Policy Problem

Stakeholders 

In light of Sri Lanka’s economic turmoil, several nations have extended economic aid.  After extending a $1.54 billion currency swap and a $700 million loan to Sri Lanka in 2021, China was passive after Sri Lanka asked for further aid. However, after months of silence, China has announced an urgent emergency humanitarian aid of around $31 million.⁶ Experts speculate the possibility of “debt-trap-diplomacy,” where China would allow Sri Lanka to take out loans despite not being able to pay them fully.⁸

China has long been accused of using debt traps to coerce dependence from developing nations. For one, Sri Lanka’s past inability to pay debts resulted in a 99-year lease of the Hambantota Port to China, where China ultimately acquired 70% ownership of the port.¹ Since January 10, Sri Lanka has sought to delay repayment of $11 billion but has been met with silence from China.

Gulbin Sultana, an associate fellow for Defense Studies and Analyses, comments on China’s refusal to reschedule loans:  "China wants to take advantage of Sri Lanka's inability to repay loans in time. Beijing is waiting for a good time to enter into a debt-to-equity swap and acquire land in Sri Lanka.” Nevertheless, Colombo-based think tank Verité Research states that China has just contributed to 15% of Sri Lanka’s foreign debt, indicating that Chinese debt-trapping may not be the root of Sri Lanka’s struggles.

Meanwhile, Bangladesh has extended a $200 million loan to Sri Lanka, while India has committed financial aid of $2.4 billion for necessities such as food and oil.²⁹ Within a week, 16,000 Megatonnes of rice have been supplied under India’s support package. Yet given continuing predicaments, Colombo has continued to seek further aid from its neighbors.¹⁸ 

Nonpartisan Reasoning

At first, Sri Lanka dodged negotiations with the IMF due to conditions attached to the relief package, instead of leaning on countries such as China and India.  In March, however, Sri Lanka’s central bank devalued the rupee by up to 15%, which analysts interpret as a step to obtain an IMF loan to help debt restructuring and bolster currency reserves.¹⁹ On the brink of bankruptcy, Sri Lanka began talks with the IMF in April for Rapid Financing aid to mitigate supply chain issues.³⁵ The IMF, though initially hesitant, has now pledged to “support Sri Lanka’s efforts to overcome the current economic crisis”.¹⁶ 

Policy Options

As Sri Lanka fails to make an economic recovery and the government faces increasing political pressure from angered citizens, a policy shift is imminent. There are three primary ways this change may manifest, including a hybrid option of the policies outlined: 1) a comprehensive bailout from the International Monetary Fund (IMF); 2) significant alternative foreign assistance from non-Western nations; and 3) structural government reform. 

IMF Bailout

The IMF has a long, controversial history of bailing out debt-ridden countries, and, despite initial hesitancy, the Sri Lankan government appears to now be taking steps to partner with the fund. After pausing external debt payments in early April, Colombo announced it would be refinancing and restructuring these obligations following the economic advice and counseling of the IMF.²⁴ 

This, necessarily, means the government will be obligated to undergo severe austerity measures as demanded by the IMF, including a tighter monetary policy and higher taxes. Such measures are just the baseline, as the IMF’s vagueness regarding certain “structural issues” in Sri Lanka opens the door for more strict measures – “privatizing [ . . . ] state-owned enterprises, increasing charges for utility services such as water and electricity, and slashing subsidies on essential goods.” 

These austerity measures will push the limits of Colombo’s political legitimacy. Social unrest stemming from accusations of the government’s economic mismanagement is already straining Rajapaksa’s political control, and policies that limit government assistance and risk increasing the price of common goods and utilities may cause escalation. Lacking trust and political legitimacy, implementing such measures while minimizing the risk of social upheaval stands to be a large challenge for the administration. 

Even in the case where Rajapaksa is able to enforce the austerity measures that the IMF requests, it is unclear whether this will lead to the long-standing stability of the Sri Lankan economy. The IMF’s bailout system has long been criticized for allowing problematic governments to remain in power while the structural and systemic issues that lead to the crisis the country faces are met with surface-level solutions in the form of large influxes in foreign dollars.²⁷ There also exists substantial critiques of the neoliberal system that the IMF promotes, prioritizing growth over all else and allowing for unsustainable economic inequality to manifest.⁹ k,

Alternative Foreign Assistance

Up to this point, there have been two primary actors in Sri Lanka’s attempt to receive alternative forms of foreign assistance – India, and China. Most recently, India increased its commitment to Sri Lanka by $500M, extending its $1.5B credit line to the country significantly.¹⁷ China, on the other hand, has been more hesitant to offer its support for Colombo. Beijing has provided the country with some funds, $31M, serving more as a diplomatic smoothing-over than genuine financial support. China’s hesitancy to engage with Sri Lanka represents a shifting philosophy in Beijing whereby the government is refining the aims of its Belt and Road Initiative in an attempt to minimize its involvement in messy domestic political affairs.¹⁵ 

Despite its newfound willingness to engage with the IMF, Sri Lankan government officials have expressed a desire to avoid interactions with the IMF unless forced to do so.³² There is, in the case of sourcing external funding, a binary to be had: either China and/or India move to pull out the checkbook, or Sri Lanka is coerced by economic and political pressure to continue pursuing relief from the IMF.

Structural Governmental Reform

Even if the money exists, being provided by the IMF or China/India, substantial government reform is needed to ensure a) the measures demanded by the IMF are able to be effectively implemented and/or b) the funds provided are effectively allocated by the Sri Lankan government. 

Sri Lanka’s present struggles are, at least in part, a function of economic mismanagement, and reforms to the system that created the crisis are prerequisites to its resolution. The acquisition of large amounts of debt in order to finance popular infrastructure projects initiated Sri Lanka’s debt struggles, encouraging irresponsible finances motivated by political ambitions.³³ Reducing the power of the Sri Lankan executive to pursue populist policies and create a nepotistic government is a first step in distributing control and enforce stability through a more parliamentary system – rebuilding the political legitimacy needed to convince prospective financiers that reform is being taken seriously.