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Will Sri Lanka default in 2022?

19 Dec 2021

By Imesh Ranasinghe The Sri Lankan economy is on the verge of collapse as the President Gotabaya Rajapaksa-led Government is struggling to finance upcoming debt repayments amidst a worsening foreign exchange crisis, according to economists. With more and more pressure from the opposition parties, professional, academics, and even members of the governing party to seek a bailout from the International Monetary Fund (IMF), Central Bank Governor Ajith Nivard Cabraal said that Sri Lanka does not need to go on bended knees to an outside agency such as the IMF to solve the country’s debt problem. “We are now on that path to debt sustainability. We are changing our debt profile,” Cabraal said at an event held by the Ceylon Chamber of Commerce (CCC) in early December. The Covid-19 pandemic hit the country’s tourism sector, which was considered an important source of foreign exchange earnings. This resulted in tighter import restrictions to conserve the foreign reserves. However, Finance Minister Basil Rajapaksa visited India On 1 December seeking assistance, from where he discussed securing $ 500 million fuel credit, $ 1 billion import loan for food, drugs, and essential items, and a $ 400 million swap to strengthen the foreign reserves of the country. Sri Lanka had turned to India for financial assistance after the diplomatic ties between Beijing and Colombo were in a roar after Sri Lanka rejected a ship of organic fertiliser from China following tests proving them to be not up to standard.  Moreover, State Minister Shehan Semasinghe announced in Parliament that the Central Bank has commenced discussions with the Qatar Central Bank to obtain a swap of $ 1 billion.  Sri Lanka’s foreign reserves was recorded at $ 1.6 billion at the end of November 2021, an amount many expect to further decline in the coming two months. The country had a record low of foreign reserves worth $ 1.2 billion in March 2009. By the end of August 2021, Sri Lanka had a total outstanding debt of Rs. 17 trillion ($ 84 billion), out of which about Rs. 10 trillion ($ 49 billion) was domestic debt. This is an increase of Rs. 2 trillion from the Rs. 15 trillion in December 2020. For the Government, meeting foreign currency debt-servicing needs for 2022 should be the immediate concern. Two big payments, according to reports, need to be honoured in 2022 – a $ 500 million bond in January, followed by $ 1 billion debt maturing in July. It is estimated that a total of $ 4.8 billion will be required to service debt obligations (principal + interest) and other commitments in 2022.  Sri Lanka at the mercy of others  Speaking to us, University of Colombo Department of Economics Senior Professor in Economics Prof. Sirimal Abeyratne said that there is risk of Sri Lanka defaulting in 2022. However, he added there is a possibility that, under certain conditions, the Government might be able to find money from somebody to avoid defaulting. “But it is merely a possibility given the dire situation of the country,” he said. The economist said that Sri Lanka is at the mercy of others around it to avoid a default in 2022. “There might be somebody to help us to at least keep our nose above the water without letting us sink,” he added. Samagi Jana Balawegaya (SJB) MP Eran Wickramaratne also said that Sri Lanka is at the mercy of other bigger economies when it comes to debt repayment for 2022. The former Finance minister said since the reserves of the country were down to $ 1.6 billion by the end of November as revealed in Parliament, there will definitely be a crisis, because in addition to paying debt, the country will have to pay for the essential services. “Sri Lanka has to get bailed out, so it has to be one of the bigger countries that will have to bail us out,” the former Finance State Minister said. In an email response, independent think tank Verité Research said that they had started forecasting the decline in reserves from the second half of 2020, and without a policy shift, they expect Sri Lanka's reserves to run dry in 2022. “When forecasting, we have three scenarios; best case (optimistic), worst case (pessimistic), and base case (most likely). We have had to recently update our projections. Currently, the end 2021 outcome is what we had forecasted as the worst case – so that is now our base case for end 2021. Therefore, while our previous projections were that reserves will run dry towards the end of 2022, we now expect them to run dry in the first six months of 2022,”  Verité said in their response. The think tank said that Sri Lanka’s  window of opportunity to steer out of a debt default outcome has now passed. It added that presently, Sri Lanka has no plausible scenario that could provide a path for the country avoiding a debt default outcome. “The choice now is about the way in which Sri Lanka enters debt default. The choice is between an orderly default (through preemptively restructuring debt) and a disorderly default (where Sri Lanka enters a default without negotiated agreement). The second default option would be more harmful than the first,” it said. Choosing IMF isn’t unusual  Speaking on the role of the International Monetary Fund (IMF), Abeyratne said that it is not unusual during the Covid pandemic for many countries in the world to receive IMF assistance, as it was a crisis nobody expected. He added that even the countries with strong foreign exchange situations received the IMF assistance including Bangladesh, which received $ 732 million from the IMF to address the Covid-19 pandemic under emergency financial assistance in May 2020. In June 2021, Bangladesh’s Central Bank approved a $ 200 million swap to Sri Lanka to strengthen the depleting foreign reserves. “So going to the IMF is not something unusual,” Abeyratne