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SRI LANKA'S FOREIGN DEBT AND REMEDIES IN 2022

Context

Protests against Sri Lankan President Gotabaya Rajapaksa's handling of the island country's increasing economic crisis turned violent, with hundreds of protestors clashing with police for several hours. Rajapaksa's government has been unable to pay for basic imports such as fuel due to a substantial lack of foreign currency, resulting in power outages lasting up to 13 hours. Ordinary Sri Lankans also suffered from shortages and rising inflation after the country weakened its currency last month ahead of talks with the International Monetary Fund (IMF) for a loan package.

Key Points

  • According to opponents, the foundation of the crisis, the worst in decades, is economic mismanagement by successive governments that built and sustained a dual deficit — a budget deficit and a current account deficit.
  • Sri Lanka is a classic twin deficits economy, according to a working paper produced by the Asian Development Bank in 2019.
  • When a country's national expenditure exceeds its national revenue, it shows that the country produces insufficient tradable goods and services.
  • However, substantial tax cuts promised by Rajapaksa during his 2019 election campaign. 
  • They implemented months before the COVID-19 pandemic, which wiped out large swaths of Sri Lanka's economy, have exacerbated the current disaster.
  • With the pandemic decimating the country's key tourism economy and remittances from foreign workers, credit rating agencies downgraded Sri Lanka, effectively shutting it out of international capital markets.
  • Sri Lanka's debt management policy, which relied on access to those markets, failed, and the country's foreign exchange reserves plummeted by almost 70% in just two years.
  • The Rajapaksa government's decision to ban all chemical fertilisers in 2021, which was later reversed, affected the country's farm economy and resulted in a fall in critical rice production.

Foreign Debt:

  • Currently, the country has only $2.31 billion in reserves but $4 billion in debt commitments due in 2022, including a $1 billion international sovereign bond (ISB) due in July. 
  • The Asian Development Bank, Japan, and China are among the other major lenders, with ISBs holding the largest share of Sri Lanka's foreign debt at $12.55 billion.
  • In a note issued late last month, Citi Research stated that the IMF report's conclusion and the government's recent measures were insufficient to restore debt sustainability, meaning that debt restructuring is required.

Measures Taken:

  • Rajapaksa's administration and the Central Bank of Sri Lanka (CBSL) have refused appeals for IMF help from experts and opposition leaders despite rising worries. However, with rising oil costs following Russia's invasion of Ukraine in late February, the government created a plan to approach the IMF in April.
  • Rajapaksa has also sought assistance from China and India, particularly in the petroleum sector. A petroleum cargo is expected to arrive on Saturday as part of a $500 million credit line signed with India in February. 
  • Sri Lanka and India have agreed to a $1 billion credit line for basic imports such as food and medicine. 
  • The Rajapaksa administration has requested at least another $1 billion from New Delhi.

After providing the government with a $1.5 billion swap and a $1.3 billion syndicated loan, China is considering extending the CBSL a $1.5 billion credit facility and a separate loan of up to $1 billion.

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