Sri Lanka still paying past bills as it plans for the future

For Sri Lanka, 2015 was a major turning point that saw voters  reject a corrupt and authoritarian regime led by Mahinda Rajapaksa and move decisively towards democracy and communal reconciliation.

Sri Lanka has long been the most economically developed state in South Asia and despite decades of civil war, its social indicators are still among the best in the region. The new government under President Maithripala Sirisena and Prime Minister Ranil Wickremesinghe signal a return to Sri Lanka’s  ‘balanced’ foreign policy, away from its tilt towards China.

The country’s decision to reject authoritarianism, kleptocracy and communal division augurs well for its long-term future, but 2016 was a reminder that Sri Lanka must pay the price for past economic policies before it can move forward with national renewal.

After destroying the Liberation Tigers of Tamil Eelam in 2009, the former Rajapaksa regime embarked on an accelerated construction program largely funded by foreign debt.

The construction by Chinese companies of a port, an airport and a cricket stadium in Rajapaksa’s home town of Hambantota, which now lie largely unused, symbolise everything that was wrong with this approach. Sri Lanka’s foreign debt-to-GDP ratio increased to 94 per cent in 2015 from 36 per cent in 2010, with more than a third of government revenue going towards servicing Chinese loans

Rajapaksa raised trade barriers, including new para-tariffs, or tariffs on tariffs, resulting in a real tariff rate of around 30 per cent. Razeen Sally, a prominent Sri Lankan economist, argues that these measures effectively de-globalised Sri Lanka’s economy, reducing its trade-to-GDP ratio to 50 per cent just as Sri Lanka’s neighbours were moving towards greater global engagement.

Last year was when the bills really started to fall due. Growth slowed to around 5 per cent in 2016, well below that of India, its largest trading partner. Sri Lanka also suffered a debt and balance of payments crisis, with its financial position only being temporarily stabilised through a US$1.5 billion IMF rescue package. The government promised new revenue measures to limit the budget deficit and it is negotiating a new trade deal with India.

But the high debt load has made Sri Lanka beholden to China, constraining its choices. Despite an earlier pledge to block the controversial Colombo Port City Project, the government has been bound to grant further concessions that would give Chinese owners even more control. A debt for equity swap for the uneconomic Hambantota Port will effectively hand over control of the port to China.

Despite these problems, Sri Lanka is still a country with big ambitions, including aspirations to become an Asian trading hub like Singapore. Just as Singapore successfully leveraged its geographic position between the Pacific and Indian Oceans, the hope is that Sri Lanka can do the same using its position on Indian Ocean trade routes.

These aspirations are not new, but Sri Lanka now hopes to be able to break through the problems created during its 30-year ethnic conflict, including weak institutions, rampant corruption and loss-making state-owned firms.

Looking beyond 2016, if stability and good governance can be restored then Sri Lanka could be well positioned to take advantage of the growing economic connections between East and South Asia.

Its location and relatively well-educated workforce could make it an attractive destination for some industries that are moving out of Southeast Asia and China. Sri Lanka is well placed to be a major beneficiary of China’s Maritime One Belt One Road initiative, which involves developing infrastructure and special manufacturing zones. It may also play off other big investors, such as Japan and Singapore.

One big opportunity would be to use Sri Lanka’s comparative advantage in port services as the basis for a broader shipping services industry, much as Singapore used shipping as a foundation to build its economy. Colombo Port is already the biggest transhipment hub in South Asia, with some 70 per cent of containers handled by the port destined for elsewhere, mostly India.

But a far bigger prize would involve ‘opening the boxes’ and moving up the value chain just as Singapore did, potentially turning Colombo into a regional hub for logistics, maintenance, engineering and financial services.

This would require the government to take on the vested interests in the shipping industry and strengthen institutions, including tackling corruption and strengthening the rule of law. While Sri Lanka may have the potential to one day become a ‘Bengal Tiger’ to rival some of the East Asian economic tigers, this will require hard decisions and disciplined governance.

This article originally appeared on East Asia Forum here. 

David Brewster is a Senior Research Fellow at the National Security College, The Australian National University.