Sri Lanka is growing at a decent pace. Now if it can just find a way out from under all those pesky IOUs.

 

A  minnow in a sea of powerhouse Asian countries, Sri Lanka would seem primed for economic growth.

Sitting midway between Singapore and Dubai, the island forms a pivotal link on major East-West shipping lanes. Eight years after a violent civil war, it is reaping a peace dividend, averaging a healthy annual growth rate of just over 6 percent from 2010 to 2015. The poverty rate sits at 6.7 percent, the lowest in Asia. Tourism is on the rise. A business-friendly reform government is blossoming.

Yet despite its modern advances, Sri Lanka’s economy faces formidable challenges.

An astounding 95 percent of its revenue goes to pay down billions of dollars in loans from China and the International Monetary Fund. Meanwhile, its own fiscal mistakes and recent severe weather plague the country domestically.

In an August interview, Karu Jayasuriya, speaker of Sri Lanka’s Parliament, acknowledged his country’s rising debt, but noted that Sri Lanka has never failed to make its payments.

The island’s economy also suffers from a lack of local entrepreneurship. Many typically seek government jobs and accompanying benefits over starting their own businesses.

Sri Lanka, said the speaker, “is paying a high price” for having one government employee for every 15 persons in the population – a percentage much higher than the standard one for every 280. Besides a bloated bureaucracy, he said, “We have too many holidays. Every full moon day’s a holiday … It’s not easy to change. If you try to change, you get thrown out from the government.”

Still, Sri Lanka, a lower middle-income nation, is gradually overcoming many developmental challenges faced by poorer nations – specifically the transition from rural agriculture to a more urbanized economy.

Service, industry, and agriculture now dominate the economy, in that order, with tourism gaining ground.

Last year, the government estimated the number of employed at 8 million. Of these, 46.1 percent were in the service sector in fields such as education, transportation, and communication. About 27.1 percent worked in agriculture (primarily tea farming and fishing), and 26.8 percent worked in mining, manufacturing, and construction.

According to World Bank data, in 2015, the service sector represented 62.4 percent of Sri Lanka’s GDP, with industries at 28.9, and agriculture at 8.7.

The IMF and World Bank are not the only ones who see diversification and an increase in exports as necessary to sustain Sri Lanka’s growth amidst globalizing markets.

In an article for the World Economic Forum, Prime Minister Ranil Wickremesinghe recently summed up the island’s ambitions: “I see Sri Lanka’s economic future as a services hub; a niche manufacturing destination to produce goods which plug into regional and global value chains, particularly light engineering; and a location for high-value agricultural products such as fruits, vegetable and dairy, both to service the rapidly growing tourism sector and for exports, especially to the Middle Eastern and Indian markets.”

But there is much to be done.

Even though Sri Lanka is making strides towards a more diversified, business-friendly economy, tea remains its top export commodity ($1.22 billion in 2015). So, though agriculture makes up the smallest portion of its GDP, it still comprises its largest export.

Sri Lanka’s top imports are motorized aircraft such as planes and helicopters ($2.06 billion in 2015), refined petroleum, cars, crude petroleum, textile fabrics and mineral products.

Consequently, MIT’s Observatory of Economic Complexity pegged the island’s trade deficit at about $9.2 billion in 2015.

Not only does this mean that the nation is spending more than it makes, but that it is also dangerously adding to a major developmental threat: debt.

Its burgeoning debt load, nearly three-quarters of its GDP, is sizable for a developing country. It stands at approximately $64 billion, according to the BBC.

On top of that, in early 2016, Sri Lanka requested a loan from the IMF to the tune of $1.5 billion for structural economic support.

It could be argued that Sri Lanka’s own fiscal mistakes are at the root of its economic fragility. Its unstable tax system made it vulnerable to foreign investors’ withdrawal when money was tight, leading the country to turn to the IMF for help.

According to The Economist, tax revenues amount to just 13 percent of Sri Lanka’s GDP of more than $81 billion. Countries with comparable income levels usually reap 20 percent. Since the country is not utilizing a primary revenue source to balance its budget, it has to rely heavily on foreign funds to finance its economy instead.

To exacerbate the problem, Sri Lanka’s new administration cut corporate and income taxes, introducing flat rates of 15 percent, to lure investors to the country and grow business around the island.

But a loan from the International Monetary Fund does not come without strings. The IMF wants to see a reduced budget deficit, simplified tax system, tighter oversight of state-owned enterprises, well-managed public finances, and increased support for trade and investment.

A large chunk of Sri Lanka’s debt is owned by Chinese investors who have paid Chinese firms to build infrastructure around the island. Constructed by a Chinese company, the Hambantota port is funded with Chinese loans totaling $6 billion. Yet despite being open for seven years, the port receives little use.

