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    How big is Sri Lanka's mess — and is there a way out?

    Sri Lanka has defaulted on its debt and is trying to get an IMF deal going. The next few months are likely to be painful for a country already suffering from high inflation, including soaring food costs and fuel shortages.

    By Shabtai Gold // 27 May 2022
    Sri Lanka is in a state of turmoil. The country has defaulted on debt and is seeing regular political protests, including some that have turned fatal. Fuel is in short supply, with an ever greater cost. Just this week, gasoline prices rose by more than 20% and diesel by over 35%. Long lines to buy gas to power cars and cooking stoves are now the norm. Earlier this month, President Gotabaya Rajapaksa replaced his prime minister — his brother Mahinda Rajapaksa — with Ranil Wickremesinghe, after his entire Cabinet was forced to step down. It’s hoped that Wickremesinghe, who has served as prime minister five times before, can hammer out a deal with the International Monetary Fund for billions of dollars in assistance. The country’s new leadership has said it is drastically chopping government expenditure — “cutting to the bone” — and more pain is likely to come. “Even in the best case scenario, which is an IMF deal, the next few months are going to be pretty bad,” said Mick Moore, a political economist and expert on Sri Lanka at the Institute of Development Studies. The situation is unique enough that it does not yet signal the cascading wave of defaults set to sweep emerging markets, but it has created some jitters, with countries such as Pakistan also at risk of being unable to make debt payments. JPMorgan Chase has eight countries on a watchlist for high default risks. Inflation in Sri Lanka is expected to hit 40% over the coming months, with food prices already soaring. When the government cuts back on its civil service, as it will inevitably have to as part of a restructuring and debt deal, hardship will ripple through the wider economy. “The biggest impact is probably going to be through job losses and the economy not functioning in various kinds of ways,” said Moore. In a sign of the need for reform, the World Bank this week denied media reports that it was preparing to make a cash infusion into the country. “Until an adequate macroeconomic policy framework is in place, the World Bank does not plan to offer new financing to Sri Lanka,” the lender said, adding that for now it would only repurpose existing funds for urgent needs such as school meals for children. IMF staffers wrapped a mission to the country this week and warned that “public debt is assessed as unsustainable,” adding that Sri Lanka will have to enact a concrete reform program to ensure that “debt sustainability will be restored.” The government failed to make payments on nearly $1.3 billion in sovereign bonds, and its grace period expired in mid-May, making its default official. That, combined with depleted foreign currency reserves, means the import-dependent nation may become unable to purchase lifesaving medicines and other desperately needed foreign goods. “What is going to happen is that all those people who need serious medical interventions of any kind, and especially drugs, may find that they're not going to get it, because the drugs are not there,” Moore said. The road to this economic collapse was paved with corruption and mismanagement, in what experts described to Devex as a human-made crisis. “If you take 10 steps back and look at the Sri Lankan economy as a whole, it was just not a sustainable way of running an economy,” said Mario Arulthas, a Ph.D. candidate at the University of London’s School of Oriental and African Studies, speaking from northern Sri Lanka. There is a laundry list of what went wrong. For example, government revenue has been in decline due to successive changes in taxation policy that effectively cut off sources of cash for state coffers. There was massive borrowing to fund questionable infrastructure projects over the past decade, with accusations of corruption rife in the construction industry. In all, the country is estimated to owe some $50 billion to a broad range of creditors — debt it is now desperate to restructure so that it can manage payments. The loans by themselves would have been a heavy burden but possibly bearable — until COVID-19 struck. The tourism sector, being built on mountains of debt, ground to a standstill. Making matters worse, the government banned the import of fertilizers in April 2021. While the move was couched in the language of environmentalism and nationalism, the true concern was likely more immediate: The government lacked the money to purchase fertilizers. “The president suddenly announced that from henceforth the whole agricultural sector would be organic, which means … no more [imports of] fertilizer, no more agrochemicals,” Moore said of last year’s decision, which he called “total nonsense.” It was soon reversed, but not before the damage was done. “It was incredibly stupid,” said Arulthas. Crop yields plummeted, adding to the economic malaise. “Farmers are not sowing the crops, because they can't afford to maintain it afterwards,” he said, adding to the cycle of problems. “If you take 10 steps back and look at the Sri Lankan economy as a whole, it was just not a sustainable way of running an economy.” --— Mario Arulthas, Ph.D. candidate, SOAS University of London President Rajapaksa, a former military strongman who was elected with an overwhelming mandate in 2019, has balanced his administration on rampant Sinhalese Buddhist nationalism and his strong inner circle, which included his brother Mahinda, who had served as president or prime minister on and off since 2004. Until recently, the country seemed likely to be ruled by the Rajapaksa dynasty for the foreseeable future. Wickremesinghe, the current prime minister, is now in charge of debt negotiations, particularly with IMF. But China, a major creditor, has been unclear on whether it might accept a reduced level of repayment on its loans, which would smooth an IMF deal. “The messages from the government of China have been very ambiguous on this,” said Moore. In reference to Beijing, World Bank President David Malpass has said “it’s to their advantage” to prevent defaults across lower-income countries. Malpass noted that members of the Paris Club, a group of rich and mostly Western creditors, are no longer the main lenders to many countries, including Sri Lanka. Is it contagious? While Sri Lanka’s situation is specific to its own mistakes and is not expected to set off a domino effect, concern has grown over the past year that countries facing debt burdens are increasingly at risk of deep problems. The World Bank predicts that up to a dozen countries may default by mid-2023, which will freeze them out of debt markets and create extreme difficulties around purchasing vital foreign goods. IMF says 60% of low-income countries are already in debt distress or at risk of debt distress. “What we're seeing are very broad trends that are affecting a lot of low-income and emerging-market countries right now. Debt stocks have been rising, and debt service payments are high,” said Scott Morris, an expert at the Center for Global Development. He warned that the G-20 group of industrial and emerging-market countries currently lacks a real debt relief system for nations like Sri Lanka. The group’s so-called Common Framework for Debt Treatments has not been functioning as intended, leaving many nations in the lurch. “A debt crisis leads to step-backs in economic progress. For developing countries, that's sort of defined in terms of development progress,” said Morris, urging major wealthy nations and international financial institutions to support low- and middle-income countries. “In a very real sense, they can help them avoid default situations,” he said.