said. He said Sri Lanka did not go to the IMF seeking assistance, but instead went around the world looking for assistance from other bilateral sources. “Now it’s quite late and probably too late to go there,” he said, and added that even if it is too late, there's a possibility that Sri Lanka would have to go to the IMF. “The more late we get,  the more damage it will cause,” he noted. He also pointed out that if Sri Lanka had gone to the IMF earlier, the country would have avoided a lot of damages that happened during the last one and half years. Abeyratne said that the world saw a negative picture of Sri Lanka during the pandemic through the statistics published and media reports, which was confirmed by Sri Lanka’s own statistical evidence, rapid decline in reserve position, tightening import controls, and others. The economist said the negative picture the world saw about Sri Lanka was also confirmed by the downgrading of its credit worthiness by rating agencies, which could have been avoided or mitigated if Sri Lanka had chosen the IMF path. He added that if Sri Lanka had chosen the IMF path earlier, it would have stabilised Sri Lanka’s credit worthiness, as the country is now pushed to a position where it cannot borrow anymore as it used to. He noted that Sri Lanka cannot for commercial borrowings from money markets as the rates which were bad had become worse  “The IMF would have been a better choice, and even now it is a better choice; obviously, there will be conditions, as nobody in the world will give money without conditions,” he said.  Moreover, he said while others may offer interest, the IMF will have conditions, so it's a matter of fact whether Sri Lanka chooses interest or conditions. Following the end of the Civil war in 2009, the IMF came to Sri Lanka with a 20-month Stand-By Arrangement of $ 2.6 billion to support the country's economic reform programme and in 2016, the IMF came to Sri Lanka for 36-month lending arrangement under the EFF lending facility worth $ 1.5 billion following the Government’s request,  which the country shouldn’t have gone into, according to Abeyratne.  In 2009, two main conditions were set out by the Stand-By-Arrangement. One is to support Sri Lanka’s reform programme and the other to support Sri Lanka to strengthen its reserve position.  “If we had done those two things, we would have avoided the 2016 borrowings from the IMF,” Abeyratne said. However, Sri Lanka did not receive the $ 200 million, which was the last part of the $ 1.5 billion arrangement, in 2019 as the Government did not follow the conditions of the programme. Wickramaratne said by waiting this long and not facing up to the problem a year ago, they have pushed Sri Lanka to the wall, putting the country in a weaker position when going to negotiate debt servicing.  He said if Sri Lanka negotiated upfront, the country would have been negotiating in a much stronger position. “Now one of the larger countries might help us, but we will have to start looking at the details of the bail out package,” he added. Moreover, he said Sri Lanka will definitely default if it doesn’t agree to some deal with India or anyone else that will come up with a package  He said even if Sri Lanka chooses the IMF now, it will take time for the policies to be implemented, and meanwhile Sri Lanka will still need a bailout package for debt repayment.  “We have pushed ourselves to the wall by not managing the economy prudently; prudently managing an economy means doing things in a timely manner,” he added.  Verité said restructuring negotiations require a professional approach and takes time and hard work. In the last two years, several countries have entered such a process.  Those countries that managed it well succeeded in getting agreements within six months and building back their reserves as well as their credit rating soon after agreement was reached. Those who managed it poorly didn't conclude the negotiations and have kept moving deeper into crisis and default. Verité pointed out that the assistance of the IMF can help to improve the coordination of the process, to gain better terms for Sri Lanka when negotiating with creditors, and to move the process forward faster.  “However, the main responsibility for success will hinge on the decisions and the approach that is taken by Sri Lanka – the IMF can only provide limited assistance and guidance,” It said. Further, Wickramaratne said that the next two months would be very crucial for the economy of Sri Lanka and any package that would emerge would emerge during that period. What needs to be done? Abeyratne said that the only solution for Sri Lanka is to increase Foreign Direct Investments (FDIs) and export earnings to cover the debt obligations. However, Wickramaratne said that even if there is revival of tourism and other areas, income from tourism, FDI and exports will take time and it won't help the country immediately.  Verité commented on the matter and said that even now, there are ways of kicking the can down the road temporarily through short term currency swaps that cannot be restructured to settle foreign debt, or through fire sales of national economic assets.  But it said these are economically detrimental decisions, they are not solutions. Each time Sri Lanka kicks the can down the road, the can gets heavier, and harder to kick or even to pick up the next time around. “Instead, Sri Lanka should open up negotiations immediately (and the urgency cannot be overemphasised) to pre-emptively restructure its foreign debt and seek to delay all the capital repayment of the debt that is due from 2022 onwards,” it said. Verité pointed out that every payment of foreign debt, from now on, speeds up the pace of reserves running dry, and moves Sri Lanka away from the first to the second default options.


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