Sri Lankan Bankruptcy: An Economic Fiasco

Sri Lanka is in the midst of a financial and humanitarian crisis that is spiraling out of control. A bankrupt island nation is projected this year due to soaring inflation, rising food prices, and pandemic-related disruptions to the financial system. It was on August 30 of last year, when the Sri Lankan government declared a national financial emergency after the country's currency depreciated sharply, resulting in food prices rising. As Suhail Guptil pointed out in an article in the Colombo Gazette, Sri Lanka has been grappling with budget and trade deficits for much of the last decade. Sri Lanka's external debt has increased steadily since 2014, reaching 42.6% of GDP in 2019. According to Guptil, the government owes a total of USD 33 billion in foreign debt, which means it must shoulder a significant portion of the cost of repaying that debt. Standard and Poor's, Moody's, and Fitch reduced Sri Lanka's credit rating to B from C, making it more difficult to raise financing through International Sovereign Bonds (ISBs), Guptil said.

According to a report in the British publication Guardian, the government must repay an estimated $7.3 billion in domestic and foreign debts over the next 12 months. This includes the repayment of a $500 million foreign sovereign bond due in January. According to the report, the accessible foreign currency reserves were only $1.6 billion in November. It was not just the COVID-19 pandemic that had a direct impact on Sri Lanka's economy but also high government expenditure and tax cuts, enormous debt obligations to China, and record low foreign exchange reserves aggravated the economic disaster. A surge in money printing to pay off domestic loans and foreign bonds boosted inflation to 12.1 percent in December, up from 9.9 percent the previous month. Monthly inflation as assessed by the Colombo Consumer Price Index was driven by price increases in both food and non-food goods. The country's central bank said that food price inflation increased to 22.1 percent in December, up from 17.5 percent the previous month.

According to the World Bank, 500,000 people have dropped below the poverty line since the epidemic began, which is the equivalent of five years' progress in battling poverty. In November, inflation reached a record high of 11.1 percent, and rising costs have left some who were formerly well-off struggling to feed their families, while basic items have become expensive for many. Following Rajapaksa's declaration of an economic emergency, the military was granted authority to guarantee that vital products, including as rice and sugar, were supplied at regulated government rates - although this has done nothing to alleviate people's plight. According to the World Travel and Tourism Council, the loss of employment and important foreign currency from tourist, which typically contributes more than 10% of GDP, has been significant, with more than 200,000 people losing their livelihoods in the travel and tourism sectors.

What if Sri Lanka declares bankruptcy?

If Sri Lanka's currency reserves are totally depleted by January 2022, the country will be obliged to borrow at least US$437 million to meet vital payments. The primary difficulty now confronting the administration led by President Gotabaya Rajapaksa is determining how to handle the US$4.8 billion in foreign debt service due between February and October 2022. In order to mitigate the impact of depleting reserves, the Sri Lankan government is said to have turned to temporary relief measures such as credit lines from its neighboring ally India to purchase food, medicines, and gasoline. It has also decided to exchange currencies with India, China, and Bangladesh, as well as to borrow money from Oman to purchase petroleum. Sri Lanka likewise intends to repay its oil obligations to Iran with tea, sending the Islamic Republic $5million in tea. To save money, the government has decided to shutter three overseas diplomatic posts beginning in December 2021. However, even these techniques are likely to cause issues for the country in the long run, increasing the debt load. Sri Lanka would have to repay any sum borrowed from the nations at some point. Other initiatives made by the Rajapaksa administration to address the country's economic difficulties included a request to China for debt restructuring and preferential credit for imports and vital products.

According to the Associated Press, Sri Lanka is currently experiencing its greatest economic crisis in decades, owing in part to Beijing-financed projects that have failed to generate cash. On Sunday, the President of debt-ridden Sri Lanka met with Chinese Foreign Minister Wang Yi. Rajapaksa informed Wang that it would be "a big relief to the country" if attention could be directed to restructuring debt repayments as a response to the economic problem caused by the COVID-19 outbreak. It is worth noting that Sri Lanka's foreign reserves have fallen to roughly $1.6 billion, and the country's foreign debt obligations would reach $7 billion in 2022, including bond payments of $500 million and $1 billion in January and July, respectively.

Will India step in and lend a helping hand?

Not so long ago in December 2021 Rajapaksa met with Indian Finance Minister Nirmala Sitharaman and External Affairs Minister S Jaishankar during a meeting that birthed a "four-pillar" venture that included India agreeing to extend emergency Lines of Credit for the import of food, medicines, and fuel, as well as a currency swap designed to mitigate Sri Lanka's foreign exchange woes. PM Rajapaksa's request for a debt freeze over two years ago has not been responded to by New Delhi. In May 2020, President Rajapaksa requested a $1.1 billion currency swap, but India has yet to respond. India seems to be concerned about Sri Lanka's ability to meet its debt obligations going forward, given the country's dwindling foreign reserve position.