Sri Lanka: Risk Assessment
Country Risk Rating
Business Climate Rating
- Diversified agricultural production (tea, rice, coconuts, rubber)
- Strategically located at the center of trade routes between Asia and the Middle East
- Indian, Chinese and Japanese interests
- Successes in education, health and poverty reduction
- Agricultural production vulnerable to climate disasters; dependence on tourism
- Low levels of public capital expenditure due to debt servicing burden
- Reliance on short-term external financing
- Lack of infrastructure
- Ethnic tensions between Sinhalese and Tamils
Recovery constrained by the tourism sector, which is at a standstill
The economy contracted in 2020 due to the COVID-19 crisis. To deal with the pandemic, the government first imposed a quarantine for travelers from at-risk countries. Local lockdowns were then imposed as the epidemic evolved. The latter took a toll on economic activity. Tourism (11% of GDP), which had already been affected by the Easter 2019 attacks, suffered from the closure of borders between March and December 2020. The conditions of travel and access remain constraining for tourists despite their reopening. The textile industry (15% of the labour force and 50% of exports) is exposed to the spread of the virus and may create clusters. It has been affected by the decline in both external and internal demand. In 2021, the economic recovery in partner countries (United States, Europe) is expected to help increase exports and support the recovery. Periods of drought observed throughout 2020 are expected to affect future agricultural yields. In this difficult context for businesses, there is a moratorium on bank loans for the tourism, garment and ICT sectors, as well as for SMEs, until April 2021. Investment is expected to rely mainly on the public sphere in 2021. However, in order to stimulate private investment, the central bank will maintain an accommodative policy. It lowered its key rates by 200 basis points in March 2020 to stimulate lending. Inflation is expected to remain high due to rising demand and import controls, which reduce competition in the domestic market.
Sri Lanka's public finances continue to deteriorate
Sri Lanka's public finances continue to deteriorate: the effect of the attacks and then the border closures on tourism, and the decline in exports, have reduced revenues and worsened deficits, leading to failure to achieve the targeted primary balance criterion. Nevertheless, the IMF granted it USD 800 million (1% of GDP) under the Rapid Credit Facility. Previously initiated reforms to improve the public accounts are expected to be suspended temporarily because of the COVID-19 crisis. The introduction of a mandatory electronic tax collection system, beginning in April 2021, is expected to facilitate public revenue collection. Public debt is high and weighs heavily on the government budget: interest payments accounted for 44% of 2019 revenues. Financing needs are high, debt is expensive and external dependence is high. Half of this debt is in foreign currencies and is therefore exposed to the risk of depreciation. Over the period 2021/2024, external debt obligations will amount to USD 23.2 billion, while foreign exchange reserves amounted to USD 5.9 billion in October 2020, or about 5 months’ worth of imports.
In 2020, despite the decline in tourism revenues and textile exports, the current accounts have been saved from too great a deterioration thanks to the drop in imports linked to the controls in place and the continued flow of remittances from expatriate workers. Import restrictions have led to a slight improvement in the trade balance, which will nevertheless remain in deficit (10% of GDP), while the services balance, which was affected by lower tourist arrivals, remained in surplus (3% of GDP) and is expected to improve with the recovery in 2021.
The Rajapaksa clan, which holds power, is causing people to fear abuses
Gotabaya Rajapaksa, a former member of the military who is popular for ending the civil war in 2009, won the November 2019 presidential elections. His victory, on a nationalist and security agenda, is symptomatic of the continuing ethnic tensions in Sri Lanka: the president had the support of the Sinhalese ethnic majority, but received few Tamil votes. Parliamentary elections in August 2020 resulted in the victory of Sri Lanka Podujana Peramuna (SLLP), the president's party. The appointment as prime minister of his brother and former president Mahinda Rajapaksa, who had ruled on a nationalist, centralist and authoritarian line between 2005 and 2015, has raised fears that the previous government's achievements in terms of corruption, separation of powers, and press freedom would be reversed. The SLLP, which now has a majority in parliament, passed the 20th Amendment on 22 October 2020, strengthening most of the constitutional powers of the president, which had been abolished by the 19th Amendment in 2015.
Externally, the Rajapaksa clan seems to be trying to slip away from the international scene. Sri Lanka withdrew from the UN Human Rights Council in February 2020. Relations with China have been greatly strengthened under Mahinda Rajapaksa's two terms of office, and may deepen again in the coming years. The Sino-Indian conflict of influence remains significant, but Indian projects have stagnated, while China helped the Rajapaksa family escape international investigations into war crimes committed in 2009, and holds about a quarter of the public debt. China is heavily involved in Sri Lanka's development, for instance, financing the Colombo Financial District to the tune of USD 1.4 billion, the country's largest foreign investment. The question of dependence on this financing arises: when it became impossible to repay the debt taken on to finance the port of Hambantota, the authorities were forced to cede the latter to China for 99 years in 2017.