How the IMF bailout is changing Sri Lanka’s foreign policy
The recent IMF bailout package has significantly shifted Sri Lanka’s foreign policy with major players such as China, India and the United States, though such shifts do not seem to bode well for its people
On 20 March, the International Monetary Fund announced its approval of an Extended Fund Facility to Sri Lanka.
The facility – which amounts to USD 2.9 billion in financial support, to be disbursed in tranches over the next four years –- marks the 17th occasion the island nation has gone to the IMF for help. The Sri Lankan government expects the bailout and its attendant structural reforms to boost confidence in the country's economy, and to unlock funding of up to USD 7 billion from other sources. The hope is that the IMF deal will revive the country's economic prospects and encourage global capital markets and foreign investors who had fled the country to return.
Since last April, when Sri Lanka declared sovereign default, the country has gone through one crisis after another. The domestic dimensions of the crisis, including its economic aspects, have been widely covered, and there has been a flurry of debate over the exact economic reforms that should be enforced by the Sri Lankan government – now led by an unelected and deeply polarising president.
In comparison, there has been very little analysis of how the crisis has altered the island's foreign policy, even though Sri Lanka has experienced massive shifts on this front in the last six months. These shifts have come about in the face of the IMF bailout, an arrangement that has pushed the government closer to the West and India, while maintaining its ties with China. Certain analysts, including local economists, have pointed out that the agreement with the IMF has become "an international issue."
Friends and needs
These foreign policy shifts have their origins in last year's economic crisis. In response to the country's impending collapse, the Indian government dispatched more than USD 4 billion in aid. After June, when New Delhi discontinued a line of credit for fuel, the country's return to the brink revealed Sri Lanka's dependence on imports and the region's de facto hegemon.
P K Balachandran, a foreign policy analyst based in Colombo, told this writer that Indian assistance, after New Delhi intervened in Sri Lanka's negotiations with the IMF, did much to help the country stay afloat for several months, with credit lines for fuel and other assistance. According to Balachandran, the Indian government eventually faced a challenge in justifying to its own citizens the extent of its assistance to Sri Lanka, though it was still willing to provide aid.
Against that backdrop, Sri Lanka appears to be moving closer to its neighbour, as signified by the January visit to Colombo by S Jaishankar, India's minister of external affairs, as well as a flurry of visits and delegations from New Delhi last year and a controversial energy deal with the Adani Group.
At the same time, Sri Lanka has been keen to maintain its relationship with China. This has not always been easy, as the visit last year of a Chinese research vessel, the Yuan Wang 5, showed clearly. Yet on crucial issues like the One China policy – a policy the United States and the West, together with their allies, have been wavering on recently – the present government has taken definitive stands, with President Ranil Wickremesinghe reiterating Sri Lanka's commitment to the policy.
On the other hand, certain government MPs have not been above depicting Beijing as a major hurdle to negotiations with the IMF. These include the foreign affairs minister, Ali Sabry, who referred to incompatibilities between China's attitude to debt restructuring and "what the IMF wants" in an interview.
The relationship with Japan, a long-standing bilateral partner to Sri Lanka, has also been affected, primarily due to the controversy over the cancellation in 2020 of a proposed Light Rail Transit project in Colombo. The government of the time justified its cancellation of the project on the basis that it was "very costly" and not an "appropriate cost-effective transport solution." While reports indicate that Japan will resume the project, especially in light of the IMF's assurances, the way in which the deal was unilaterally shelved – without even a communique to relevant officials – is a stark reminder of how recklessly the Sri Lankan government at the time, led by Gotabaya Rajapaksa, conducted foreign policy.
The centrepiece of Japanese assistance to Sri Lanka is the work of the Japan International Cooperation Agency. Around a month ago, Prime Minister Dinesh Gunawardena urged the agency to resume its projects in the country, a dozen of which were put on hold in August last year owing to the economic crisis.
The present government's moves on these projects reveal not just its desperation for foreign funding, but also its newfound confidence in light of the IMF bailout and Japan's involvement in Sri Lanka's negotiations with the IMF. For its part, Japan has responded lukewarmly: while companies like Mitsubishi and Taisei have scaled back operations in Sri Lanka, citing the crisis, Japanese investors have expressed interest in returning to the country, according to the Sri Lanka Board of Investment.
Sri Lanka also seems to be eyeing closer cooperation with other East Asian countries, in particular South Korea, which in turn seems to be courting Sri Lanka. In late February, the country's ministry of foreign affairs chose Sri Lanka as the first nation to host an overseas seminar on its Indo-Pacific strategy.
More than anything, however, Sri Lanka is closing in on some crucial, if controversial, agreements with India. Currently, Sri Lankan and Indian officials are trying to facilitate bilateral trade in Indian rupees and the government has advocated closer economic integration with its neighbour. In themselves, moves towards de-dollarisation are not unprecedented: India and Russia, to give one example, are trading in roubles. Yet, as a number of foreign policy commentators told this writer, the foreign minister's recent remarks about currency integration, in particular his view that Sri Lanka should "integrate and probably allow Indian currency to be a tradeable currency," suggest a wilful surrender of the country's economic sovereignty.
