Restructuring Sri Lanka’s Debt talks

There is no doubt that International Monetary Fund (IMF) loans often come with a set of conditionalities that most countries find unfavourable to implement. With its ongoing economic crisis and complex multilateral debt negotiations between creditor nations, Sri Lanka is no exception.

The IMF extended a loan of US$2.6 billion to Sri Lanka in 2009 on the condition that Colombo reduces the country’s budget deficit to around 5 per cent of GDP. But the island nation failed to improve its exports or growth, so it requested another IMF debt facility of about US$1.5 billion in 2016. That was also ineffective due to internal issues ranging from multiple monsoon failures derailing agricultural productivity to the politically destabilising constitutional crisis of October 2018.

Between 2015 and 2019, the country’s growth rate fell from 5 per cent to 2.9 per cent and government revenue contracted from 14.1 per cent to 12.6 per cent of GDP. The bitter coincidence of falling output and revenue made Sri Lanka reluctant to seek an IMF bailout in the early stages of its 2022 sovereign debt crisis — diminishing its options to avert the current economic disaster.

The COVID-19 pandemic has been harsh for the entire South Asian region, with countries seeking hefty assistance from the IMF. Apart from Sri Lanka, the IMF has approved a loan tranche of US$1.17 billion to flood-hit Pakistan. Bangladesh formally requested an IMF loan of US$4.5 billion in June 2022 due to inflationary pressures, a volatile taka and depleted foreign exchange reserves.

Given the interconnectedness of global value chains and the regional economy, Sri Lanka’s recent economic woes cannot be understood in isolation.

In early April 2022, Sri Lanka declared it would default on its external debts comprising International Sovereign Bonds and syndicated and bilateral loans worth approximately US$51 billion. It then awaited a bailout from bilateral and multilateral creditors.

The subsequent months saw a humanitarian disaster and massive civil unrest that triggered the resignation of Sri Lankan government ministers, including the former president, Gotabaya Rajapaksa, and the former prime minister, Mahinda Rajapaksa. Sri Lanka reached a preliminary agreement with the IMF for a US$2.9 billion loan in early September 2022. It requires Sri Lanka to restructure all of its debt held by external and private creditors.

On the request of Sri Lankan President Ranil Wickremesinghe, Japan will lead the debt restructuring talks with creditor nations. Japanese Finance Minister Shunichi Suzuki emphasised the role that bilateral creditors like India and China should play in dragging Colombo out of its worst economic crisis since gaining independence in 1948.

The restructuring of Sri Lanka’s debt held by India and China provides Sri Lanka with a certain amount of leverage in the IMF negotiations. Interestingly, this also reflects the changing regional dynamics of the last few years. Sri Lanka is of strategic interest to China for its trade and infrastructure connectivity in the Indian Ocean region as part of the Belt and Road Initiative (BRI). It became more crucial after India announced its non-participation in the BRI.

China has been accused of engaging in debt-trap diplomacy with Sri Lanka, especially after the Hambantota Port incident in which the China Merchants Port Holdings Company paid $US1.12 billion for an 85 per cent share in the port on a 99-year lease in 2017. But in the post-pandemic world, the BRI, like China’s general dedication towards Sri Lanka, is losing steam.

East Asia Forum