The story so far: Sri Lanka’s external reserves dropped to $1.6 billion in November 2021, triggering alarm in different quarters. Foreign reserves draining so rapidly could only mean that a sovereign default is imminent, economists and thinktanks warned. American credit rating agency Fitch downgraded the island nation to a ‘CC’ rating, which is the lowest rating prior to default. Despite its mounting foreign debt over the years, Sri Lanka has never defaulted until now. The current economic meltdown – marked by a persisting dollar crisis, soaring living costs, and a possible food shortage this year – is threatening to dent that record.
- Sri Lanka’s external reserves dropped to $1.6 billion in November 2021, triggering alarm in different quarters. American credit rating agency Fitch downgraded the island nation to a ‘CC’ rating, which is the lowest rating prior to sovereign default.
- Sri Lanka’s external debt is dominated by market borrowings, by way of international sovereign bonds, which amount to half of the country’s total foreign debt. Meeting the repayment deadlines this year would mean that Sri Lanka might be left with no dollars to import essentials —be it food, fuel, or medical supplies.
- The best option for Sri Lanka would be to negotiate a programme with the IMF, restructure its external debt, and mobilise bridging finance for the interim.
What is the Government’s response?
Last week, the Governor of the Central Bank of Sri Lanka said the country’s foreign reserves stood at $3.1 billion at year-end, apparently including the $1.5 billion currency swap cleared by China earlier this year. On Wednesday [January 5, 2022], Governor Ajit Nivaard Cabraal said the Central Bank has earmarked $500 million to repay an international sovereign bond maturing on January 18. The Rajapaksa administration has expressed confidence about being able to meet its debt obligations this year, despite its Balance of Payments problem.
Meanwhile, Finance Minister Basil Rajapaksa on January 4 announced a $1.2 billion package for “economic relief” that includes a special allowance for government employees. The Government almost entirely blames the pandemic for the current crisis. It is true that all major revenue earning sectors of Sri Lanka – exports [mainly garments, tea and spices], tourism and inward worker remittances – were severely impacted by the pandemic, but some commentators argue that the pandemic only exacerbated an older crisis, didn’t create one.
What are the immediate challenges?
Contrary to popular narratives, Sri Lanka’s external debt is dominated not by Chinese loans, but by market borrowings, by way of international sovereign bonds, which amount to nearly half of the country’s total foreign debt. Following the $500 million that the Government is preparing to repay later this month, another $1 billion is due for repayment in June. Meeting the repayment deadlines this year would mean that Sri Lanka might be left with no dollars to import essentials —be it food, fuel, or medical supplies. That too when the country may have to import more food this year, if agricultural production drops by half, as paddy farmers and tea growers widely predict, following the Government’s overnight switch to organic farming in May 2021. Already, there are frequent instances of consumers not finding milk powder – which is largely imported - and other essentials in the stores. A shortage of LPG cylinders persists, following a spate of explosions reportedly owing to a change in the chemical composition of the gas.
What are the options before Sri Lanka?
The main political opposition, think tanks and most mainstream economists are advocating that Sri Lanka negotiate a programme with the International Monetary Fund (IMF), restructure its external debt, and mobilise bridging finance for the interim. But the Government maintains it can tide the crisis without resorting to an IMF loan and is counting on other options.
IMF agreements usually come with specific conditions for the borrower, including greater transparency on how the money is spent. “Transparency has never been a strong point of a Rajapaksa regime,” Colombo-based business newspaper, the Daily Financial Times (FT), said in a recent editorial titled ‘Time for the IMF’. While acknowledging that IMF agreements of the past in fact “worsened Sri Lanka’s economic situation due to their strict conditions”, the editorial said it was hard to imagine that the conditions imposed by the IMF could be any worse than the predicament facing the Sri Lankan public at present. “As unpalatable as it may seem in some quarters, the IMF might just be the best way to achieving those goals,” the Daily FT said. Those opposing the IMF route, argue that such a deal invariably entails austerity measures that will target social services and welfare programmes, further aggravating poverty that is growing since the pandemic.
Can India help?
Sri Lanka has repeatedly sought financial assistance from India since the pandemic struck – by way of a debt freeze, a currency swap and more recently, emergency Lines of Credit for importing essentials, during Finance Minister Basil Rajapaksa’s visit to New Delhi early December. Colombo is awaiting a positive update from New Delhi. Addressing the weekly press conference on Thursday, Ministry of External Affairs spokesperson Arindam Bagchi said India “has always stood by” the Sri Lankan people, and Sri Lanka is an important part of India’s ‘Neighbourhood First’ policy. Referring to Mr. Basil’s recent visit he said discussions on deepening cooperation in areas of food and health security, energy security, balance of payment issues and Indian investments in Sri Lanka took place. “I understand that further consultations are ongoing,” he said. Mr. Basil was scheduled to attend the ‘Vibrant Gujarat’ summit next week, and possibly meet Prime Minister Narendra Modi. But the event has been cancelled due to COVID-19 surge. Sri Lanka is also in talks with China, whose Foreign Minister is scheduled to visit Colombo this weekend.
