According to “The World Ahead 2024” report of The Economist magazine, 76 countries representing a population of 4.2 billion, more than half of the global population of 8 billion, will participate in elections to choose their governments, presidents and governors in 2024. This remarkably high number of potential voters makes 2024 the largest election year since the establishment of universal suffrage. Among the 76, there would be five South Asian nations: India, Bangladesh, Pakistan, Sri Lanka and Maldives. Out of these, Bangladesh, Pakistan and Maldives already had their parliamentary elections. At the time of writing, India is currently in the process of voting, and Narendra Modi would have comfortably secured a third consecutive term by the time you read this.
The Sri Lankan scenario is distinct from the other four cases. Primarily, the electoral process in Sri Lanka, scheduled for September-October 2024, will involve the direct election of the President, who will serve as the nation’s leader, as opposed to the selection of parliamentary members. Then, the elections in Sri Lanka are expected to exhibit a higher level of democratic integrity. Opposition parties in Pakistan and Bangladesh have already raised concerns regarding the prevalence of electoral fraud. However, the most noteworthy aspect of the upcoming Sri Lankan Presidential election is the presence of three equally powerful prominent political parties in the race, with two aligning with right-wing ideologies and one espousing pro-left principles. It is the first instance that a left-wing political party has achieved such a level of prominence, since the 1970 general election, when left parties together won 25 seats out of a total 151, becoming the second largest political force.
The problem is we are going to have this left-wing flavour at a time when we seriously do not need one. The need of the hour is an economically pro-right government. Presently, Sri Lanka crawls but needs substantial economic growth within a shorter time frame. Typically, periods in which countries are governed by right-wing policies have experienced greater economic growth as compared to times under left-wing governance. Sri Lanka has so far followed the same pattern. This can be attributed to the pro-business policies adopted by right-wing governments. Such governments tend to prioritize reducing government intervention in the economy, exemplified by the implementation of flexible labour laws and increased deregulation. These measures create a more conducive environment for businesses and investment, thereby facilitating accelerated economic expansion. Furthermore, right-wing governments are associated with robust legal systems and the protection of property rights, which in turn enhance economic growth by providing stability and security for economic activities.
In 2022, Sri Lanka faced severe economic challenges, leading its government to default on its debts. This has placed Sri Lanka in the same group as Lebanon, Mozambique and Venezuela all have been defaulting on their debts for more than three years in a row now. Following the default, and after a significant delay, the IMF stepped in to assist, offering a glimmer of hope. However, to alleviate the heavy burden of debt servicing and create space for economic growth, Sri Lanka must take decisive action to restructure its debt. Many local economic pundits have hailed this decision as if it were a magic bullet to end the debt crisis.
What had been completely ignored by our pundits was the changing nature of debt restructuring at the international level. It does not work the way it did twenty years ago. In the past, governments and banks, under the supervision of the IMF, collaborated to alleviate the debt burden of nations facing insurmountable financial challenges. As part of this process, developing nations would agree to implement neo-liberal reforms, ultimately benefiting their creditors. These initiatives often involved the reduction of debt repayments through percentage reductions, commonly referred to as “haircuts.”
This process does not seem to work for Sri Lanka. Our debt issue is much more complex due to the country’s unique circumstances. Sri Lanka’s biggest creditor is China. Unlike other countries, China now does not write off its debts, when the recipient is in trouble. This is primarily because China has nothing to do with neo-liberalism. Thus, it does not feel obligated to abide by the same rules as Western financiers. Among the 21 countries currently undergoing debt restructuring, only Zambia has managed to reach a successful agreement involving China. Consequently, Sri Lanka cannot rely on the usual mechanisms employed by other countries to negotiate debt restructuring.
The issue is far more complex. Another major factor complicating the debt restructuring negotiations could be the ongoing “cold war” between China, and India, the second largest creditor. Given the stark rivalry between these two countries, reaching an agreement that satisfies both parties seems almost impossible.
In such a situation, it would be naive to expect “haircuts” or debt reduction measures to be feasible. So far Sri Lanka has not been successful in its foreign debt restructuring to the optimal level, and most probably it might never be. However, even for a flawed outcome, Sri Lanka has to pay for the effort. The country is currently undertaking a complex domestic debt restructuring initiative aka “optimization”. While this process carries inherent risks, it is considered essential by the IMF to achieve long-term economic stability. However, financial analysts, including those at The Economist, have expressed concerns that this “optimization” could potentially lead to severe stress within the banking system.
With this backdrop, the inevitable outcome, before long, is Sri Lanka realizing a few harsh realities. Our policymakers may already be aware of these issues, yet they may choose to either delude themselves into believing that everything will be fine or present an overly optimistic portrayal until the elections are over.
