Sri Lanka will need structural reforms for debt sustainability
Posted on May 23rd, 2022

Courtesy Mint

An IMF bailout would depend on the country fixing its economy.

High school teacher S. Jeeva spent two days in the hot sun lining up for cooking gas in Sri Lanka’s capital. He’s been standing with thousands of others waiting for a delivery that so far hasn’t come. Many of his students have joined protests against the government at the waterfront along Colombo’s iconic Galle Face Green. Both are symbols of the economic and political crisis gripping the nation, the result of decades of corruption and financial mismanagement that pushed the country to default on 19 May. Those teenagers should be thinking about their future and preparing for university. Instead, they are worrying about how the island nation will ever emerge from its pile of debt.

What happens in Sri Lanka matters way beyond its borders. Global markets see it as a bellwether for a raft of potential defaults across the developing world as countries face a growing, post-pandemic debt burden.

So what does a country in default look like in 2022? Armed soldiers are on the streets and there’s days-long queues for gasoline and cooking gas. Harvests are down by 50% because farmers either cannot afford to cultivate crops or they’re only growing enough for themselves because there’s no fuel to transport what they’ve produced. Pharmacies are running out of medicine; and hospitals are short of lifesaving drugs and devices. Incomes are shrinking and inflation is accelerating above 30%. Parents are eating just one meal a day so their children can have three, while doctors report that patients are rationing essential drugs. There are also demonstrations throughout the country calling for the resignation of President Gotabaya Rajapaksa; his brother Mahinda stepped down as prime minister on 10 May 10 after a spurt of violence. Police and security forces are pushing back with water cannons and tear gas.

How did Sri Lanka go from being named by Lonely Planet the world’s best travel destination for 2019 to a debt default? The warning signs were there from the moment the powerful Rajapaksa clan retook control of the country in late 2019. Their divisive dynastic politics, combined with questionable financial decisions—including heavy capital-market borrowing that accounts for some 38% of its debt—explain its path to ruin. Yes, the pandemic was a disaster for the tourism-reliant economy, and so too were the Easter Sunday bombings in 2019 that ushered in the Rajapaksa dynasty, but the rot had set in well before that. Sri Lanka’s interest payments on decades of borrowing are now almost equal to the principal.Importantly, Sri Lanka has lost its agency—with the International Monetary Fund, World Bank and its bilateral lenders, China, India and Japan—if it ever had any to begin with. It has had 16 IMF agreements since 1965, though the situation this time seems more desperate than past episodes.

Other countries are struggling too. In South Asia, Pakistan is teetering on the edge economic peril. If the government doesn’t increase fuel prices, it is in danger of defaulting in just three months. It needs an IMF programme to avoid this eventuality. The World Bank noted in March as many as a dozen developing economies may be unable to service their debt in the next year. The biggest challenge for these nations, it says, is sovereign debt restructuring, just like the case of Sri Lanka.

On 19 May, the G-7 economic powers announced their support for debt relief efforts for Sri Lanka. Assistance may also come up at the Quad meeting in Tokyo on Tuesday, where the leaders of the US, Japan, India and Australia will hold talks on issues of regional concern. In the meantime, Sri Lanka is negotiating with the IMF for a bailout that will help it negotiate debt restructuring with its creditors. The country has previously said it needs between $3 billion and $4 billion this year to pull itself out of crisis, but the true extent of its debt has yet to be exposed. Last week, new Prime Minister Ranil Wickremesinghe (in his sixth stint in this role) revealed a previously undisclosed debt of $105 million to a Chinese bank that had also fallen due. That means, as Lakshini Fernando, senior vice president and economist of Asia Securities, told me, Sri Lanka actually defaulted on $183 million, not $78 million as previously thought.

In the short term, the situation is only going to get worse, especially for daily wage earners who are most vulnerable to inflationary pressures. The only way the entire population is going to simmer down is when there is gasoline available and no more food shortages, and that is not going to happen any time soon,” she said. But because Sri Lanka is such a small economy, a large immediate infusion of US dollar aid could quickly stabilize the situation. Then it will be up to the government to ensure the structural reforms are in place to ensure Sri Lanka does not find itself back at the IMF for the 18th time.

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