Previous Quarterly Editions
Expropriation Risk: 61 62 62 61 ►Political Violence Risk:48 51 51 51 ►Terrorism Risk:55 55 57 57 ▲Exchange Transfer and Trade Sanction Risk: 55 64 64 73 ▲Sovereign Default Risk:57 57 57 83 ▲
TREND ▲
Geopolitical alignmentEast 1 2 3 4 5 West
Alignment five years agoEast 1 2 3 4 5 West
Degree of contestationSettled 1 2 3 Contested
As an economy and society, Sri Lanka is at a standstill with little clarity on which way it can and must go. By mid-2022, the country was engulfed in a deep economic crisis which surfaced in the form of a collapse of foreign exchange reserves to levels equalling a fortnight’s worth of imports, and which saw the country afflicted with shortages of energy, food, and other essentials, a depreciating currency, unstoppable inflation, and a near-complete shutdown of economic activity.
In the circumstances, Sri Lanka’s government was forced to default on payments due on sovereign bonds it had issued to foreign creditors. Sri Lanka has an inadequately diversified economy, heavily dependent on imports financed by exports of a few commodities, on receipts from tourism, and on remittances from Sri Lankan workers abroad. The economy thus proved incapable of surviving the shocks imparted by the COVID-19 pandemic and the fall-out of the Russia/Ukraine crisis.
However, policies adopted by the Rajapaksa regime were equally responsible. Tax concessions denuded the state of much-needed resources, forcing it to borrow large sums from abroad. In addition, measures to save foreign exchange such as the ban on fertiliser imports affected production adversely, curtailing exports and increasing imports. A desperate population almost spontaneously revolted against the government and forced it to fall.
One reason why the Rajapaksas were able to muddle through for as long as they did was the support they garnered by exploiting the conflict between two large neighbours, China and India. This has involved juggling concessions between the two to keep their favour, even when each resented the presence of the other. The East Container Terminal at the Colombo Port initially promised to a joint India-Japan consortium was handed over to China instead. Objections from trade unions in Sri Lanka against the handover of “a strategically important terminal” to the Indian Adani group, which they claimed had questionable credentials, provided an excuse. When India protested, a West Container Terminal was handed over to the Indo-Japan consortium on favourable terms.
In early 2021, a China-based joint venture was contracted to implement a hybrid renewable energy system in three islands off the coast of Jaffna, at a cost of USD12 million. The project was mooted by the Ceylon Electricity Board and was to be funded by the Asian Development Bank. China was subsequently persuaded to suspend the project citing “security concerns” from a “third party”, which was clearly a reference to India’s objections based on security considerations given the closeness to India of the islands where the projects were to be located. Following this, India took up implementation of the projects. More recently, when China was granted permission to dock a survey ship at the Hambantota port, which China controls, India’s protests only resulted in a delay in the ship’s arrival.
Clearly, the Sri Lankan government has been walking a tight rope between its two strategically important neighbours. Overall, however, under the Rajapaksas, China has financed and undertaken many projects, resulting in Chinese sources accounting for about a tenth of the country’s debt. This has given China much influence. With the onset of the crisis, India has sought to counter the China with support amounting to close to USD4 billion. In the balance between China and India, the former does seem to have an edge, suggesting that Sri Lanka is veering eastward rather than looking more to Western nations.
TREND ►
With Sri Lanka holding back on payments due to foreign creditors including private bondholders, it has signalled it will not be able to make the payments in full. The International Monetary Fund (IMF) which has been approached, is considering provision of a small loan to Sri Lanka. Yet that would prove inadequate to shore up reserves and help resume payments to creditors.
In the event, the IMF has asked Sri Lanka to work out a rescheduling arrangement with private creditors before its programme is initiated. As of now, it appears that without these creditors accepting haircuts and deferred payments, no resolution is possible.
The risk of some degree of expropriation is therefore high. Moreover, until such time as foreign reserves are stabilised, the government may be forced to impose restrictions on repatriation of foreign exchange by foreign investors.
The crisis that led to the ouster of the Rajapaksa regime in July 2022, though marked by widespread protests, was largely non-violent. But after the ousting, a new government under Ranil Wickremesinghe, which lacks legitimacy, has chosen to come down heavily on those seen as having been the leaders of the mass movement.
This, together with the return of the much-disliked Gotabaya Rajapaksa after fleeing Sri Lanka in July, in a context in which no resolution of the crisis and the hardship faced by the people is in sight, could trigger a round of political violence in a nation that has seen many rounds of violent political activity.
Sri Lanka has had a long history of civil strife, epitomised by the war between the government and the Liberation Tigers of Tamil Eelam. Following the Easter Sunday bombings of 2019 attributed to radical Islamists, Sri Lanka has been seen as a country that is prone to terrorist violence.
It did not help that the Rajapaksa government adopted discriminatory policies against Muslims and was contemplating a burqa ban, both of which could breed terrorist activity. A January 2022 report from Human Rights Watch alleged the Sri Lankan Government was suppressing minorities and harassing activists.
The crackdown against suspected Islamic terrorists and terrorist organisations brings other risks. Though the state claims success of its moves against terrorism, and the evidence seems to support that claim, there is widespread concern the Prevention of Terrorism Act is being misused. There have been signature campaigns and demands from the International Commission of Jurists to repeal what is seen as a draconian Act.
For the foreseeable future, the Sri Lankan rupee is likely to be under pressure and in continued decline. This has negative implications for those with foreign liabilities. This situation could also force the government to restrict repatriation of foreign exchange, something that would adversely affect foreign investors.
Sovereign default is a reality in Sri Lanka and as of now there is no reason to believe payments to foreign creditors falling due in the coming months and years will be met. Even flows of foreign exchange from China and India appear to have peaked, making the availability and use of such flows to pay foreign creditors unlikely.
Return to contents Next Chapter