Harsh Reality
What are these harsh truths? First and foremost, it is crucial to acknowledge that the economic crisis is far from resolved. Unless it is effectively and permanently addressed, it remains a lurking threat that can resurface unexpectedly, much like an insidious cancer. To provide a sense of the magnitude of the debt we are currently dealing with, consider this illustration. The largest denomination of currency in Sri Lanka is the Rs5,000 banknote. It is 0.1 mm thick. If we were to bundle up Rs1 million worth of these banknotes, the resulting stack would measure a mere 2 cm in height. Now, let’s ponder a thought-provoking question: If we were to represent our total debt using Rs5,000 notes, how tall would the tower of money be? It would reach a staggering height of 600 km! To put it into perspective, this is greater than the direct distance from Kankesanturai to Matara.
Secondly, it is unlikely that Sri Lanka will derive significant benefits from the IMF arrangement. Even achieving a 7-10% haircut is likely to remain a distant dream, as creditors are unlikely to agree to compromise unless others do the same. Consequently, Sri Lanka may find itself in a position where it must independently resolve its financial challenges without external assistance. This echoes the circumstances faced in 2020 when Sri Lanka received a loan injection of a few hundred million USD from the IMF.
The Choice
So what could our choice between a right-wing government and a left-wing one mean? It is crucial to carefully consider the one that possesses the capability to effectively execute debt restructuring and repayments independently. This requires ensuring a stable and robust economy. In the case of countries like Sri Lanka, where external investments play a vital role, the government must adopt a market-friendly approach and garner the trust of potential investors.
Reflecting upon past experiences, we observe that only a handful of previous governments have met these criteria. The Jayawardene administrations of 1977 and 1982 were particularly favoured by both investors and donors due to Sri Lanka’s pioneering adoption of neo-liberal economic policies, which positioned the country ahead of its regional counterparts. However, Jayawardene’s leadership faced challenges in resolving issues related to terrorism. The Rajapaksa government in 2010 successfully enticed investors with the establishment of a newfound peace. In the middle, the short-lived Premadasa administration played a pivotal role in spearheading the garment factory programme, thus granting Sri Lanka a competitive advantage in the apparel industry. These instances represented periods of rapid growth, in contrast to many other governments that struggled to achieve positive or even neutral economic growth.
Then, regardless of the political party that comes to power, the government must align with the IMF austerity measures. This alignment is crucial for addressing economic challenges and ensuring financial stability. Sri Lanka, like many other South Asian nations, faces several issues in implementing an effective system for optimal tax collection. The country’s tax revenue to GDP ratio remains low compared to other middle-income countries. This is partly due to a significant portion of the economy operating in the informal sector, which falls outside the purview of the tax system.
Additionally, there are issues of tax evasion and corruption, even as the tax system improves. Another issue is the inadequate infrastructure, including a shortage of trained personnel and outdated technology. These factors contribute to the complexity of filing tax returns, making the process time-consuming and discouraging some taxpayers from complying with tax regulations. Simplifying the tax system and improving infrastructure are essential for addressing these challenges. Improving tax administration by streamlining procedures and eliminating corruption, as seen in other countries, could significantly boost tax revenue collection. Diversifying revenue sources away from trade taxes, which account for a high proportion of Sri Lanka’s tax revenue, is also critical to achieving fiscal stability and sustainable economic growth
The left-wing perspective on taxation and economic policies differs from that of the right-wing. While left-wing governments often advocate for taxing the rich, it is interesting to note that only right-wing governments have effectively implemented such measures. What would be the reaction of a left-wing government to all the issues above? Will it be ready to bring the informal sector to the tax network, given that all in this segment are not necessarily rich? Will a left-wing government be ready to make the necessary systematic changes to streamline the tax collection process to avoid corruption and evasion?
Further, left-wing governments tend to rely more on regressive consumption taxes like VAT, as these are efficient revenue generators. This allows them to fund generous social welfare programmes, even though consumption taxes disproportionately burden the poor. The outcome could be not meeting the tax collection targets. While the risk of this happening exists for governments across the political spectrum, it may be higher with a left-wing government.
Socialist parties possess a distinct advantage when it comes to garnering public support, as they can present captivating promises and narratives. However, these promises are often short-lived, resulting in a subsequent loss of trust from the masses and significant implications for the economy. Interestingly, the blame for implementing austerity measures during the recovery phase is frequently assigned to right-wing governments, leaving these incidents unnoticed or forgotten. Therefore, it is crucial to recognize that relying solely on a sense of comfort should not be the determining factor during this crucial moment.