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What International Financial Actors Need to Learn From Sri Lanka

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What International Financial Actors Need to Learn From Sri Lanka

Establishing rules of the aid game and channels of communication might prevent a repeat of the current crisis, in Sri Lanka and elsewhere.

What International Financial Actors Need to Learn From Sri Lanka

A woman reacts to a police announcement aired using loudspeakers ordering protesters to vacate the site of months long anti government protests outside the president’s office in Colombo, Sri Lanka, Thursday, Aug. 4, 2022.

Credit: AP Photo/Eranga Jayawardena

Sri Lanka is currently facing its largest economic crisis since independence, and its largest political crisis since the end of the civil war in 2009. Soaring inflation (54.6 percent in June), lengthy power cuts, and shortages of fuel and food led to protests. The protests, in turn, led to the resignation and flight of former President Gotabaya Rajapaksa. He left behind him $7 billion in debt repayments due this year, and only $2 billion in foreign reserves, with some estimates of the latter going as low as $250 million. The present crisis is mostly the result of economic mismanagement, but also crippling debt and bad luck. 

Sri Lanka’s strategic position in the Indian Ocean at the crossroads of major shipping routes to South Asia, East Asia, and the continents of Europe and America, and its closeness to India, has made it ripe for competition amongst Chinese, Indian, and Western governments and development banks. In the rush to purchase political influence and coastal areas that could be used for connective and military infrastructure, Sri Lanka accumulated a level of debt it could not service. 

It is unlikely that aid and development loans will cease to be tools for securing political influence and foreign policy goals any time soon. Indeed, these calculations are complex, and often there were and are very good reasons to lend money to Sri Lanka (perhaps most especially now, as even the most basic conditions for restoring economic stability are far from secured). What is clear, however, is that crippling debt is part of what has led to Sri Lanka’s current context, a situation that is unlikely to be solved at any point in the near future. Political stability is all but destroyed, Chinese influence in Sri Lanka is likely to be replaced by Indian influence (which, in turn was displaced only a few decades before), foreign lenders are unlikely to be paid in full and certainly not on schedule, and ordinary Sri Lankas are suffering immensely. In short, no one benefits from Sri Lanka’s current situation. 

For international financial actors capable of providing loans to nation states, there should be two lessons. The first is that rules of the game are required: The global development banks and core loaning states need to find a way to agree on some basic rules regarding what should and should not be funded. The details of these rules can be developed through discussions between, for example, the World Bank, the Asian Development Bank, the IMF, and the aid-distributing ministries of China, the U.S., U.K., Europe, and Japan. However, the starting point could be agreement on what a project’s minimum level of financial and environmental sustainability should be, and an agreement that projects that disproportionately benefit a narrow political elite should be avoided. 

The second, and perhaps more important lesson, is the need for channels of communication – something like military de-escalation hotlines – between these international financial actors, so that crises can be prevented ahead of time, rather than managed after the fact. Alarm bells have been ringing for some time in Sri Lanka, and farther afield, the World Bank has warned that as many as 12 other developing countries are at risk of defaulting over the coming year. It is clear that channels for emergency preventive actions are required. 

Trust between Western states and China may be at an all-time low, and therefore, it is clear that agreement will not be easily attained, but there would be clear benefits for lending actors to prevent a similar situation happening again. Ongoing discussions between China and the IMF to manage Sri Lanka’s current situation also provide evidence that pragmatic engagement is still possible where it is in the best interests of every party.

If Sri Lanka’s crisis today is the result of bad luck, poor domestic economic management, and unrestricted access to aid driven by foreign competition, establishing rules of the game and channels of communication might prevent a repeat of the current crisis. With the two largest lenders in Africa being the World Bank and China, such coordination could reap significant rewards well beyond the small Indian Ocean state.