JVP victory and its effect on the Lankan economy

The victory of Anura Kumara Dissanayake, leader of the Marxist-Leninist Janatha Vimukthi Peramuna (JVP, People’s Liberation Front), has the potential to destablise Sri Lanka’s fragile economy. Having become the first Asian nation in at least three decades to default on its sovereign debt in April 2022, Sri Lanka’s economy had been painfully restored to stability by outgoing President Ranil Wickremasinghe, while remaining vitally dependent on the International Monetary Fund (IMF)’s goodwill and funding support.

The JVP victory (although well telegraphed in pre-election polls) is an astounding result. The Communist party had never won more than a tenth of the nationwide vote in any previous parliamentary or presidential election. Whatever fleeting tastes of power JVP had in the past were in coalition with the centre-Left Sri Lanka Freedom Party (SLFP) founded by SWRD Bandaranaike in the 1950s, and inherited by his family in subsequent decades.

The SLFP has faded politically, although its machinery was appropriated by the Rajapaksa clan, which has since 2015 renamed its faction of the party SLPP. The rump of the SLFP (led by Maithripala Sirisena, who was president from 2015 to 2019) supported Wickremasinghe in this election.

Like the victory of the radical Left Syriza party in Greece after its sovereign default in 2015, and the brief emergence of the anarcho-leftist Five Star Movement as Italy’s leading party during the Eurozone debt crisis a decade ago, JVP’s Dissanayake has capitalised on the demise of the centre-Left. Mahinda Rajapaksa (president from 2005-15) was lionised for winning the three-decade civil war against the LTTE, but borrowed heavily from China to fund faster infrastructure-led growth.

He failed to diversify the economy away from “tea, textiles and tourism”, contributing to mounting problems of external debt servicing from 2012 onwards, when the current account deficit soared to 6% of the Gross Domestic Product. When Sri Lanka was unable to repay expensive debt owed to China to build a port and airport at the Rajapaksa electoral base of Hambantota, those facilities (plus 68 square miles surrounding them) were given to China, in an echo of the colonial “treaty port” system China itself had been subjected to in the 19th century.

Defeated in 2015 by an alliance between Sirisena (a former Rajapaksa acolyte) and the centre-Right United National Party (UNP) led by Wickremasinghe, the Rajpaksa clan regained both the presidency and control of parliament in 2019-20. The SLPP’s Gotabaya Rajapaksa (Mahinda’s brother) won the presidential election in 2019, with 52% of the vote, to 42 for Sajith Premadasa (who finished a narrow second this year too). However, Gotabaya led Sri Lanka into the abyss of its sovereign default in April 2022, following which economic chaos ensued, as inflation soared and fuel supplies turned scarce, leading to riots that caused Gotabaya to flee the country.

Ranil Wickremasinghe, a masterful behind-the-scenes political operative with a distressing inability to win elections, became president in July 2022 with SLPP support, beating Sajith Premadasa in a parliamentary vote. Wickremasinghe, the leader of the conservative UNP, had split with Premadasa before the 2020 parliamentary election. While Premadasa’s party finished second in that election, Wickremasinghe’s UNP won just a single parliamentary seat, his own. Despite the advantages of incumbency, Ranil finished a distant third in this year’s election too.

Within weeks of the sovereign default, the Sri Lanka rupee collapsed from 200 per US dollar to nearly 370 rupees/dollar. This exacerbated inflationary pressures, but President Wickremasinghe raised interest rates and undertook key fiscal reforms (rescinding Gotabaya’s tax concessions, reining in spending and reforming energy prices to ensure cost-recovery) and began stabilising the economy. His efforts were rewarded with the IMF approving a $3 billion Extended Fund Facility in March 2023, Sri Lanka’s 17th IMF programme.

The depreciated Sri Lanka rupee (which is still at 305 rupees/dollar) has restrained non-essential imports, boosted exports and improved tourist inflows. Consequently, the current account swung from a deficit of 1.8% of GDP in 2022 to a surplus of the same amount in 2023. Foreign exchange reserves have rebounded from a trough of $2 billion to $5.7 billion, sufficient to pay for 3.75 months of imports. However, Sri Lanka’s massive foreign debt (totalling $55.38 billion in March 2024, and still rising) remains a huge burden.

In order for creditors to keep rolling over Sri Lanka’s short-term external debt of nearly $9 billion, the continuance of the IMF programme is essential. Dissanayake gained popularity by attacking the IMF, saying the terms need to be re-negotiated. He has promised to cut income tax rates, and eliminate Value Added Tax (VAT) on ‘essentials’ like food, health and educational services, while increasing taxes on the wealthy (but supporting their businesses).

Dissanayake’s wide-ranging tax cut proposals would immediately jeopardise the IMF programme. Without that, the delicate deal to restructure Sri Lanka’s sovereign debt (tentatively agreed three months ago) would be imperilled, plunging its economy into renewed strife.

This article is authored by Prasenjit K Basu, economist and author.