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Sri Lanka: debt default threat strains the string of pearls

Sri Lanka says repaying its sovereign debt has become “impossible”. International investors are bailing out. A $1bn bond maturing in July trades at 46 cents on the dollar. Will the IMF and China, a big creditor, save the day?

Do not bank on a fix. Sri Lanka’s meltdown is political, economic, financial — and predictable. The island country, with a population the size of Florida, is a link in “a string of pearls” of strategic importance to China and the US. It is also beset with corruption, according to Transparency International. Its economy is in tatters after the pandemic disrupted tourism and transport.

Last week, amid blackouts and food shortages, the entire government of President Gotabaya Rajapaksa walked out, apart from his brother, Prime Minister Mahinda Rajapaksa.

Newly minted central bank governor P Nandalal Weerasinghe inherits dwindling foreign exchange reserves that last month fell below $2bn. External debt, public and private, is north of $50bn. That is awkward when the home currency has weakened even more than the rouble this year, notwithstanding last week’s doubling of interest rates to 14.5 per cent.

At a time of spiralling food prices, triggered by the war in Ukraine, the island is highly vulnerable: more than half of household spending goes on food.

The IMF has two challenges. First, handouts without structural reform simply kick the can down the road. Sri Lanka itself has only completed half its prior IMF programmes. But these are febrile times, unconducive to raising taxes to boost government coffers.

Second, Sri Lanka has multiple external creditors. China, with about a fifth of the total, looms large. Sri Lanka has asked China for help restructuring its debts. Beijing built and bankrolled big infrastructure projects, including the strategically positioned Hambantota port.

Sri Lanka is not alone in this respect. China’s Belt and Road Initiative, decried by critics as “debt trap diplomacy” has left a swath of countries from Asia to Africa in a similar position.

The IMF and China can take cold comfort from this: a successful bailout of Sri Lanka would create a blueprint for bailouts elsewhere.

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