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Sri Lanka is staring at bankruptcy

Sri Lanka is staring at bankruptcy

there is a widespread food crisis in the country backed by a steady rise in inflation and dwindling forex reserves 
January 13, 2022
5 min read
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Sri Lanka is staring at bankruptcy

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the signs of a crisis were brewing for two years. basics such as oil, rice, cooking gas had become unaffordable and the Sri Lankan armed forces had to step in to ensure availability. simultaneously, depleting foreign exchange reserves meant that Sri Lanka's import strength was heavily curtailed. and now, it is time to repay debt. 

Sri Lanka, today, is staring at bankruptcy. the country’s December food price inflation soared to 22.1% from 17.5% a month before. its foreign reserves dropped to just $1.5 billion at the end of November, which is enough to pay for only about a month’s worth of imports.

the country, this means, will soon run out of funds to pay for expenses. it is now asking its largest international lender, China, to go soft on repayments. 

how did Sri Lanka get into this crisis?

Sri Lanka earns a large portion of its foreign currency from tourism. once Covid hit in March 2020, the country had to be locked down, barring entry to foreign tourists.   

as tourism was shut down, Sri Lanka’s economy shrank by a record 3.6% in 2020, its worst in 73 years. however, the country’s central bank remained optimistic, saying that the economy would rebound in 2021 and record an optimistic 6% growth. 

even as the economy was reeling from the Covid shock, in April 2021, the Rajapaksa government banned the use of chemical fertilizers in farming. while six months later, this decision was partially revoked, it by then had impacted crop production. 

therefore, the expected rebound never happened. the economic downturn continued and the World Bank said that around 500,000 people have fallen below the poverty line since the beginning of the pandemic.

on the other end, foreign currency was getting fast depleted. Sri Lanka’s foreign reserves fell to $2.8 billion as of July 2021, from $7.5 billion in November 2019, when the present government took office. 

as concerns about dwindling currency positions rose, Sri Lanka received $787 million from the International Monetary Fund’s (IMF) special drawing rights (SDR) allocation and $150 million from Bangladesh Central Bank as a currency swap arrangement. 

this support came in late. by then essential groceries had become unaffordable

as conditions worsened by the end of 2021 and into 2022, the government announced a USD 1.2 billion economic relief package. 

is there a way out?

while announcing the relief package, the Sri Lankan government said the country will not default on its international debt obligations. this is despite rating agencies expressing doubts about repayments. 

the country needs to repay an estimated $7.3 billion in domestic and foreign loans in the next 12 months, including a $500-million international sovereign bond repayment due in January. it’s now seeking reschedulement of payments from China and economic relief from neighbors like India.  

President Gotabhaya Rajapaksa’s office said in a statement on January 9 that it would be a great relief if debt payments could be rescheduled in view of the economic crisis. China is yet to comment on this request, but it has contributed about 10% percent of Sri Lanka's $35 billion foreign debt as of April 2021. 

a bailout package from the International Monetary Fund (IMF) would offer some stability to the economy. however, the country’s ruling party and opposition have sparred over seeking IMF assistance to tide over the financial crisis. 

current estimates predict that Sri Lanka will run out of its foreign exchange reserves by January end and will need an additional $437 million to survive. the biggest question plaguing the country is how soon will the Xi Jinping government agree to the request and on what terms. the clock is ticking.