Sri Lanka looks to strengthen trade and international relations

After centuries of foreign rule and years of internal conflict, Sri Lanka is now changing its focus to reforming the nation’s political and economic spheres to exert its renewed influence in the region and become an independent, global player. Now is the time to see if Sri Lanka has the will to implement challenging reforms and take its place on the international stage.

History

Sri Lanka’s first inhabitants were hunter-gatherers who likely crossed a land bridge from India and formed the first definitive settlement around 28,000 BCE. The land bridge, which later disappeared around 5000 BCE, allowed humans and their ancestors to come and go, with early Stone Age tools found on the island dating as far back as 125,000 years. By 900 BCE megalithic culture, and both the Indo-Aryan and Dravidian languages began to emerge in proximity to India, while Anuradhapura, an ancient city in the island’s interior, began to bud as a population centre.

Buddhism came from India in the 3rd century BCE, which is considered the real origin of Sinhalese culture. Buddhist scholars of the era recorded much of the early history of Sri Lanka, with politics and religion intertwining throughout the island’s history. When the Tooth Relic of Buddha arrived in Anuradhapura in 371 CE, the city was one of the largest in South Asia.

The Anuradhapura Kingdom frequently fought with other dynasties on the island in a series of power struggles – including kingdoms in South India – and was later left for a new location in Polonnaruwa, which survived for two centuries. Following its abandonment, Sinhalese culture shifted south, founding the major dynasties of Kandy and Kotte, while Tamil kingdoms, notably Jaffna, grew in the north. By the 13th century a vast jungle interior and the spread of malaria to the country’s dry zone forced a separation that would divide the country through to its civil war in 1983.

While Arab traders had been present in Sri Lanka before the 7th century CE, the Portuguese arrival in 1505 – on the trail of an increasingly lucrative spice trade – brought a significant shift in Sri Lanka’s affairs. With the demise of the Jaffna and Kotte kingdoms at the hands of the Portuguese, the Kingdom of Kandy served as the central resistance and protector of the Buddhist faith for three centuries.

In 1602 the Dutch arrived, ousting the Portuguese by 1658 and obtaining a monopoly on the island’s spice trade from Kandy in exchange for notional Sri Lankan autonomy. The Dutch remained in power for 140 years, until 1796, when they ceded control to England. In 1802 Ceylon became an official colony, and by 1815 the British had conquered Kandy, abolishing the island’s monarchy in the process. This was the first time in the island’s history that the entire country was dominated by a single foreign power.

By the 1830s, drawn by plantation land, settlers were arriving and often imported Indian-born Tamil plantation labour to grow crops of coconut, coffee and rubber. In the 1870s the island’s entire coffee crop was destroyed by fungus, forcing a shift to tea, which today is by far the country’s most important export crop.

Independence

While Ceylonese participation in government began at a relatively early stage, it was not until the beginning of the 20th century that the country’s Buddhist and Hindu populations began to call for greater representation. Constitutional changes in the 1920s and 1930s gradually allowed more Sinhalese power-sharing and full universal suffrage. Sri Lanka gained self-government in 1946, followed by full independence on February 4, 1948 – just six months after India achieved the same.

A new constitution in 1972 effectively made Sri Lanka a republic, and changed the country’s name from its former title of Ceylon. In 1978 the country established its executive presidency under a revised constitution. During this period, increased spending on welfare brought improvements to heath care and education, indicators which remain high to this day. However, a wave of nationalist policy-making contributed to an overall slowdown of the economy, which had lasting implications. Sri Lanka lost much of its tea market in the UK, while large swathes of its Burgher population migrated to Australia.

Under British rule, Tamils were favoured for government jobs and university postings, and quickly became more proficient English speakers, causing resentment from the country’s Sinhalese population. The rise of nationalist politics under successive administrations played on the fear that Sinhalese religion, language and culture could be overshadowed by the Indians and Sri Lankan Tamils, who shared certain aspects of cultural identity. A Sinhala-only bill overtly disenfranchised the Hindu and Muslim minority populations, while making Sinhalese the official language of the country.

The conservative United National Party and more liberal Sri Lanka Freedom Party (SLFP) have been at the forefront of politics since independence. Each party in power has, at times, arranged coalitions with smaller parties, the strongest of which is the SLFP-led United People’s Freedom Alliance. Today the Buddhist clergy and labour unions maintain heavy influence in political dialogue and decision-making.

Federal Composition

The executive branch of government consists of a president, who functions as both chief of state and head of government; a prime minister, who is appointed by the president; and a Cabinet appointed by the president in consultation with the prime minister. The president is directly elected by preferential majority popular vote to a maximum of two six-year terms. He or she concurrently serves as commander-in-chief of the armed forces and retains the ability to dissolve Parliament.

