Explained: What is the economic crisis in Sri Lanka?

Sri Lanka is in the grip of its worst economic crisis in decades, collapsing under the weight of its debt. While neighbors India and China have secured aid from President Gotabaya Rajapaksa, the island nation’s citizens have deserted the flagging economy and are showing up on Indian shores by the dozens.

Overview of the key points to understand this crisis.

What’s going on in Sri Lanka?

The island’s foreign exchange reserves have hit rock bottom, with commercial banks unable to raise dollars to finance imports of food, fuel and medicine. Sri Lanka was going through a deep economic crisis when the Covid-19 pandemic hit, reducing remittances from foreign workers and crippling the lucrative tourism sector – a key source of dollars for the economy.

The government imposed a broad import ban in March 2020 to save foreign currency. Shortages pushed food prices up 25% last month, with headline inflation at 17.5%, the fifth consecutive monthly record. Sri Lanka also faces five-hour blackouts as thermal generators run out of fuel.

Three international rating agencies have downgraded the island since late last year over concerns it may not be able to service its $51 billion sovereign debt.

The International Monetary Fund (IMF), in an analysis, stressed that the country’s “over-indebtedness”, as well as persistent budget and balance of payments deficits, “will constrain growth and jeopardize macroeconomic stability in the short and long term. middle term”.

“Based on staff analysis, the fiscal consolidation needed to bring debt down to safe levels would require excessive adjustment over the next few years, indicating a clear solvency problem,” the IMF said.

Also read: Lankan newspapers run out of newsprint due to forex crisis; suspend publication

Sri Lanka debt profile

Sri Lanka must repay about $4 billion in debt this year, including a $1 billion international sovereign bond maturing in July. But its reserves fell to $2.31 billion at the end of February, down about 70% from two years ago.

The country, through repeated rounds of borrowing since 2007, has accumulated $11.8 billion in debt through sovereign bonds (SBIs), accounting for the bulk – or 36.4% – of its foreign debt. The Asian Development Bank (ADB) is in second place with a 14.3% share, having lent $4.6 billion. Japan is at 10.9% and China at 10.8%, each having lent about $3.5 billion each.

The rest of the debt belongs to countries like India and international agencies like the World Bank and the United Nations.

The Chinese Debt Link

China is Sri Lanka’s fourth largest lender, behind international financial markets, the Asian Development Bank (AfDB) and Japan.

Over the past decade, China has loaned Sri Lanka more than $5 billion to build highways, ports, an airport and a coal-fired power station. But critics say the funds were used for low-return white elephant projects, which China has denied.

President Gotabaya Rajapaksa asked China to help restructure debt repayments when he met Chinese Foreign Minister Wang Yi in January, but China has yet to respond to the request.

Reimbursements to China are estimated at $400 million to $500 million, a finance ministry source said. Reuters.

Before the pandemic, China was Sri Lanka’s main source of tourists and the island imports more goods from China than from any other country.

Sri Lanka is a key part of China’s Belt and Road Initiative (BRI), a long-term plan to fund and build infrastructure linking China to the rest of the world, but others, including the United States, States have called it a “debt trap” for smaller nations.

Also read: Sri Lanka in talks with China for $2.5 billion credit support, Chinese envoy to Colombo says

What are the experts saying?

Some experts believe that Sri Lanka should restructure its debt and establish a three-year repayment structure.

This would save precious dollars and ease the burden on Sri Lankan citizens who are facing shortages of imported goods such as powdered milk, gasoline and fuel.

“Sri Lanka has made an unreasonable commitment to debt repayment. It is safer to suspend debt repayment and address critical economic needs,” said Verité Research executive director and economist Dr Nishan. of Mel.

Fitch estimates that Sri Lanka’s central bank will also need to arrange $2.4 billion to help the country’s public and private companies service the debts they have in 2022, on top of the $4.5 billion in debt. of the central government.

The country also needs about $20 billion for essential imports such as fuel, food and intermediate goods for exports.

Reserves have been at critical levels for months, but rose to $3.1 billion at the end of December, boosted by a 1.5 billion yuan currency swap from China.

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