Struggling to repay the loan, Sri Lanka gave a Chinese firm, China Merchants Port Holdings, a 70 percent stake in the port via a signed agreement to convert Sri Lanka’s loans into equity, according to news accounts.

Hambantota was intended to relax pressure on the Colombo port and increase the flow of ships to the island. Yet many here fear China may have an ulterior motive.

With so much of the island’s revenue going to repay debt, and a large percentage of its revenues coming from foreign investors such as China, Sri Lanka will be partly repaying China with China’s money. How much do the Chinese really stand to gain from the island financially?

However, Sri Lanka happens to occupy a prime location on sea routes navigated by oil shipments from the Middle East.

Energy security through increased influence on Indian Ocean routes would be a strong reason for China to invest, and a way to counter American hegemony on two choke points along oil shipping lanes – the Strait of Hormuz and the Strait of Malacca.

A knowledgeable American in Colombo noted that half of all the world’s petroleum reserves and containers pass Galle in the south headed for China. “We [U.S.] are very worried about China,” he said.

The Hambantota port on the island’s southwest tip holds a strategic geographic position for China – a few nautical miles from some of the world’s busiest shipping lanes. Now that the port has struggled to make money (due largely to its isolated location), and China is set to take over, China aims to alleviate the problem by creating a large economic zone – buying 15,000 acres of adjacent land.

Many locals resent China’s influence. Not only do they not want to give up their land, they also feel the country is being parceled off bit by bit to the Chinese.

Local fishermen have been among the most outspoken foes of Chinese investment, organizing protests. Police used tear gas and water cannons to disperse demonstrators in January, which deepened the fury against the Chinese and the government.

Others suggest the rapidly expanding Chinese Navy could one day muscle its way into Sri Lanka’s ports, with Sri Lanka lacking the military might to impede them.

We have a policy of being friends to everybody with no enemies.

Karu Jayasuriya, Speaker of the House

Yet maintaining independence is hard for developing nations who must grow to remain competitive and attract the eye of wealthier countries. They often rely on foreign investors to prop up their economies. When Sri Lanka was poised to face sanctions from the West for crimes committed during its war with Tamil separatists, China eagerly became a key economic and diplomatic ally.

Many of the Chinese projects were implemented during the autocratic presidency of Mahinda Rajapaksa, and in 2015 the new democratic government pledged to reduce Sri Lanka’s dependence on China.

But financial pressures have forced President Maithripala Sirisena’s government to cave. After suspending a major Chinese project – a new city built off the coast of Colombo designed to become a South Asian hub by 2040 – the government ultimately found the $1.4 billion project too tempting to resist.

Complicating matters is the island’s long relationship with India, its greatest trading partner. More than 70 percent of cargo in Colombo’s port is shipped to and from India, which also has provided billions in developmental assistance.

Investment in Sri Lanka also has considerable strategic value for India, and it seems determined to check China’s geopolitical ambitions in South Asia.

Many of Sri Lanka’s Tamil residents in the central north and northeast migrated from India, and the mutualistic Indo-Sri Lankan relationship has lasted for over 2,500 years.

Sri Lanka sees cultivating ties with both nations as a way to transform the island into a regional commercial hub. However, as it navigates relationships between its new investor and its longtime trading partner, Sri Lanka may find difficulty in striking a balance between two fierce rivals’ competing interests.

Speaker Jayasuriya flashes a diplomatic smile at this suggestion. “We have a policy of being friends to everybody with no enemies,” he said.

Besides its mounting debt and the pressures of foreign influences abroad, the island’s economy also faces a domestic threat it cannot control.

A record drought has raged since last year. With little rain, many farmers have lost their crops and their income.

The U.N. Food and Agriculture Organization reports that production of rice, Sri Lanka’s staple food, is likely to fall almost 40 percent to 2.7 million tons this year. Other crops like chilies and onions are projected to dwindle. Around 900,000 people can’t grow enough food to feed their families, and prices have skyrocketed at local markets.

To combat rising food insecurity and prevent domestic economic crisis, Sri Lanka needs seeds, irrigation support, equipment, and cash assistance for farmers. Where this will come from and whether it will add to the debt remains to be seen.

Besides building resilience to natural disasters, the World Bank (like the IMF) recommends Sri Lanka raise revenue while checking its current spending to bring debt to manageable levels. Sri Lanka hopes to begin this process through implementation of its new Inland Revenue Act, which the IMF expects will boost tax revenues.

Whether Sri Lanka will be able to dodge its nagging perils to become a key regional player is uncertain. The stakes are high, and moving towards real economic development will start with whether reforms now in motion will take root.

Author Ariyl Onstott

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