Sri Lankan Economy in Financial Emergency: The Role of Debt

By Suhail Guptil

COLOMBO: Sri Lanka is facing a deepening financial and humanitarian crisis that could lead it to bankruptcy in 2022 as inflation rises to record levels, food prices are rocketing and its coffers run dry. The Sri Lanka government announced a national financial emergency on August 30, 2021 after a steep fall in the value of the country’s currency which caused a spike in food prices.

The country is continuously facing twin deficits, i.e., fiscal deficit and trade deficit during a major part of the last decade. Since 2014 foreign debt level of Sri Lanka have been on the rise and reached 42.6% of GDP in 2019.

The cumulative foreign debt of the country was estimated at $33 billion in 2019, which puts a huge burden on the country for debt servicing.

After this, several credit rating agencies including Standard and Poor’s, Moody’s and Fitch downgraded Sri Lanka’s credit rating to B from C, which makes it difficult to obtain funds through International Sovereign Bonds (ISBs).

The financial crisis in Sri Lanka is primarily caused by low growth rate, currently at 4% and huge debt service repayment obligations and the situation is worsening.

The economic crisis is in part caused by the immediate impact of the Covid pandemic on the lead revenue generating sector tourism. The financial crisis facing Sri Lanka is compounded further by high government spending and tax cuts eroding the state revenues. Sri Lanka’s debt to GDP ratio continuously worsened from 79.02% in 2016 to 84.21% in 2018 and further to 86.4% in 2019.

The latest data indicate further deterioration in the ratio as the country’s debt to GDP ratio increased to 101% of the GDP in 2020 and is expected to reach the level of 108% of GDP by 2022. Sri Lanka also depends on borrowing to cover its unsustainable fiscal deficit which stood high at 11.1% in FY 2021 and the budget for FY 2022 has set a target of 8.8%, which is still very high given the post Covid resource constraint.

Internationally it is believed that fiscal deficit up to 3% of GDP is sustainable. Out of total foreign debt of Sri Lanka, the sovereign bonds, a major source of budgetary funding, constitute more than one third of it. The problem is further accentuated due to huge debt repayments every year, especially to China and depleting foreign exchange reserves that is at their lowest levels in a decade.

As of November 2021, available foreign currency reserves were just $1.6 billion while in the next 12 months, the government and private sector of Sri Lanka will have to repay an estimated $7.3 billion in domestic and foreign loans, including a $500 million international sovereign bond repayment in January 2022. One of the most pressing problems for Sri Lanka is its huge foreign debt and debt service burden, in particular to China. It owes China more than $5 billion in debt and last year took an additional $1 billion loan from Beijing to wean off its acute financial crisis, which is being paid in installments.

It is estimated that, foreign currency reserves of the country would completely deplete by January 2022 and it would need to borrow at least -$437 million for necessary payments. The major problem facing the country now is how to manage foreign debt service of $4.8 billion being due during February-October 2022. Inflation in Sri Lanka was spurred initially due to the printing of money by the government to pay off domestic loans and foreign bonds and now there are supply shocks, which is further aggravating it.

Inflation hit a record high of 11.1% in November and escalating prices have left those who were previously well off struggling to feed their families, while basic goods are now unaffordable for many. After Rajapaksa declared Sri Lanka to be in an economic emergency, the military was given power to ensure essential items, including rice and sugar, that were sold at set government prices – but it has done little to ease people’s woes.

The former central bank deputy governor, WA Wijewardena warned that the struggles of ordinary people would exacerbate the financial crisis, which would in turn make life harder for them. The costs of cultivating paddy [wheat] have gone up astronomically as the government has no money for fertilizer subsidies adding to the food shortages in Sri Lanka. The World Bank estimates 500,000 people have fallen below the poverty line since the beginning of the pandemic.

The loss of jobs and vital foreign revenue from tourism, which usually contributes more than 10% of GDP, has been substantial, with over 200,000 people losing their livelihoods in the travel and tourism sectors, according to the World Travel and Tourism Council. Meanwhile, Central Bank Governor Ajith Nivard Cabraal gave public assurances that Sri Lanka could pay off its debts “seamlessly”, however, Wijewardena noted that the country was at substantial risk of defaulting on its repayments, which would have catastrophic economic consequences.

In an attempt temporarily to ease the problems and stave off difficult and most likely unpopular policies, the government has resorted to temporary relief measures, such as credit lines to import foods, medicines and fuel from its neighbouring ally India, as well as currency swaps from India, China and Bangladesh and loans to purchase petroleum from Oman. The Sri Lankan government also plans to settle its past oil debts with Iran by paying them with tea, sending them $5 million worth of tea every month in order to save “ much needed currency”.

Besides this, Colombo has decided to close three overseas diplomatic missions from December 2021 to cut down expenditure in the face of ongoing financial crisis and dollar crunch. However, these measures will provide only short-term relief and the loans will have to be paid back at high interest rates, adding to Sri Lanka’s debt load.

1 COMMENT

  1. We are Sovereign Debt Experts and were advisors to Essar Steel during its first debt default in 1999. We arranged to settle their $1.2 billion in debts at roughly 50% of face giving Essar Steel a book profit of $600 million which made them viable. Since then the Essar Family – the Ruias – welcomed debt defaults, no longer afraid of the consequences.
    Argentina has defaulted over 7 times. Poland was in default as was Russia and even China during the late 1990’s when China refused to recognize China Construction Bank letters of credit issued to Pharma companies. We tried to collect on $200mm of letters of credit issued to Ciba Geigy without any success. SO… my message to President Gotabaya is “Dont be afraid of defaulting on China. Do unto to them what they have done to others”.

LEAVE A REPLY

Please enter your comment!
Please enter your name here

This site uses Akismet to reduce spam. Learn how your comment data is processed.