High school teacher S. Jeeva spent two days in the scorching sun for cooking gas in the Sri Lankan capital. He along with thousands of others await a delivery that hasn’t arrived yet. Many of his students have joined the protests against the government on the banks of Colombo’s iconic Galle Face Green. Both are symbols of the economic and political crisis gripping the country, the result of decades of corruption and financial mismanagement that prompted the country to default on May 19. Those teenagers should think about their future and prepare for university. Instead, they are worrying about how this island nation will emerge from its debt pile.
What happens in Sri Lanka matters beyond its borders. Global markets see this as a threat to potential defaults across the developing world as countries face mounting, post-pandemic debt burdens.
So what does a country with defaults look like in 2022? Armed soldiers are on the streets and there are queues for petrol and cooking gas day in and day out. The crop has decreased by 50% because farmers either cannot cultivate the crops or they are only growing enough for themselves because they have no fuel to transport what they have grown. Pharmacies are running out of medicine; And hospitals are short of life-saving drugs and equipment. Income is declining and inflation is rising above 30%. Parents are feeding only once a day so that their children can have three meals, while doctors report that patients are rationing essential medicines. There are also demonstrations across the country demanding the resignation of President Gotabaya Rajapaksa; His brother Mahinda had resigned from the post of Prime Minister after violence on 10 May. Police and security forces are using water cannons and tear gas shells.
How did Sri Lanka go into a loan default from being named by Lonely Planet as the world’s best travel destination for 2019? There were warning signs from the time the powerful Rajapaksa clan took control of the country in late 2019. Their divisive dynastic politics, coupled with questionable financial decisions—including heavy capital-market borrowings that account for about 38% of its debt—explain this. way to ruin. Yes, the pandemic was a disaster for an economy dependent on tourism, and so were the Easter Sunday bombings in 2019, which marked the beginning of the Rajapaksa dynasty, but had already rotted away. Sri Lanka’s interest payments on decades of borrowing are now almost equal to the principal amount. Importantly, Sri Lanka has lost its agency—along with the International Monetary Fund, the 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, although the situation this time seems more depressing than in the previous episode.
Other countries are also struggling. Pakistan is facing economic crisis in South Asia. If the government does not increase fuel prices, it is in danger of defaulting in just three months. It needs an IMF program to avoid this phenomenon. The World Bank noted in March that more than a dozen developing economies could be unable to pay back their debt over the next year. The biggest challenge for these countries, as in the case of Sri Lanka, is sovereign debt restructuring.
On 19 May, the G-7 economic powers announced their support for debt relief efforts for Sri Lanka. Assistance is also expected at the quad meeting in Tokyo on Tuesday, where leaders from the US, Japan, India and Australia will discuss issues of regional concern. Meanwhile, Sri Lanka is in talks 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 to lift itself out of the crisis this year, but the exact extent of its debt has yet to be revealed. Last week, new Prime Minister Ranil Wickremesinghe (in his sixth term in this role) disclosed a previously undisclosed loan of $105 million to a Chinese bank that had also become due. This means, as Lakshmi Fernando, senior vice president and economist at Asia Securities, told me, Sri Lanka actually missed out 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 boil is when there’s gasoline available and there’s no more food shortages, and that’s not going to happen anytime soon,” he said. But because Sri Lanka is such a small economy, an immediate aid from the US dollar can stabilize the situation immediately. It will then be up to the government to make structural reforms to ensure that Sri Lanka does not find itself back at the IMF for the 18th time.
Ruth Pollard is the editor of Bloomberg Opinion.