A major economic crisis has been brewing in Sri Lanka over the last several months. The country has run out of foreign currency reserves triggering shortages of imported items like fuel, power blackouts, and raging inflation. After resisting till now, the government of Gotabaya Rajapaksa has finally sought the help of IMF. This follows help from India, which including that promised last week during the Finance Minister's visit to New Delhi, in the form of credit lines of more than $2 billion.
Sri Lanka has debt and interest repayments worth about $7 bn due this year, and cannot service it without restructuring the debt. Consider this,
Sri Lanka owes $15bn in bonds, mostly dollar-denominated, of a total $45bn long-term debt, according to the World Bank. It needs to pay about $7bn this year in interest and debt repayments but its foreign reserves have dwindled to less than $3bn. The government’s next big challenge is a $1bn bond repayment due in July. If it fails to pay, it would join countries including Suriname, Belize, Zambia, and Ecuador in defaulting on its debt following the pandemic.
The country has suffered the triple shock of prolonged political instability in 2018, the Easter Sunday bombing of April 2019 and finally the Covid 19 pandemic lockdowns. The last two have devastated the tourism focused economy. Compounding matters was a large tax cut in 2019. And all this comes on top of the pile of Belt and Road Initiative (BRI) debts to China.
I pulled up some graphics about the country (from EIU and Fitch). The economic growth rate has been on continuous decline since 2012. The collapse of tourism has been spectacular.
The country's public and foreign debts have ballooned, especially since the country initiated BRI projects in 2017.
Strikingly, it has the highest public debt to GDP ratios among all Asian economies.
Similar is the trend with foreign debt exposure.
This is a good progress report of the country's several BRI projects
What can be done quickly? One, it's inevitable that there will have to be some debt restructuring. Will the Chinese play ball on this? Given that the Chinese have resisted clubbing of their debt restructuring with those of other sovereign creditors, as was seen during the G-20 efforts to restructure African debts during the pandemic and Zambia's recent debt restructuring, it will be interesting. India should push for the Chinese debt restructuring to be done along with the other debt. This is necessary to also ensure that the Chinese don't strike a bilateral deal with the Sri Lankans at terms that push the country deeper into Chinese clutches.
The Sri Lankan crisis should be an eye opener for governments everywhere, including state governments in India. Its populist decision in December 2019 to cut VAT by nearly half from 15% to 8% and the abolition of several other taxes like the 2% national building tax aimed at financing infrastructure construction were extremely irresponsible steps. The steps were taken in response to its manifesto promise. This is what an FT article wrote then
But the sharp tax reduction may alarm investors holding some of Sri Lanka’s estimated $72bn in public debts — equivalent to about 82 per cent of the country’s gross domestic product... “As long as somebody keeps rolling over the debt, you are going to see a massive economic boost in the short term,” said Murtaza Jafferjee, chief of Colombo-based JB Securities. “We are going to have one heck of a party for six months. But invariably the party will end and we will have a very long hangover.” The sweeping tax cuts — which are expected to cost about $2bn, or approximately 2 per cent of GDP — are also likely to put Sri Lanka on a collision course with the IMF. In 2016, Sri Lanka’s previous government agreed to a $1.5bn, four-year structural reform programme to strengthen its public finances... Even before the tax cut, Sri Lanka’s fiscal deficit for 2019 was expected to overshoot the original IMF target of 4.6 per cent of GDP, coming in closer to 5.6 per cent of GDP, due to a sharp fall in tourist revenues after April’s deadly suicide bombings that targeted hotels.
The Rajapaksa government could not have imagined that the consequences of the populism would come back to bite so soon!
Update 1 (1
Feature in the NYT on the Sri Lankan economic crisis.
Update 2 (28.05.2022)
More on the Sri Lankan crisis. A third of the country's debt is owed to foreign sovereign debt holders.
And its share has been increasing sharply since 2013, driven by the entry of China
Sri Lanka’s reserves have fallen from $7.5bn in November 2019 to the point where finding $1mn is “a challenge”, Wickremesinghe, the new prime minister, said in an address last week. This has meant shortages of not only fuel but food and medicine, with hospitals forced to postpone surgeries. The country has the worst inflation in Asia at about 30 per cent in April and the currency has almost halved in value since it was floated in March.
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