The legislative branch is a unicameral parliament of 225 seats serving six-year terms; 196 are elected into multi-seat constituencies, and 29 seats are allocated to political parties as a share of the national vote. To qualify for a seat, a party must secure 5% of the vote. Voting is preferential, choosing from three candidates.

The Supreme Court of the Republic is the highest-ranking court representing the judicial branch. It consists of a chief justice appointed by the president and a maximum of 10 other justices. Below it sits a court of appeals, various high courts, municipal courts and primary courts, along with a number of tribunals. There are 54 judicial districts in Sri Lanka. Its legal system is a mix of Roman-Dutch civil law and a number of customary indigenous laws, including Kandyan Law and Theswalamai Law, which apply more to personal affairs. The executive and judicial capital of Sri Lanka is its main urban centre of Colombo, while a Colombo suburb, Sri Jayewardenepura Kotte, is its legislative capital and the location of Parliament.

Lower Governments

The country is further divided into second-tier provincial councils and third-tier local governments. While the Ministry of Local Government and Provincial Councils is responsible for national policy-making, the provincial and local authorities are responsible for implementation.

The 13th constitutional amendment, the Provincial Councils Act of 1987, legislates this political devolution to nine provincial councils, further broken down into 25 districts and 329 divisional secretariats. Responsibilities include law and order, economic planning, education, housing, agriculture, land use and cooperative development. The supervision of local government is devolved to provincial councils. Each provincial governor, appointed by the president to a five-year term, executes policies through a board of ministers.

Subsequently, there are 335 local government authorities, including 23 municipal councils covering cities and larger towns; 41 urban councils representing smaller towns and less urbanised areas; and 271 rural pradeshiya sabhas – the smallest representative body in Sri Lanka. Municipal councils are headed by a mayor serving four-year terms and nominated by the party in power, while urban councils are headed by a full-time chairperson serving four years, also nominated by the presiding party. Local authorities are tasked with public health, utility services and the upkeep of roads, as well as tax collection and property rates. The pradeshiya sabhas have additional responsibilities, such as drafting community by-laws and creating annual development plans for their relevant areas of governance.

Human Development

According to the UN’s “Human Development Report 2015”, Sri Lanka’s human development index (HDI) score is 0.757, well above the average of 0.607 for South Asian nations. This represents a roughly 32.5% jump from 1980 when its score stood at 0.571. Out of 188 countries, Sri Lanka’s rank is 73. The HDI takes into account life expectancy and GNI per capita, as well as education.

The World Bank calculated GNI per capita in Sri Lanka at $3800 in 2015, below the threshold of $4125 that separates lower-middle-income and upper-middle-income countries. Its poverty ratio was 6.7% when last calculated in 2012, a welcome decrease from 22.7% in 2002. On income inequality, Sri Lanka’s Gini coefficient – a measure by the UN of the deviation of income distribution among individuals and households – was 36.4 in 2013, and ranked 73rd of 187 nations, well above neighbouring India at 135 and Pakistan at 142.

When looking at gender differences in society, the UN’s gender inequality index rates Sri Lanka at 0.370, ranking it 71st out of 154 countries surveyed, and placing it in the high human development category. For commerce, female participation in the workforce is 35.1% versus 76.3% for men.

Sri Lanka has fared very well on a number of its UN Millennium Development Goals. In 2013, 91.2% of all people aged 15 and above were literate, while the net enrolment rate for primary education was 94.6%, helped by an expansive universal education system established in 1945. Meanwhile, free universal health care and a broad network of health institutions have helped to increase average life expectancy to 74.9 years, decrease infant mortality figures to 8.2 per 1000 live births, and lessen the extent and impact of various communicable diseases.

Malaria

In 2016 the World Health Organisation announced that Sri Lanka had no locally transmitted cases of malaria – confirming the eradication of the disease in spite of the country being one of the heaviest affected just some 60 years ago.

Malaria was introduced in Sri Lanka by waves of migration flows and, later on, gained momentum with the increased traffic of commerce by merchants who saw Sri Lanka as an strategic trading point. Early in the 20th century malaria ravaged the local population, and by 1935 there were approximately 5m cases reported, resulting in over 80,000 deaths. Population figures took a significant dip, leaving the nation searching for a solution, as it was the first time more deaths than births were recorded in a calendar year. Around that time the Red Cross was established, in part to fight the disease, but initial efforts were hampered by a lack of funding and essential resources.

