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Sri Lanka’s Economic Crisis: The Role of ISBs, IMF, and Political Dynamics

Sri Lanka, is currently grappling with a severe economic crisis. The country’s financial instability is largely attributed to a burgeoning public debt, necessitating comprehensive restructuring efforts. Central to these efforts are the International Monetary Fund (IMF) and the complexities surrounding International Sovereign Bonds (ISBs).

The economic crisis in Sri Lanka has been long in the making, with roots tracing back to years of fiscal mismanagement, corruption, and a lack of transparency in government operations. The situation has been further exacerbated by the global COVID-19 pandemic, which hit the country’s tourism industry hard and led to a significant decrease in foreign exchange earnings.

The IMF’s Extended Fund Facility (EFF)

In an attempt to stabilize the economy, the IMF approved a 48-month extended arrangement under the EFF for Sri Lanka, amounting to SDR 2.286 billion (approximately USD 3 billion) in March 2023. This program is not just a financial bailout; it represents a blueprint for sweeping economic reforms aimed at restoring macroeconomic stability, ensuring debt sustainability, and laying the groundwork for long-term growth. The success of this program hinges on the country’s commitment to implementing these reforms effectively.

The EFF is a tool designed to provide medium-term assistance to countries facing serious balance of payments problems that require structural economic reforms. For Sri Lanka, the EFF aims to address the country’s high levels of public debt and weak fiscal position, which have been exacerbated by the COVID-19 pandemic.

The Role of International Sovereign Bonds (ISBs)

Sri Lanka’s debt issues are intertwined with complexities surrounding ISBs. From 2007 to 2019, Sri Lanka issued $17 billion worth of ISBs, often at high coupon rates between 5-8 percent. Unlike project-specific loans, these bonds have significantly contributed to the country’s debt burden, accounting for a substantial portion of the government’s annual interest payments. According to government data, 40% of the country’s debt consists of ISBs. The structure and terms of these bonds have exacerbated the debt crisis, making the restructuring process more complex and challenging.

ISBs are bonds issued by a national government in a foreign currency to finance the issuing country’s growth. While these bonds can provide necessary capital, they also come with risks. For Sri Lanka, the high interest rates associated with these bonds have led to a significant increase in debt service obligations.

Debt Restructuring

The Central Bank of Sri Lanka plans to reduce ISB exposure to 10% of GDP over three years by managing yield rates and exploring buy-back options, though bondholder interest has been limited. This strategy is essential for easing the debt burden and achieving financial stability.

Sri Lanka’s debt restructuring agreement with creditors, including India and Japan, is key to unlocking further IMF support. The IMF stresses the need for continued reforms, especially addressing corruption, before finalizing the bailout package. Successful debt restructuring is crucial for economic recovery.

Domestic support is vital, with Sri Lanka’s Parliament approving a plan to reduce foreign debt by USD 17 billion. This support helps maintain momentum and ensures smooth reform implementation. The IMF recognizes signs of economic stabilization but emphasizes the importance of resolute reform implementation for complete recovery and preventing future crises.

The Political Underpinnings of Debt Restructuring

In any discussion about debt restructuring, the role of politics is intrinsically linked to the current predicament. Sri Lanka has been a direct casualty of party politics, with policy changes often driven by political promises and the pursuit of public popularity.

Since gaining independence, political power in Sri Lanka has oscillated between two primary camps: one influenced by free-market principles and the other leaning towards more conservative economic policies. This constant shift in political ideologies has significantly impacted the country’s economic stability and debt management strategies.

Samagi Jana Balawegaya (SJB) on Debt Restructuring

The SJB is the largest opposition party in Sri Lanka, led by Sajith Premadasa. Formed as a breakaway group from the United National Party (UNP) ahead of the 2020 General Election, the SJB backs a liberal economy and advocates for adopting a digitalized economic model. However, these policies often mirror those of the UNP.

The SJB has consistently expressed disappointment over the government’s lack of transparency regarding discussions with the Ad Hoc Group of Bondholders of its ISBs. SJB MP Dr. Harsha de Silva criticized the government for not providing transparency in the debt restructuring process despite requests from the party. The SJB has also announced that it will vote against the government’s domestic debt restructuring (DDR) plan, expressing concerns over its implications for Sri Lanka’s banking and finance sector.

National People’s Power (NPP) and Its Economic Policies

The NPP has been vocal about the country’s debt restructuring process. However, recent comments from prominent NPP figures have sparked significant debates. Former COPE Chairman Sunil Hadunnetti suggested that Sri Lanka’s bondholders would not cause disputes if the government defaulted on ISB commitments, arguing that the risk premium is included in the bonds’ coupon rate. This assertion was refuted by the lawsuit filed by Hamilton Reserve Bank in June 2022 against the Sri Lankan government, highlighting severe financial losses incurred by American retirees due to Sri Lanka’s default.

Additionally, NPP’s Professor Anil Jayantha hinted that an NPP government might not honor “odious debts,” a concept not recognized in international law. These statements raise doubts about the party’s credibility on economic matters. Observers emphasize the need for a clear, coherent, and orthodox economic program for Sri Lanka’s governance, particularly during ongoing IMF-assisted recovery efforts.

Government Initiatives and the Need for Transparency

The Government recently introduced the Economic Transformation Bill of Sri Lanka, gazetted by President Ranil Wickremesinghe’s office, setting ambitious economic targets for the next 25 years. This bill outlines government debt restructuring measures, aiming to maintain the Public Debt to GDP ratio below 95% by 2032 and reduce the central government Annual Debt Service in foreign currency to GDP ratio below 4.5% by 2027.

While the bill represents a pivotal step towards sustainable and inclusive economic growth, merely introducing new legislation will not address the challenges. Both key opposition parties have highlighted the importance of transparency. The Government has yet to act upon these calls to win public trust regarding the debt restructuring process.

In this context, the Government has failed to provide comprehensive documents regarding its agreement with the IMF on debt restructuring. Despite numerous calls by opposition political parties, the Government has remained unresponsive. This lack of transparency raises serious suspicions and can cause public doubt about the IMF and the debt restructuring process.

Transparency is crucial for gaining public trust and restoring the economy. Otherwise, this will be yet another failed attempt to address Sri Lanka’s debt issues, exacerbating political instability.