplies in the most visible manifestation of a crisis that, the Eurasia Group consultancy warns, is turning the island into a “failed” state. . . .
Sri Lanka’s debt crisis is the product of hubris, mismanagement and alleged venality of political elites including the Rajapaksa family, as well as irresponsible lending on the part of its creditors.
Sri Lanka’s struggles help to put wealthy countries’ concerns into perspective. A high-inflation environment with sanctions and war roiling global markets means prices go up and politicians lose elections in the well-off West. But for much of the rest of the world, it can mean food is gone and governments collapse.
As Steve Hanke wrote for Capital Matters in April, the Sri Lankan rupee had lost 44 percent of its value since August 2020, and the inflation rate was around 75 percent per year. After winning elections in 2019 and 2020, “President Rajapaksa and his brother Mahinda, the prime minister, went on a spending spree that was financed in part by Sri Lanka’s central bank,” Hanke wrote.
The government embarked on a number of wasteful megaprojects. A Times of India report on those projects includes an international airport, a seaport, numerous unnecessary roads and bridges, and a cricket stadium that “has had only a few international matches and is so remote that arriving teams face the risk of wildlife attacks.” Many of these projects were named after the Rajapaksas, an association that would come back to bite them.
It wasn’t just a spending spree; the other side of the ledger wasn’t any better. After taking power, Parkin writes, President Rajapaksa “cut taxes sharply — eroding government revenues — and changed the constitution to concentrate power around him and his family, with several relatives also in government.” (In addition to being prime minister, Mahinda was also the country’s finance minister.)
The country had to borrow to stay afloat. Interest rates were low, the economy was growing rapidly, and Sri Lanka is geographically situated to benefit from globalization. Colombo is a common stop for ships carrying freight from East Asia to the Persian Gulf and the Suez Canal.
But on top of the fiscal troubles, in April of 2021, Sri Lanka announced that it would try to become the world’s first 100 percent organic country. President Rajapaksa banned chemical fertilizer, despite warnings from agricultural scientists and farmers that the country wouldn’t be able to produce as much food without it. A blend of protectionism and medical quackery influenced Rajapaksa’s decision, and it was pitched as a way to create a “Green Sri Lanka.” Some organic proponents still defend the policy, saying that the crisis began before the ban, and the ban wasn’t in effect long enough to matter — but that should only increase concern for how much worse things could get.
All of that spooked creditors, and Sri Lanka’s debt was downgraded multiple times. Then, factor in the effects of Covid. Sri Lanka’s foreign-currency reserves dwindled because “the pandemic cut off remittances and tourism, vital sources of dollars,” Parkin writes. Now, as interest rates rise globally, refinancing Sri Lanka’s loans in a way that would help looks increasingly difficult.
Coming out of the pandemic, Sri Lanka was counting on the return of tourism, a vital industry to the island country with many beaches on the Indian Ocean. One problem: The first- and third-largest tourism markets for Sri Lanka were Russia and Ukraine. Russia is also a major buyer of Sri Lankan tea. The realities of the war and the sanctions on Russia have upended that plan.
The Rajapaksas went from being very popular to very unpopular very quickly. Mahinda is out of government now, and Gotabaya is having a hard time working with the new prime minister, Ranil Wickremesinghe (it’s trickier when it’s not your brother). Wickremesinghe is proposing a new budget to raise taxes, and the government is begging farmers to plant more rice, but it’s too late now. Protesters are in the streets, some of them setting politicians’ homes on fire, and police used tear gas to disperse them. Parkin writes that there are miles-long lines for gasoline, and some people are only eating one meal per day.
Sri Lanka’s default may just be the start of a wider financial crisis in the developing world as a result of worsening global economic conditions. The country had the disadvantage of exceptionally poor leadership and bad timing of the pandemic and the war in Ukraine. But poor leadership is common in the developing world, and less robust economies are especially susceptible to bad luck.
Countries are economically connected in strange ways. In many cases, those connections only become widely known in hindsight, after a crisis has made them obvious. It would be an overstatement to say that fewer Russians and Ukrainians going on vacation plunged Sri Lanka into crisis, but that seemingly innocuous fact was one of many contributing factors. Those in the prosperous West who are cheering for the end of globalization should be careful what they wish for.