Saving Sri Lanka

Source: This post is based on the following articles

“Read Lanka right: Structural economic weakness, not illiberalism, caused the crisis. And that weakness doesn’t apply to India” published in The Times of India on 11th Jul 22.

“Saving Sri Lanka” published in Business Standard on 12th Jul 22.

Syllabus: GS2- India and its neighborhood

Relevance: India-Lanka relations

Context: The prevailing economic crisis in Sri Lanka, pre-crisis problems and how can India help in improving the situation.

Problems with Sri Lanka

Sri Lanka has been a South Asian epitome for many decades on Human Development Indicators (HDI). Health, education have been at near-European levels.

Average income has been above the rest of the subcontinent – with a pre-crisis per-capita income nearly double that of India.

But there were always problems in the island nation.

– Sri Lanka received IMF bailouts 16 times since 1965.

– There hasn’t been a single decade since the 1960s when Lanka did not receive at least 2 IMF bailouts.

– With time, size of the bailouts has gone up, but essential bug has persisted.

– During this time, Lanka has endured civil war, political instability and long periods of presumptively “liberal, tolerant” governments – but frequency of bailouts needed didn’t change.

What led to present economic crisis in Sri Lanka?

First, the lack of domestic savings to fund government debt and the lack of stable capital flows to fund the shortage of dollars created every year with a persistent CAD.

Second, since the 1960s, Lanka has depended on multilateral borrowings to finance its Current Account Deficit (CAD) as well as undertake key development projects.

Third, lack of a development bank infrastructure and local savings meant that the bulk of Lanka’s famed HDI achievements came to be funded by the likes of World Bank.

Fourth, despite large concessional foreign loan flows, Lanka had to periodically resort to IMF bailouts in order to bridge its foreign exchange deficits.

Fifth, aided by the optimism around the end of the civil war, Lanka started issuing International Sovereign Bonds (ISBs).

– By 2019 short-tenure ISBs became nearly 50% of government borrowings.

– ISBs, in the absence of drastic improvement in government finances and/or ability to raise local savings, need to be refinanced by raising further ISBs. All of this, in a country that has struggled to raise any meaningful non-debt capital inflows over the years, is close to a casino musical chair game.

Sixth, Loans by China: Belt and Road Initiative (BRI) loans fund large infrastructure projects (often unviable, like the Hambantota port) where bulk of the funding is to Chinese contractors executing the project.

This has resulted in a project with little cash flows, limited benefit to the local economy, but a funding liability of the Lanka government.

Seventh, the last and the final reason was likely the sudden wholesale switch to organic farming.

Why such a crisis isn’t possible in India?

India issues zero ISBs, and has negligible dependence on foreign flows to fund its budget.

As a large, sophisticated economy, it attracts enough non-debt capital flows to fund its CAD.

It has a world-class regulatory framework to manage external risks.

Way forward

Short term

Humanitarian suffering and a political vacuum must be avoided.

Money to pay for immediate and essential imports must be found, and New Delhi must support a peaceful transfer of power.

Long term

Sri Lanka’s debt, as currently structured, if unsustainable, will need to be restructured. This is critical as it will set precedents for other sovereign debt restructuring that appears inevitable, from Ghana to Laos.

India’s role

India must now take up a leadership role in addressing Lanka’s problems, without waiting for the global community.

Also, Sri Lanka is small compared to most Indian states, and so a bailout cost will not be prohibitive. Plus, bailing out a fundamentally productive neighbouring country is clearly in the national interest.

There was talk of the outgoing prime minister convening a conference of the country’s creditors, including India, Japan, and China. Such a meeting should certainly go ahead even if the current prime minister himself is not around to conduct it.