The introduction of the spray campaign, as it was known in the 1940s and 1950s, used DDT spray, which significantly reduced the number of infections. By the 1960s – when the disease was nearly wiped out – the government became satisfied and redirected funds from the malaria campaign to other channels. Malaria prevalence crept up again towards the end of the decade and into the 1970s, until rates spiked significantly in 1983 due to crumbling infrastructure and poor supply lines stretching to the north and the east from the country’s civil war, which began that year.

In response to the surge, the anti-malaria campaign shifted its focus from eradication to control, and launched eight regional and customised programmes. In 2009 the end of the war saw the Ministry of Health begin an eradication programme that ultimately saw the deadliest strand of the disease eliminated in 2012, followed by the most common strand in 2014.

Foreign Relations

Sri Lanka’s strategic geographic location at the centre of global shipping routes remains a point of interest for nations such as China, the US and members of the EU. Indeed, the relative location of Sri Lanka should provide it with considerable foreign relations leverage, but in spite of this, the country remains bogged down by a heavy debt burden and ongoing domestic political gridlock.

In 2015 the election as president of moderate Maithripala Sirisena – the minister of health under the previous administration – surprised many and was seen as a direct rebuke of former President Mahinda Rajapaksa’s perceived lack of inclusiveness. The West greeted Sirisena as a reformer, pleased at the chance of renewed engagement with the island nation. Though constitutional changes have been slow, there are signs of progress being made on important post-conflict reforms.

Additionally, on May 22, 2017 a Cabinet reshuffle was announced in a bid to restore confidence in the government’s handling of the economy and to give fresh momentum to recent development work. The reshuffle has affected nine Cabinet ministers and a state minister, the most significant of which was the swapping of the finance and foreign affairs ministers, Ravi Karunanayake and Mangala Samaraweera.

Generalised System Of Preferences

In January 2017 the European Commission recommended to the European Parliament that Sri Lanka be reinstated in the Generalised System of Preferences Plus (GSP+), a trade concession programme designed to promote economic growth in developing countries on the conditions of certain criteria, such as governance, human rights, labour conditions and environmental protection laws. After much deliberation, the EU announced the reinstatement of GSP+ benefits in mid-May 2017, enabling Sri Lankan exporters to enjoy duty-free privileges. Given the successful reinstatement, a boost is anticipated for the apparel sector, which has watched its neighbours and economic rivals capitalise on the facility since 2010. The affirmative outcome will also further strengthen economic cooperation between Sri Lanka and the EU. As it stands, the EU is Sri Lanka’s largest trading partner, with one-third of total exports heading to the bloc. The reinstatement of the title should immediately benefit exports, with 66% of tariff lines being removed. This applies to strategic goods such as textiles and garments, fisheries products, rubber products and machinery. Apparel manufacturers in particular would benefit, as current export revenues remain stagnant at $4.8bn, compared to Bangladesh earning $25bn in 2016 alone with full access to GSP+.

The loss of GSP+ in 2010 is said to have cost Sri Lanka $32bn in exports since: a significant sum for an island nation interested in remaining open to the world to ensure higher growth. Sri Lanka is taking concrete steps in this direction with concurrent trade negotiations ongoing with strategic Asian allies. However, even with the expected reinstatement of the facility, it is not easy to recapture missed business opportunities and make up for lost time when competitor nations have gained so much ground in certain sectors.

Nevertheless, this is a vital step forward for the country’s medium- and long-term prospects. It is estimated that over the next 12-18 months Sri Lanka will earn an additional $500m from potential buyers – a considerable sum for a country looking to create greater fiscal space. The main draw of the facility is lower duties or a waiver of all export duties into the EU. This is expected to drive demand for Sri Lankan products, benefitting the greater economy, particularly through foreign direct investment (FDI).

Renewed Trade

The relationship between Sri Lanka and India could be shifting towards a more prosperous, shared future with an economic and technology cooperation agreement (ETCA) set to be ratified. The deal is seen as mutually beneficial from the perspective of business leaders. They argue that the agreement will create much-needed investment in the Sri Lankan economy that will boost manufacturing and employment opportunities in struggling sectors, while also clearing the way for greater fiscal operating room so the government can bolster social safety nets and reinvest in other strategic areas. However, others argue that it provides a back door for creeping Indian control over the economy. Furthermore, China will be closely monitoring the deal as it seeks to increase its influence.

