Trouble in Paradise
Sri Lanka’s Economic Woes and the Outlook for Investors
Sri Lanka is witnessing its worst economic crisis since it achieved independence in the 1940s. On 4 May, then finance minister Ali Sabry told parliament that the country had only USD 50 million left in usable foreign reserves.
The country faces a reduction in imports and widespread shortages of food, medicine and fuel. Several factors have brought the island nation to this point: the impact of the COVID-19 pandemic on its lucrative tourism sector, tax cuts in 2019 that reduced the country’s revenue, as well as significant foreign debt accumulated by successive governments. In April, the incumbent administration defaulted on this debt – believed to be somewhere in the region of USD 50 billion.
With bankruptcy looming, talks have started with the International Monetary Fund as well as countries such as China for financial help, although negotiations could take months to finalise.
The Rajapaksa Grip Weakens
The ongoing crisis and shortages of basic necessities has impacted the living standards of ordinary Sri Lankans. Thousands have taken to the streets to protest the government headed by President Gotabaya Rajapaksa.
The Rajapaksas are a prominent family that has dominated Sri Lankan politics for decades. Gotabaya has held several senior political appointments and has been president since 2019. His brother – Mahinda – was prime minister until his resignation on 9 May and previously served as president between 2005 and 2015.
Mahinda’s presidency was tainted by widespread allegations of corruption and nepotism. Having appointed family members to key positions in government, he and his relatives were accused of misusing public funds, illegally transferring state assets, money laundering, and other wrongdoing. Gotabaya’s own presidency has also faced severe criticism, with opponents accusing him of exacerbating ethnic and religious divides to serve his political needs.
As calls widen for Gotabaya’s resignation and the pressure builds, it is becoming ever more apparent that the strength of the Rajapaksa political dynasty is dwindling.
The Outlook for Investors
Sri Lanka has long been a popular destination for outside capital. Although there has been a decrease in foreign direct investment during Gotabaya’s presidency, money has still flowed into the country’s hospitality, real estate, infrastructure and telecoms sectors.
The situation is not positive for investors. Politicians have stated that the current crisis could last for at least another two years. Political instability compounds the risks of business disruption. Companies face frequent power cuts and employees cannot get to work, whether due to demonstrations or because they have run out of fuel.
From an investment perspective, many international businesses have taken a wait and see approach. It may take a long time for Sri Lanka to return as an attractive jurisdiction. But when this happens, it will be more important than ever to have a full and nuanced picture of any potential counterparties, business partners, or acquisition targets, alongside an appreciation of the wider political and economic risks.