09 Apr Sri Lanka’s Bankruptcy journey
Sri Lanka’s Bankruptcy journey – Today Current Affairs
In the last few months, Sri Lanka has been tottering on the verge of insolvency, with its scheduled external debt repayment obligations far exceeding its limited foreign exchange reserves. All efforts to restructure the country’s external debt had come to naught after the international credit rating agencies reduced its sovereign rating to junk status. Unfortunately, firmly ensconced in its own echo chamber, the majoritarian government had largely ignored the early warning signs and stumbled straight into the impending doom.
Today Current affairs
The first sign of the emerging crisis was evident more than a year back when the country’s foreign exchange reserves shrunk to a 11-year low in February 2021. Though a currency swap with the People’s Bank of China helped tide over the immediate crunch, the problems have only aggravated since then. Sri Lanka’s foreign exchange reserves, which peaked at $7.6 billion in 2019, have more than halved to $3.1 billion in 2021 and are now set to further fall to $2.2 billion in 2022. Consequently, the share of imports covered by the forex reserves has steadily fallen from five months to 1.5 months and further to one month during the period, and any sudden improvement is very unlikely.
The imbalance in the external sector was primarily fuelled by a growing current account deficit and a surge in government debt. Sri Lanka’s current account deficit, which shrunk from 2.2% of the gross domestic product (GDP) in 2019 to 1.3% in 2020, has suddenly bloated to 3.8% in 2021, and this is now expected to only improve to 2.6% of the GDP in the next few years. Similarly, the ratio of public and publicly guaranteed debt to GDP went up from 94.3% to 114% of the GDP between 2019 and 2021. This is ominous given that around half of the government borrowing is denominated in foreign currencies. And with one-third of the foreign debt falling due between 2021 and 2023, the country is now hurling towards a disaster. In fact, the external public debt service requirements alone will exceed $4.1 billion each year during the period. The Hindu Analysis
Unfortunately for Sri Lanka, all these developments followed soon after its reclassification as an upper-middle-income country by the World Bank in July 2019, making it the second South Asian nation on the list after the Maldives. However, the unexpected pandemic has now completely derailed the economy. This was because the economic disruption severely dented Sri Lanka’s earnings from tourism, remittances, and foreign direct investment (FDI)—the three mainstays of its external sector. While the receipts from tourism fell from around $4.5 billion in 2018 to less than half a billion dollars now, remittances have dipped from a high of $6.1 billion in 2020 and is now expected to bounce back only in 2026. Similarly, the FDI inflows have fallen from the peak levels of 1.8% of the GDP in 2018 to 0.5% in 2020 and will only slowly pick up to 1.2% of the GDP in the next few years. Today Current Affairs
Surprisingly, despite its sharp descent into an increasingly dire scenario, the Sri Lankan government, which had earlier availed of the International Monetary Fund (IMF) assistance on many occasions, initially hesitated to seek any help from multilateral agencies, fearing that the harsh conditionalities they impose would only further erode the already shrinking popular support to the government. Instead, Sri Lanka first sought Chinese help in restructuring its foreign debt. It also requested an economic package from India. However, the reduction of Sri Lanka’s credit rating to CCC or junk status by the international rating agencies, citing the rising possibility of a sovereign default in a few months, was a catastrophe. This firmly closed Sri Lanka’s access to the international capital markets and jinxed all efforts to roll over the maturing international obligations.
Strangely, the government’s response to these debilitating developments has been perverse and tardy. It first passed a constitutional amendment in October 2020, which further centralised powers in the office of the President. Then, it cut down on all non-essential imports, which badly hit the economy. Similarly, the fixing of the official exchange rate of the Sri Lankan rupee between 200 and 203 per dollar and the rules for surrendering foreign exchange led to widespread hoarding and caused dollar shortages. A fallout was the scarcity of medicines and fuel, which raised the electricity outage to more than 10 hours each day. And consumer inflation crossed the 18% mark with food prices soaring by 30%. The Hindu Analysis
But it would be unfair to blame Sri Lanka’s current predicament to the pandemic and external sector constraints. The civil war and poorly advised policies had forced the country to seek IMF’s assistance at least four times since the turn of the millennium. And the current regime aggravated the problems by both radically cutting tax rates to bolster business sentiments and by offering largesse worth a billion dollars, including salary hikes to bureaucracy amidst the crisis. These measures ensured that while the tax-to-GDP ratio has dipped from the peak levels of 11.6% in 2019 to around 7.2%, now the expenditures remained sticky at around 19% of the GDP. The Hindu Analysis
The response of the government to the growing economic stability and the threats to its legitimacy has been to clamp down on public gatherings and to restrict access to social media. It appointed a new central bank governor even as the new finance minister relinquished office just a day after taking charge. The President has now asked all national parties represented in Parliament to join a new interim government to tackle the national crisis. But surely, there are no shortcuts to ensure an immediate recovery.
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