At the World Economic Forum in Davos, Switzerland in January 2017, Prime Minister Ranil Wickremesinghe sounded upbeat about the prospect of increasing trade agreements with India and other South-east Asian neighbours. “Sri Lanka will be going in for separate trade agreements with five southern Indian states, including Tamil Nadu,” he announced at the event. “Sri Lanka will be looking at entering into a trade agreement with the ASEAN rather than going for separate trade pacts with the member states of the region. We will also have trade ties with Japan.” While some argue for the need of a more ambitious trade deal with India, the ETCA will allow for more flexibility in the exchange of services between the two governments, and this should prove to be a positive first step.

Fiscal Reforms

Concerns raised by China and other international investors were quickly placated as the Sirisena administration reassured them of their investments in the country. Foreign creditors, including the IMF, have shown satisfaction with reforms undertaken by the government to raise revenues and slash the debt burden to a sustainable level. The country’s debt-to-GDP ratio is projected to fall to 69% by the next election cycle in 2020, down from a current 74%.

A contractionary fiscal policy could restrict growth over the short term as the government prepares to honour foreign debt obligations. More than one-third of government revenue is being diverted to service Chinese loan repayments, and 95% of all government revenue is going to foreign creditors. Consolidation lessens the balance of payments burdening the country, thus staving off a potential default, and aligns with the long-term view of expanding fiscal capacity and the country’s economic sovereignty from foreign creditors. This policy is predicted to fare better than increasing taxes and raising borrowing costs, which tend to curb investment. With the government set to use reforms to increase its long-term fiscal capabilities, projections for GDP growth in 2017 were lowered slightly, with Reuters estimating 5.5-6% in January and then 5-5.5% in March 2017.

In addition, if Sri Lanka can import less and export more with the resumption of GSP+ trade concessions, the trade deficit would ease and the government’s revenue stream would diversify. As a country with one the lowest tax-to-GDP ratios in the developing world, building a diverse revenue stream will be vital to Sri Lanka’s future. Moreover, the country has 245 state-owned enterprises (SOEs), employing a total of 1.3m people, which can prove to be a heavy burden on the balance sheet. The state may benefit from long-term solutions that reorient its role in the market economy, moving from being an active player to a more passive presence in the form of a regulator.

Regional Influence

As the tide of influence undergoes rapid change in Asia, Sri Lanka has an opportunity to position itself to capitalise on its natural competitive advantages and exert its own influence in the region – and sorting the country’s fiscal house is the best way to do so. While Sri Lanka is the most developed market economy in South Asia, productivity efficiencies, labour costs and a lack of scale are a concern for long-term competitiveness.

It is encouraging to see progress being made on the Colombo Port City, a prospective financial hub in South Asia heavily backed by the Chinese government. This investment comes at a time when FDI accounts for around 1% of Sri Lanka’s GDP. The project, however, has at times become a symbol of political wrangling, centred on economic sovereignty.

It is true that China has taken concrete steps to exert its influence in South Asia. The establishment of the Asian Infrastructure Investment Bank acts as a clear signal that the Belt and Road initiative to link ancient and modern trade routes by land, rail and sea will be the foremost network of economic activity in the region centred on strengthening ties with Beijing.

Sri Lanka is a vital hub along the maritime route of the Belt and Road initiative, and in January 2017 the government announced a deal that granted China a 99-year lease of the Hambantota port in exchange for $1.8bn in debt relief. The debt-for-equity swap has proven controversial, with some in the country fearing a loss of state assets and economic sovereignty during a time of creeping Chinese influence. Others welcomed the decision, since many of the expensive projects constructed in the city by the previous administration have sat largely neglected. This will be a balancing act for the government as it outwardly displays an investor-friendly environment while simultaneously convincing the local populace that residual benefits from the port will be felt by all.

Moreover, to the north lies India – Asia’s second-largest economic superpower – which is also looking on with interest and concern, as its own long-term policy goals are not aligned one-to-one with those of China. Sri Lanka will surely benefit by continuing on its path of rebalancing foreign investment in large capital expenditures to include a wider array of governments.

Outlook

Sri Lanka has emerged from its long internal conflict, but with the post-war euphoria behind it, a number of structural challenges remain that will determine the country’s trajectory as it pushes forward. The state’s involvement in large parts of the economy could present stumbling blocks to a number of liberalising economic reforms that Sri Lanka is likely to need if it is to increase its competitiveness in international markets. In terms of state finance, Sri Lanka remains heavily in debt and carries a low revenue base. Maintaining a contractionary fiscal policy aims to avoid a crisis in the debt repayment schedule until the country gets back on its feet.

While there has been a wait-and-see approach within Sri Lanka’s private sector, the long-term impact is expected to be positive. The reinstatement of GSP+ benefits should see SOEs release more power to the private sector to reap all potential benefits, expand revenue streams and repay creditors more quickly.