Some of these commentators have derided the government's lack of transparency on agreements with India's Adani Group in the renewable energy sector, and its decision to sell state assets to foreign entities, including Indian companies. Interestingly, such moves towards economic liberalisation come even as recent polls suggest growing opposition to privatisation of key sectors such as health and education, and more broadly, to capitalism as an economic and political system.
Moreover, following Gotabaya Rajapaksa's volte-face on the IMF – after months of his government stating it would not go to the organisation, it did exactly that last April – the government, now led by Ranil Wickremesinghe, has been tilting somewhat to the West. While Sri Lanka has maintained neutrality on issues like the Russia-Ukraine war – over which various ambassadors and foreign governments have actively canvassed for the country's support at the United Nations – its wholesale embrace of IMF reforms has won praise from the IMF itself.
Meanwhile, complicating matters further, the country has become increasingly vulnerable at a time when tensions between the US and China have ramped up to unprecedented levels. To give just one example, the US Indo-Pacific Command has asked for more than USD 15 billion to "stand up to the rapid military buildup of the People's Liberation Army."
Shifting to nowhere
In one sense, these foreign policy shifts have their antecedents in the 2015-2019 "good governance", or yahapalanaya, government. That regime went to great lengths to emphasise a more inclusive foreign policy after the government that it ousted, under Mahinda Rajapasksa, had moved the country closer to China. It welcomed two prominent US officials, Nisha Biswal and John Kerry, and tried to achieve rapprochement with India.
Yet there was a discernible disconnect between its aims in this direction and its actual achievements, symbolised by the controversy over a billion-dollar agreement with China in 2017 for the construction of the Port City in Colombo. While local and foreign economists have written that this was not a predatory debt arrangement, other commentators have disagreed. Regardless, such developments only contributed to souring relations with India.
The 2019 election brought these contradictions to the fore. In the lead-up to the presidential elections, the Rajapaksas' Sri Lanka Podujana Peramuna (SLPP) made use of public fears of foreign powers, specifically the United States, turning Sri Lanka into a military base. At the centre of this controversy was a USD 480 million grant from the Millennium Challenge Corporation, a US foreign assistance agency. The grant deal allegedly contained provisions that would have rendered US armed forces stationed in Sri Lanka immune from local laws.
Despite these fears, the government indicated that it was willing to go ahead with the deal, even though a section of the ruling party – Wickremesinghe's United National Party (UNP) – promised to reassess it upon coming to power. Of course, the UNP lost those elections to the SLPP and Gotabaya Rajapaksa, whose victory was heralded by foreign policy commentators as the prelude to a shift to China again. However, as this writer argued a year ago, the Rajapaksa government's foreign policy doctrines – from "India First" to "Kalyana Mitra" (Close Friendship) to "Neutral" – all advocated greater ties with New Delhi.
Indeed, it is notable that Narendra Modi was the first foreign official Rajapaksa invited to Sri Lanka after he assumed the country's presidency. It is also notable that it was to India, not China, that Sri Lanka turned at the height of the Covid-19 pandemic to procure vaccines; only after the outbreak of a second wave of Covid in India did Sri Lanka finally, and controversially, ramp up imports of Sinopharm vaccines from China.
The domestic dimension
It goes without saying that these developments have a domestic dimension too, again centring on the IMF. On 7 March, Wickremesinghe stated in Parliament that the Export-Import Bank of China had given written assurances to Sri Lanka supporting its debt-restructuring plans. According to Wickremesinghe, officials had signed the letter of intent for an impending IMF bailout on the previous day.
Wickremesinghe's revelations on that day, and later on 22 March – after the IMF granted approval for the bailout – were positively received by Sri Lanka's business elites. The Colombo Stock Exchange rose to a five-month high and the All-Share Price Index increased by nearly 200 points. Standard & Poor's Sri Lanka 20 gained more than 30 points, while the Sri Lankan rupee appreciated by nearly 8 percent. While the rupee has slid since, the governor of Sri Lanka's Central Bank, Nandalal Weerasinghe, has stated that he expects the economy to recover in the coming few months.
To be sure, the bailout has had its share of critics. These critics argue that all an IMF bailout does is encourage capital markets and foreign investors to resume the flow of funds into the country. They contend that Sri Lanka's economic problems are much deeper than its lack of access to capital via these avenues, and observe that, if the country is to recover fully, it must prioritise essential imports, cut back wasteful expenditure and promote food security.
The government's response to protests against the IMF's conditions for the bailout, including amendments to the tax regime, has also come under much criticism. Yet here, too, there is no consensus over the reforms that have provoked these protests. While the heads of certain INGOs and think tanks, as well as the Core Group on Sri Lanka at the UN Human Rights Council, have condemned the government, these individuals and institutions have merely argued against using IMF-backed reforms to stifle dissent, without questioning the link between the recent upswing of protests and the enforcement of neoliberal reforms. After a long spell of silence, the IMF recently denied rumours that it was intervening in the country's political and electoral process. In an official statement, the IMF said that it did not ask the government to postpone local government elections, whose delay has become a major bone of contention in Sri Lanka.
All in all, there is little doubt that the IMF bailout stands at the centre of these tensions, domestic and international. For all of the government's rhetoric about "multi-aligned" and "neutral" foreign policy, Sri Lanka remains, as ever, a pawn in the geopolitical game playing out across the Indian Ocean – and the wider Indo-Pacific region.