Wednesday 12 August 2020
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Sri Lanka’s Chronic Instability is an Investment Risk: Long-term Financial Security Calls for a Fresh Start

Sri Lanka’s Chronic Instability is an Investment Risk: Long-term Financial Security Calls for a Fresh Start

By Lorenzo Fiorito

President Sirisena’s recent appointment of predecessor Mahinda Rajapakse as Prime Minister, deposing Prime Minister Wickremesinghe, has plunged the country into constitutional and civil turmoil. Both at the end of the armed conflict, and again after the election of President Sirisena, Sri Lanka has demonstrably failed to foster positive conditions for foreign investment. A referendum for the North-East region could offer foreign investors the clean slate that has eluded them thus far.

Investor confidence and the ongoing turmoil in Sri Lanka
Sirisena’s election in 2015 was predicted to allay many foreign investors’ misgivings about Rajapakse. Yet, this past week, Sirisena deposed Wickremesinghe and appointed Rajapakse in his place. The result has been a constitutional and civil crisis, accompanied by the suspension of Parliament. Amid demonstrations and unrest, an employee of the Ceylon Petroleum Corporation has been shot dead by a member of the petroleum minister’s security team. Meanwhile, on October 29, Bloomberg speculated that Rajapakse’s return could “lead Sri Lanka to pivot back to China.”

Moody’s Sovereign Risk Group has expressed dire warnings about the present political trajectory. Spokesperson Matthew Circosta has stated:

“The current political crisis in Sri Lanka is credit negative for the sovereign. The president’s sudden appointment of Rajapaksa as Prime Minister significantly heightens policy uncertainty…. At a time when global financial markets are turbulent, uncertainty about the direction of future policy could have a large and lasting negative impact on international investor confidence.”

According to Bloomberg, Moody’s commentary refers to the maturing of Sri Lanka’s Central Bank bonds—worth 1.5 billion USD—in January and April of 2019. The value of the bonds fell drastically in response to the political crisis.

Bloomberg article quoted an analyst from Nomura International (HK) bank: “The immediate priority for Sri Lanka is to refinance the upcoming [bond] maturities and Chinese backing should prove helpful.” On October 31, Sri Lanka announced its readiness to repay its $1.5 billion in bonds.


The “Central Bank bond robbery”

Sirisena’s public remarks to justify his actions against Wickremesinghe refer explicitly to the latter’s apparent role in the “Central Bank bond robbery”—a scandal that unfolded shortly after the present administration took power in 2015. Essentially, it appears, Treasury bonds were sold at a wildly inflated price—resulting in a level of sovereign debt ten times greater than that intended. The arrangement appears to have been made through a personal connection to the Central Bank’s then-Governor Arjuna Mahendran. The firm Perpetual Treasuries, owned by Mahendran’s son-in-law, bought over 50% of the bonds.

Explaining the incident, W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, wrote in 2017:

“The Government led by Prime Minister Ranil Wickremasinghe, instead of taking prompt action to control the damage, fought tooth and nail, to defend the Central Bank’s action. Many foreign investors in the Government securities market became agitated and shocked. The impression that a few selected individuals, with the connivance of the top leadership in the bank, could defraud all other investors with total impunity caused them to withdraw from the market. Thus, within 10 months, the foreign investments in Government securities which stood at $4.5 billion as at the beginning of 2015 fell to $2 billion. But the Government, more specifically the Ministry of Finance, and the Monetary Board did not seem to have taken notice of the haemorrhage of the country’s foreign reserves putting pressure for the exchange rate to depreciate and forcing the Government to seek a bailout package from IMF.”


Sri Lanka’s inherent instability: Common ground between foreign investors’ interests and Tamil aspirations

Since the end of the armed conflict in 2009, power struggles within Sri Lanka’s political class have often violated the rule of law and judicial independence. No sooner had President Rajapakse and General Sarath Fonseka declared victory against the LTTE than Rajapakse unceremoniously jailed Fonseka. In 2013, Rajapakse deposed Chief Justice Shirani Bandaranayake—who he had previously appointed.

Similarly, in March of this year, Buddhist extremists targeted Muslim lives and property across the island. Political Buddhism (entrenched in Chapter II, Article 9 of the Constitution) has also been overtly hostile to foreign investment. The transfer of control over the strategic Hambantota port to China last December resulted in violent protests, led by Buddhist monks.

This volatile political climate has different effects on various investor states’ interests. Nevertheless, as the Central Bank scandal shows, Sri Lanka’s consistent pattern of political turmoil fosters generalized financial insecurity. Even without the LTTE to blame—now after a full decade, and spanning two administrations—Sri Lanka’s chronic volatility negatively affects all foreign capital flows in the region.

The same processes which have created this credit negative environment—no rule of law, lack of judicial independence, and strong-arm tactics amid social unrest—have also consistently brought grief to Tamils in the seven decades since Sri Lanka’s independence.  Political rivalries within and between Sri Lankan administrations overspill electoral bounds to produce shows of force, while Constitutionally-entrenched political Buddhism continues to play a crippling role in the democratic process.

Amid the crisis, Tamil politicians (both on the island and in the diaspora) have called on the international community to respect the Tamil people’s right of self-determination. They advocate international, impartial justice for war crimes and crimes against humanity (including genocide).

The potential benefits of such measures underscore the shared interests that Tamils and foreign investors hold. This equitable model of reconciliation, justified in the fundamental principles of international law, may prove effective both to protect war-affected civilians from ongoing rights violations, and to stabilize financial interests in the region.

A referendum and an international criminal tribunal offer a way out of Sri Lanka’s chaos. They offer both the Tamil people, and foreign investors, a clean slate and a fresh start.

Lorenzo Fiorito (LL.M) is a student of international economic law, focusing on investment arbitration and trade in financial services. He thanks Sowjeya Joseph (LL.M) for her invaluable insights during the writing of this article.

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