In the South Asia region, Sri Lanka is an odd country. It has the region’s lowest population growth rate, the highest average income, the highest human development index ranking, and the lowest poverty rate. But the country is also vulnerable to external shocks. The source of that vulnerability is shared by other nations of South Asia, indeed many other so-called emerging economies. So, Sri Lanka does have a cautionary lesson for the region. What is that lesson?
An external crisis arises from an inability to fund the purchase of goods and services abroad. Countries in South Asia depend on the import of food, energy, and a variety of technology-intensive goods.
Their relatively rapid economic growth in the past 25 years made them more dependent on import of oil and consumer goods like mobile phones and components. Their ability to fund these purchases comes from export capacity, net remittance inflow, and net foreign investment inflow. That capacity has grown unevenly. Take trade first, a story that goes back several decades.
When the larger countries of South Asia became independent of British colonial rule in the 1940s, their economies were very open, meaning that the trade-GDP ratio was relatively high at 20 percent or more. They were also major commodity exporters worldwide, selling cotton, jute, tea, textiles, and grains.
Sri Lanka was top of the pack, with a trade-GDP ratio well above 50 percent. It was a highly open economy and a hugely successful exporter, thanks to the world’s second-largest tea plantation industry. Tea had a steady enough global demand and the country produced some of the best in the world.
The retreat
Sri Lanka was a heavy food importer and maintained an expensive welfare system offering subsidised imported food. Leftist-leaning economists saw Sri Lanka as a model because it spent more money on welfare. In fact, Sri Lanka was a model because of its ability to fund welfare, which derived from its openness and the place of tea in the economy.
All South Asian countries saw a retreat in the 1960s and the 1970s. The trade-GDP ratio in Sri Lanka fell dramatically. The reasons behind that retreat from openness were many. One factor was a socialist ideology that, in Sri Lanka, unleashed an onslaught upon the foreign-owned tea plantation business. In 1960, British limited liability companies owned nearly 60 percent of the tea estate land. Companies like Lipton or Finlay were world market leaders. Tea marketing needed capital, market access, and brand image, and these firms were able to supply all three. Instead of valuing their contribution, the socialist-xenophobic government decided to exploit and bully the business.
It raised taxes, restrained repatriation, insisted on indigenisation of management, encouraged indigenous smallholders to grow tea often within the same plantations, and made it impossible for legitimate sales of companies to go ahead. In the 1970s, a land reform and nationalisation programmes drove the final nails. Foreign capital declined, and the business lost its place in the world.
The loss was enormous and many-sided. As Youngil Lim, a University of Hawaii academic, showed in the 1960s, the plantation business in the country was the driving force behind the economy: it carried a very high multiplier effect on income and employment. It encouraged private investment in infrastructure and financial services. Therefore, the decline of the plantation business meant a loss of many qualities that had made Sri Lanka a more advanced economy in South Asia.
Also read: Explained: How Sri Lanka spiralled into crisis
Uneven record
From the 1980s, as a new regime liberalised the economy, Sri Lanka regained export capacity on the back of garment exports. Tea revived, though it was a shadow of the past. But the import bill was rising much faster. Inward remittance and net foreign direct investment (FDI) grew in the 2000s, plugging the deficit in trade.
Still, the deficit was large and growing. While a crisis was building up, the pandemic hit exports and foreign exchange reserves hard, leading the country into bankruptcy and an inability to procure energy and food.
What lessons does this story have for the rest of South Asia?
Most oil-importing emerging countries need to worry about their ability to fund imports constantly. South Asia is fortunate in having a sizeable inward remittance and export of textiles and IT-related services, but a worldwide disaster like war and epidemic can upset that.
Also read: Trade deficit rises to record $26.1 billion in June as imports surge
In terms of FDI, it is not world-leading in the best of times. It is not because political sentiment is often hostile to FDI and conditions for business are not always ideal. This uneven record creates a potential source of vulnerability that is shared; only the degree of the risk varies.
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