Victory short lived…confronting the financial reality of Sri Lanka today
President Gotabaya Rajapaksa’s governing party won a landslide victory in Sri Lanka’s parliamentary elections on August 5th, winning almost two-thirds of the 225 seats and all but ensuring its ability to amend the Constitution and expand executive power.
The victory by the Sri Lanka Podujana Party (SLPP) is also a redemptive one for former president Mahinda Rajapaksa. After losing the presidential election in 2015, he watched the opposition, led by his former Minister of Health turned President Maithripala Sirisena, push through constitutional amendments conspicuously targeted at his administration, including a two-term limit on the presidency, elimination of presidential immunity, and parliamentary oversight for presidential appointments. Mahinda, who governed from 2005 to 2015, returned to power as prime minister when his younger brother Gotabaya, who was Secretary of Defense in the Mahinda’s administration, won the presidency in 2019.
Now, with victory in hand, Gotabaya and Mahinda must prove that they can re-claim the country’s magic of the last decade.
Putting the Rajapaksa Victory in Context
The Rajapaksa ‘family victory’ should be kept in context. Gotabaya claimed a big victory in 2019 because Sri Lankans were frustrated with the governing party at the time. Let us not forget that multiple terrorist attacks killed more than 260 and injured more than 500 on Easter Sunday last year. Eight bombs went off in popular hotels and historical churches across Colombo, other coastal cities, and towns in the east of the country. The act of terrorism, claimed by the Islamic State, stunned political analysts because there was not a history of such jihadi-styled terrorism in the country. The local population may still be digesting and processing the situation as several of the attackers—being well-educated and from wealthy families—are still the unlikely terrorists in the Sri Lankan story.
The terrorist attacks, at some level, stripped the country of an unexpected yet relatively new sense of innocence. Although the Sri Lankan civil war only ended in 2009, foreign travelers and investors had flocked to the country in droves during the Rajapaksa rule post-civil war, speaking to the transformation of the country’s international reputation and the government’s capacity to establish stability. The terrorist attacks effectively halted the economic trajectory for the country with tourism for example, which normally accounts for 11-13% of GDP, nosediving in 2019 as foreigners became wary of the country’s ability to protect them or their investments. Economic growth accordingly slowed from 3.3% in 2018 to 2.3% in 2019 with a further slowdown already projected in 2020 prior to the outbreak of covid-19 (covid-19 obviously worsened the situation).
Thus, the people of Sri Lanka are unsurprisingly looking to the Rajapaksa family to find a way to re-create stability and economic growth. That said, this cannot be mistaken for outright satisfaction with the previous Rajapaksa administration, which was beleaguered by accusations of corruption and human rights abuses. Opposition parties are already clamoring for the intervention of external parties, including multilaterals, to ensure their safety and ability to participate in civil society, at least, as a check on the president. The truth of the situation is the voters are very aware of who they have elected…the question remains on what and to what extent are voters willing to give / trade in exchange for stability and a strong economy.
Victory Short-Lived: Covid-19 and the Economy
The landslide election victory did not miraculously change the country’s and economic financial situation overnight. In May, the Economist magazine ranked Sri Lanka in the bottom, at 61, on its list of 66 “emerging economies” in “financial distress.” At some level, Sri Lanka is facing economic challenges but not too many parties are making significant ‘noise’ about it.
The currency hit a record low of 190 against the American dollar at the peak of the covid-19 pandemic lockdown. It has recently recovered slightly to 183 with a reduction of restrictions in the country. But absence a vaccine and a change in thinking among the global public, tourism revenue is likely to be minimal or nonexistent for the remainder of 2020 and part of 2021. Sri Lanka has a $400 million currency swap with India via the South Asian Association for Regional Cooperation (SAARC) relationship which has helped the currency so far.. Still, locals will worry if the currency will plummet to 200…at 250 (which seems unimaginable today), the country would be facing serious constraints on its ability to import goods and manage foreign currency reserves.
The country’s sovereign bonds have traded as low as 50c against face value in recent months Also, the country spends nearly 70% of government revenue on interest payments and debt-to-GDP levels are above 90%. All these numbers are likely to remain volatile and place the country at-risk of default with a slow global economy and international travel unlikely to return to 2019 levels for, at least, a couple years.
Most estimates of Sri Lanka’s debt payments and related costs measured against foreign exchange reserves suggest a country facing an economic and financial crossroad when a $1 billion bond payment comes due in October. The country’s central bank representatives continue to message to the market that talk of a potential default and financial stress is exaggerated. Yet, it is not the public or the market that this Rajapaksa administration will need to win-over.
More likely, it will be the International Monetary Fund (IMF) that will be most critical yet most open to helping the country. Sri Lanka cut taxes last year to buoy business during the tough economic times – the tax cut did not necessarily follow the IMF expectations for its funding program with the country. With the tax cut strategy limited this time around, Gotabaya will have to find another way to support the local economy. Yet the challenge with supporting the local economy is it requires money the government does not have in its coffers today (if it plans to cover external obligations). It is not clear if the IMF will push for further austerity measures, including cutting subsidies, and increased privatization in any support plan. If so, Gotabaya will surely be reluctant to engage the IMF.
If the IMF does not want to engage on terms appealing to Gotabaya, he could pursue a bilateral support agreement with regional countries. India already provided the currency swap…maybe India can put a moratorium on debt payments though the swap was likely the best India could offer since Mahinda already previously requested such a moratorium. Maybe China will support Gotabaya as the country backed Mahinda during his presidency. At the end of the day, the likely scenario is a mix of both bilateral support and IMF. And, as if it needs to be said, it is unlikely that the country can raises funds from international financial markets in the short term to refinance debt.
The Rajapaskas will likely find a solution to their liquidity situation, at least, in the short term because they have regional support and partners. That said, the bigger challenge will be a long-term solution. It will require cutting government spending (i.e., food and fuel subsidies), or lifting price controls on essential products. Those type of actions do not win votes especially if the country is in a recession. The Rajapaska family will have to face the reality of the fragile financial structure in a country still escaping the history of a civil war. Like any other government, Gotabaya and Mahinda will have to make decisions that create winners and losers. It is hard to always be victorious in such a scenario, but these brothers have displayed savvy and craftiness in previous situations such that it hard to count them out…this landslide election victory, at the least, proves their resilience and ability to persevere in the face of challenges.
