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Insights into Editorial: Sri Lankan lessons for India

 

Context:

Sri Lanka has been in the news so much of late that its current woes are the stuff of popular knowledge.

Everyone can see the extreme deprivation caused to its people due to the absence of their staple food at an affordable price in the market and the shortage of petrol at the pump.

Those with even a modicum of knowledge of economics can trace it back to the dwindling foreign exchange reserves which are needed not only to import food but also to service external debt.

 

Balance of Payments (BoP) problem:

The Sri Lankan economy has been facing a crisis owing to a serious Balance of Payments (BoP) problem.

Its foreign exchange reserves are depleting rapidly and it is becoming increasingly difficult for the country to import essential consumption goods.

The current Sri Lankan economic crisis is the product of the historical imbalances in the economic structure, the International Monetary Fund (IMF)’s loan-related conditionalities and the misguided policies of authoritarian rulers.

But Sri Lanka’s foreign exchange crisis is only the symptom of a larger malaise which needs to be understood.

 

Factors that triggered the economic crisis in Sri Lanka were:

  1. The Covid-19 Pandemic that put the tourism industry on hold. It accounted for 10% of Sri Lanka’s GDP.
  2. This led to a dip in the forex reserve (from $7.5 billion in 2019 to $2.8 billion in July 2021).
  3. Dip in other sources of revenue led to high cost in importing of essential items, including food.
  4. A depreciated currency, high dependence on imports and hoarding led to a steep rise in food prices in Sri Lanka.
  5. The Hambantota port was another white elephant project by the present government to shorten its economic woes.
    1. Instead it only further increased the debt problem that Sri Lanka faced as it had taken $1 billion from China.
  6. The ongoing Russo-Ukrainian Conflict also is a factor which is affecting the already precarious economic condition of Sri Lanka.
  7. The reason is that the both the Sri Lankan tourism relies on arrivals from Russia and Ukraine
  8. Russia is also the second biggest market to Sri Lanka when it comes to tea exports.
  9. Thus, the war in the Ukraine put a serious dent in the path of economic recovery of Sri Lanka.

 

Linguistic disenfranchisement and consequences of Civil war:

  1. The origins of the linguistic disenfranchisement of the Tamils owed partly to the appeasement of the Buddhist clergy, which is almost exclusively Sinhala.
  2. It not only caused the alienation of the Tamil-speaking population but led to the formation of the Tamil Tigers, a terrorist organisation, and a civil war.
  3. The Tamil Tigers were finally vanquished, but it took over two-and-a-half decades for the Sri Lankan state to achieve this.
  4. In the meanwhile, there was an exodus of Tamils, the better-off leaving for the West and, those who could escape, heading for Tamil Nadu.
  5. With the Tamils having had a significant presence in the professions, the country experienced a loss of expertise in almost all spheres.
  6. The impact of a loss of technical expertise for an economy is slow and often indiscernible but sure to affect it adversely, which we see happening in India. The civil war is also likely to have held back investment.
  7. While all uncertainty stalls investment, private investors would be particularly reluctant to commit their money in a time of near anarchy.
  8. A state pursuing a civil war can hardly make up for this through public investment, as it is bound to be severely fund-constrained due to its military operations.
  9. Nor would it have had much time to address stress points that arise from time to time in any market economy, let alone plan for economic development.
  10. In diverse ways, then, social strife can hamper the development of the productive forces of a country and its economic growth gets affected.

 

  1. So here we have the first cautionary tale from Sri Lanka for India. Sri Lanka’s woes are economic on the surface but stem from social strife that have been exacerbated by majoritarian identity politics fanned by the State.
  2. Identity politics between social groups is a recipe for economic disaster.
  3. The strife between the Centre and the States and antagonism between religious communities are sure ways to deter investment even if there is some improvement in the ease of doing business.
  4. The exit of some high-net-worth Indians from the country and the outflow of foreign direct investment are examples of this.
  5. Inflow of foreign direct investment to India has been high since 2014 but has been unable to make up for the depressed domestic private investment.

 

How is it that a country fails to produce sufficiently even the most basic of foodstuff, such as rice and milk powder?

That is less easy to comprehend. Since the end of colonial rule, Sri Lanka’s political arrangements have been an amalgam of nationalism in politics and welfarism in economics.

Ethno-nationalism was stoked to forge a nation state in terms of a Sinhala identity, the beginnings of which had emerged in the fifties.

It is recognizable in the official “Sinhala Only” language policy introduced at the time.

Though this may have been diluted subsequently, it empowered ethnic chauvinism and left the sizable Tamil-speaking population insecure.

 

Political, economic lessons from Sri Lanka crisis:

  1. If the first lesson from Lanka is about how politics can affect the economy, the second is about how flawed economic policy can affect an economy’s prospects.
    1. The country first came into the world’s reckoning in the 1950s when its economic policy was lauded for welfare programmes that included subsidized rice.
    2. In Sri Lanka, distributism seems to have run ahead of what could be guaranteed from domestic sources.
  2. It would serve as smart advice not only for the three Sri Lankan economists now tasked to take their country out of the crisis but also to the political class of India.
  3. As India’s economy has grown, many of the States have stepped up their welfare spending. Some have distributed bicycles for girls and others television sets to families.
  4. While no form of welfare need be precluded in principle, the public finances are subject to an accounting constraint.
  5. When revenues are limited, free bicycles and televisions sets crowd out spending on measures that increase an economy’s productive capacity, which includes its endowment of schools, hospitals and the infrastructure needed for production. There is also an ethical issue to be faced.
  6. When welfarism is financed by borrowing rather than taxes, future generations pay for our consumption.
  7. A third lesson from Sri Lanka is to not treat openness to the world economy as a panacea.
    1. In the 1970s, in a switch from avowedly socialist economic policies, Sri Lanka liberalized trade and capital flows.
    2. It is a moot question how this policy reorientation may have worked had a civil war lasting decades not intervened but the reliance on world markets that it led to has not helped the country.
  8. A celebrated theorem in economics, the theory of comparative advantage, encourages a country to specialize in its production and to rely on foreign trade for goods that it does not produce.

This assumes that there will be a continuing demand for the country’s product.

 

Way Ahead:

Experts opine that Sri Lanka’s forex reserves have reached bottom-low and it faces mounting challenges in the form of rising unsustainable public debts, low international reserves and the need for large financing in coming years.

Thus, there is a need for ambitious fiscal consolidation based on high-quality revenue measures, raising income tax and VAT rates and minimizing exemptions, complemented with revenue administration reform.

Overall, the nation requires immediate economic reforms to have stable economic health in the long run.

 

Conclusion:

Sri Lanka’s case shows us why it can be damaging for a country to rely on trade for its essential consumption goods.

By comparison, the States of India that face deficit of food are saved by being part of the Indian Union.

Unlike Sri Lanka, they need not earn foreign exchange to receive food from the national granary, Kerala being the prime example of this arrangement.

Sri Lanka’s first task would be to urgently revive its food producing sector.

As for India it must learn from its neighbor’s misfortunes and step-up domestic production across sectors, from oilseeds to renewable energy and defence equipment.