By: Kalyani Janakiraman
The author is a first-year master's student at the Jindal School of International Affairs. She can be reached at 24jsia-krjanakiraman@jgu.edu.in
Image Source: AP
Introduction
On the 16th of September 2024, the Sri Lankan Finance Ministry reached a debt restructuring agreement that has the potential to significantly change the economic trajectory of the country. Sri Lanka's newly elected President Dissanayake recently confirmed the country's commitment to alleviating the financial crisis. This assurance comes at a time when the Sri Lankan rupee was quoted at 293.70 to the U.S. dollar in 2024, compared to the 363 LKR in 2023. There is steady appreciation occurring, and the debt restructuring deal is a welcome change that can aid in economic stabilization.
The agreement includes a 27% haircut on the country's $12.5 billion in sovereign bonds. Having reached this agreement following consultations with the IMF and the Official Credit Committee, the new administration managed to reduce public anxiety induced by the previous government's poor management and racking up of debts.
Historical Background
Sri Lanka's economic crisis dates to April 2022, when it defaulted on its sovereign debt for the first time since its independence in 1948. This period was categorised as one of the worst civil unrest in South Asia. However, its origin goes back to the 2009 civil war, which was marked by the ascension of Mahinda Rajapaksa. Though the Sri Lankan military defeated the Tamil Tigers, it was a pyrrhic victory in every other sense. The price tag of this victory was one that the Mahinda couldn't bear. He took out loans by the billions to pay for the war expenses. The fiscal policies disastrously spelt out tax cuts, as Mahinda had to win political support in a polarised Sri Lanka, and this resulted in further reduction of the reserves.
Domestically, the situation was made worse by the 2021 ban on chemical fertilizers. This move was the brainchild of Gotabaya Rajapaksa, who desired to make Sri Lankan farming all organic. This catastrophically harmed the tea export industry. Internationally, Sri Lanka felt the pangs of the Russo-Ukraine war through the acute food shortages. These variables caused one-third of Sri Lanka to be food insecure.
To make matters worse, the country turned towards China and other commercial lenders to somehow alleviate the economic pressure. This can be witnessed by the sheer volume of unpaid debt in the country. As of March 2024, Sri Lanka's unpaid bilateral debt amounts to 10,588 million dollars. Nearly 40% of this loan is owed to China, which is a cause of concern for the nation.
Current Scenario
The default led to extensive shortages of essential goods and effectively plunged the nation into its worst economic crisis in decades. Electricity and water bills doubled and tripled overnight due to high inflation rates. Notices would be given to households that defaulted on their electricity payments and upon defaulting, even their water resources would be cut. Such shortages occurred at a time of political unrest, accelerated by the resignation of Mahinda Rajapaksa in May 2022. Inflation rates jumped as high as 67.4% by the end of 2022.
The subsequent government, led by former President Ranil Wickremesinghe, was tasked with correcting the errors of the Rajapaksa clan. His administration sought out an IMF bailout agreement worth $2.9 billion. This bailout came with the precondition of debt restructuring for further financial assistance. Wickremesinghe negotiated the terms of the current bond restructuring deal, which was crucial for the release of IMF funds. The current administration, led by Dissanayake, vehemently criticised the Wickremesinghe administration for not securing better deals with international creditors and promised to renegotiate if elected.
Despite all uncertainties, the recent confirmation of adherence is seen by many as a step towards economic relief. This new deal holds with itself the promise of paving a new way for the country, and potentially normalizing its relations in the financial markets across the world. The country has witnessed GDP growth of around 5%, contrasting with the 7.3% contraction in the previous year. However, the dark clouds continue to loom over Sri Lanka, with its debt-to-GDP ratio at 100.56% in 2024. While this is a decline from the high rates in 2022, experts predict that for the coming 4 to 5 years, this percentage is expected to persist in that range.
Conclusion
It is in this economic climate that the country prepares for its parliamentary elections in November 2024, which will likely shape the future trajectory of its economic reforms. To offset the negative effects of the external loans that the Rajapaksa clan took, a strong and detailed debt restructuring plan is required, one that allows the nation to pay off its loans without defaulting, thus inspiring confidence in investors. However, a part of external debt restructuring involves restructuring of domestic debt as well. This induces panic in the common people as they fear their savings, pensions, and other forms of deposit will undergo a similar 'haircut'. Prolonged tax hikes can potentially undermine all progress made by the country. This sentiment resonated with the lenders as well, who find it important to not jeopardise Sri Lanka's hard-won economic recovery.
Dissanayake promises to remove the burden of the restructured debt from the backs of the civilians, whilst emphasizing compliance with international organizations such as IMF and other lenders. The austerity measures adopted by the previous government left millions of citizens economically crippled, unable to fulfil their basic needs.
A mere matter of fact is that whatever fiscal policies and debt restructuring measures are undertaken will have a direct and distinct impact on the population of the country. A fragile economic climate is one where individual growth and development are stunted. This impacts the people's ability to contribute to the country's growth, too. There is a strong undercurrent of political mismanagement and corruption throughout this story, and it is one that catalysed the economic bust of the country. However, one can hope with the emergence of political stability under the current administration, economic stability follows.
Bibliography
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The views expressed in this article are those of the author (s). They do not reflect the views or opinions of Diplomania or its members.
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