    Sri Lanka is in a state of turmoil. The country has defaulted on debt and is seeing regular political protests, including some that have turned fatal. Fuel is in short supply, with an ever greater cost. Just this week, gasoline prices rose by more than 20% and diesel by over 35%. Long lines to buy gas to power cars and cooking stoves are now the norm.

    Earlier this month, President Gotabaya Rajapaksa replaced his prime minister — his brother Mahinda Rajapaksa — with Ranil Wickremesinghe, after his entire Cabinet was forced to step down. It’s hoped that Wickremesinghe, who has served as prime minister five times before, can hammer out a deal with the International Monetary Fund for billions of dollars in assistance. The country’s new leadership has said it is drastically chopping government expenditure — “cutting to the bone” — and more pain is likely to come.

    “Even in the best case scenario, which is an IMF deal, the next few months are going to be pretty bad,” said Mick Moore, a political economist and expert on Sri Lanka at the Institute of Development Studies.

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    More reading:

    ► IMF warns of rising inflation and debt as it lowers global outlook

    ► China is owed 37% of poor countries' debt payments in 2022: World Bank

    • Banking & Finance
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    • Sri Lanka
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    About the author

    • Shabtai Gold

      Shabtai Gold

      Shabtai Gold is a Senior Reporter based in Washington. He covers multilateral development banks, with a focus on the World Bank, along with trends in development finance. Prior to Devex, he worked for the German Press Agency, dpa, for more than a decade, with stints in Africa, Europe, and the Middle East, before relocating to Washington to cover politics and business.

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