Sri Lanka lies in a strategically advantageous position between Europe and East Asia, along major shipping lanes, with easy access to West Asia, Africa and India. And it has the potential to become an Indian Ocean hub of trade, manufacturing, tourism and services. But reality check shows a different picture
The Sri Lankan economy grew at an average of 6.4% between 2010 and 2015, mostly due to significant reconstruction after the 25-year long insurgency. The economy has since stagnated, with the lower than expected GDP growth registered in the first quarter of 2017 (at 3.8%) attributed, by the International Monetary Fund (IMF), to the ‘lingering effect of drought’.
The IMF believes that the Sri Lankan economy will rebound in 2017 and continue to grow in 2018.
That belief, however, did not stop the Sri Lankan Government announcing on 17 August 2017 tax cuts and subsidised loans for small businesses and exporters, as concerns that environmental stressors, including droughts and flash flooding, will continue to have negative impacts on economic growth.
The Sri Lankan economy is becoming more deeply entwined with that of China. Foreign direct investment (FDI) from China into Sri Lanka over the last ten years amounted to US$1.1 billion ($1.37 billion), compared with FDI from the United States of US$400 million ($500.8 million). China is also buying Sri Lankan debt.
After opening the Hambantota port, which was later leased to China for 99 years, Sri Lanka has since found itself caught in a debt trap with China due to the combination of a high interest rate and low returns on the project. Sri Lanka did not have many options left when it turned to China, though.
Sri Lanka’s management of debt, most of which is owned by China is distressing
Sri Lankan external debt stock at the end of 2016 was US$25.3 billion, of which 13 per cent – US$3.3 billion ($4.13 billion) – was owned by China. Most of the Sri Lankan debt owned by China has been acquired in the last ten years.
This management of debt is what The Diplomat has called ‘distressing.’
To add to concerns, a proposed Free Trade Agreement (FTA) with China has worried local industrialists, as the import tariffs that have protected them will disappear.
Regardless of the merits or otherwise of tariffs, the FTA may yet turn out to be a disaster for local industries because no proper study has been made of the impact that tariff removals might have on domestic industries.
The Sri Lankan Government will need to ensure that the removal of tariffs does not cripple local industries that then struggle to compete with imported Chinese products, thereby potentially worsening the economic malaise and creating an even greater economic reliance on China.
Sri Lanka already suffers from climate-related disasters, which negatively affect the economy.
Global warming will continue to plague the country, so the Sri Lankan Government will need to improve its debt management to be able to fund rebuilding programmes after future natural disasters and to combat persistent poverty in some pockets of the country.
Obtaining debt without analysing the long-term risks has left Sri Lanka with precarious choices that will have geopolitical consequences.
The Sri Lankan economy is potentially in dire straits with its over-reliance on China, but with more foresight and deeper analysis of economic policies and debt management, Colombo may be just able to bring the economy back under control.
( with thanks to FDI strategy paper)