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Sri Lanka: Facing an economic crisis – but IMF is not an option (for now)

Table of Contents

  • Low revenue from tourism, plummeting foreign remittances and legacy debts from the sovereign bond market are pushing Sri Lanka in the general direction of default
  • This is exacerbated by errors in the island's tea-production strategy
  • However, help from multilateral lending institutions will be the last option for the government because of the conditions these will impose
  • If Sri Lanka sinks, it could take the Maldives with it

Sri Lanka could face a sovereign loan default but its top financial leadership says Colombo will not approach the International Monetary Fund (IMF) for help just yet. If global oil prices continue to be high, Sri Lanka could slip off the precipice despite blandishments to tourists to return, exhortations to foreign labor to step up sending home remittances and restrictions on food hoarding punishable by imprisonment. Colombo has, last week, asked India for a USD 500mn loan that New Delhi will readily advance. It also has access to a USD 1.5bn currency swap with China. But doubts persist about the nation's ability to service debt amounting to USD 1.5bn that matures next year. Sri Lanka's risk premium for a default is the highest in Asia. The country's forex reserves are around USD 3bn, up marginally from USD 2.8bn in July because of USD 787mn from the IMF's special drawing rights (SDR) allocation but even then, barely enough to cover six weeks of imports. Inflation is hovering near 6% and food prices are up more than 11% over the same period last year.

The catalyst for the crisis is Covid-19 that has contributed to a loss of USD 8.6bn in revenue. Earnings from tourism, usually USD 3-4bn a year, have collapsed. Remittances from Sri Lankans abroad have fallen 35% compared to a year ago. But there are legacy issues as well, like the accumulated international sovereign bond debt that the government must pay off.

Added to this is a quixotic move by the government to announce earlier this year that all tea produced by Sri Lanka – its most important export earner – would henceforth be organic and banning all chemical fertilizer without ensuring alternatives were available. Sri Lanka's tea crop is already down 25% and recognizing the error, the government has partially rolled back its decision on fertilizer import. But this is unlikely to stem the damage the tea industry has already suffered. The government has recently introduced new capital market laws that will make foreign investment in Sri Lanka's biggest infrastructural development, the Colombo Port City, attractive, flagging these moves as measures to reel in more revenue. But until the tourists return, Sri Lanka's financial worries will continue to dog it.

In a bid to stem the crisis, the government in September asked the previous central bank governor to resign, replacing him with Ajith Nivard Cabraal, who had headed the central bank before. However, while Finance Minister Basil Rajapaksa (who is the younger brother of President Gotabhaya Rajapaksa and Prime Minister Mahinda Rajapaksa) has conceded the financial situation is “gloomy” and that help from multilateral lending institutions might be required, his preferred formula for putting the economy back on track, he says, is stability followed by growth.

This premise could be tested on 11 November, when the government presents its budget. With 70% of the population inoculated against Covid-19 and all quarantine and other controls lifted, Sri Lanka is preparing itself to welcome western visitors and the even more welcome dollars that they will bring. Till then, strict import control measures will likely stay in place as the government prints money to stay afloat, hoping tourist arrivals will offset the erosion of the domestic currency. If that does not happen, the IMF is the next stop.

Feelings against loans from institutions like the IMF run high. Apart from perceptions that they curtail sovereignty, unpopular decisions the IMF will force on the country – like cutting the size of the government bureaucracy, imposing higher personal taxation and revising fuel prices – will have political ramifications. Elections to provincial government have been postponed once because of the pandemic and will likely be held sometime in 2022. Already against the wall, the government needs to win those elections.

The outlook for Sri Lanka is grim. But even more worrying is the domino effect Colombo's crash will have on the economies around Sri Lanka. The Maldives, for instance, has extensive business investments in Sri Lanka and is facing many similar pressures. The economy of that country is on even more fragile footing. If Sri Lanka flounders, Maldives will likely drown.

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Sri Lanka: Facing an economic crisis – but IMF is not an option (for now)

Low revenue from tourism, plummeting foreign remittances and legacy debts from the sovereign bond market are pushing Sri Lanka in the general direction of