What’s Happening in Sri Lanka Following the Default Path... "Adverse Factors Keep Piling Up"

Published 05 Apr.2022 10:28(KST)

Tax revenue decline since before COVID-19 due to populist policies

Rapid increase in debt to China amid rising infrastructure investment

Government escalates measures including curfew and SNS ban amid intensified anti-government protests

[Image source=Yonhap News]

[Asia Economy Reporter Kim Hyunjung] Sri Lanka, experiencing its worst economic crisis since gaining independence from the UK in 1948 due to the paralysis of the tourism industry caused by COVID-19, is moving toward debt default. As protests against soaring prices and food shortages continue, the government has declared a state of emergency and imposed a curfew, followed by a cabinet reshuffle, but signs of crisis do not seem to subside.

On the 4th (local time), Bloomberg reported that Sri Lanka’s sovereign debt losses are deepening, making default difficult to avoid. According to the report, the $1 billion sovereign bond maturing in July fell 7 cents to 59 cents on the dollar, marking the lowest price since May 2020. The report diagnosed this as "the largest drop among developing countries, implying that investors are convinced Sri Lanka will have difficulty repaying its debt."

What’s Happening in Sri Lanka Following the Default Path... "Adverse Factors Keep Piling Up"

◆What’s happening in Sri Lanka = The economic instability in Sri Lanka can be summarized as a decline in tourism revenue and an increase in external debt due to excessive government bond issuance. Tourism income, which accounted for about 5% of GDP, declined after the 2019 Easter terror attacks and was further devastated by the halt of foreign visitors due to the spread of COVID-19 the following year. Sri Lanka’s tourism revenue reached a record high of $4.38 billion in 2018 but plummeted by 84.5% in 2020 and 94% in 2021.

Another cause is the introduction of loans from China and others for large-scale infrastructure development such as ports and roads, and the issuance of sovereign bonds to repay existing external debt. Some view Sri Lanka as having fallen into a debt trap while trying to respond to China’s Belt and Road Initiative. According to the Korea Institute for International Economic Policy (KIEP), sovereign bonds maturing within the next 10 years amount to $12.55 billion (approximately 15.2419 trillion KRW).

Additionally, in 2019, President Gotabaya Rajapaksa weakened national revenue by implementing populist tax cuts, which also played a role.

The economic crisis worsened with the adverse effect of soaring oil prices following Russia’s invasion of Ukraine, plunging Sri Lanka’s $81 billion economy into recession and rapid inflation. Authorities raised interest rates, devalued the local currency, and imposed import restrictions on non-essential goods. Consumer prices rose 19% year-on-year in March, the fastest pace in Asia.

[Image source=Yonhap News]

◆Escalating protests and government’s forceful response= Dissatisfaction among Sri Lankans toward Rajapaksa, elected president three years ago, is intensifying. Due to energy supply instability, households and businesses have experienced daily power outages since March, with blackout durations reaching up to 13 hours this month.

Long lines have formed at gas stations, and essential food items are in short supply. At the end of last month, protesters clashed with police outside President Rajapaksa’s residence.

The government’s response, including declaring a state of emergency, imposing curfews, and restricting access to social networking services (SNS), further angered public sentiment. Protesters chant "GOTA (President Gotabaya Rajapaksa) go home," which has even become a trending hashtag on SNS.

During the recent mass cabinet resignation process, Sri Lanka appointed Nandalal Weerasinghe, former governor of the Central Bank of Sri Lanka (CBSL), as the new governor. On that day, current governor Ajith Nivard Cabraal stepped down following the cabinet’s resignation, and further monetary policy reviews were indefinitely postponed.

Weerasinghe was appointed deputy governor of the central bank in 2011 while serving as IMF deputy managing director and has chaired the CBSL’s Monetary Policy Committee and Foreign Exchange Reserves Management Committee.

[Image source=Yonhap News]

◆Hastily announced measures, but short-term improvement unlikely= To overcome the economic crisis, the Sri Lankan government announced a $1 billion relief plan in January for about 2 million income support recipients and sought breakthroughs such as exempting fully vaccinated travelers from quarantine to revive tourism revenue.

At the beginning of the year, Sri Lanka conducted a $400 million currency swap with India and requested debt repayment rescheduling from China. However, the chronic current account deficit, increasing external debt, and depreciation of the rupee that had continued even before COVID-19 make it difficult to resolve the economic crisis in the short term.

Sri Lanka is a key partner country for Korea’s Official Development Assistance (ODA), with Korea’s confirmed ODA to Sri Lanka reaching 96.7 billion KRW this year.

Recently, trade volume with Korea has also been recovering. In 2021, Korea’s exports to Sri Lanka increased by 67.3% year-on-year to $288 million, and imports rose by 27.8% to $142 million, recovering to pre-COVID-19 levels. As of November last year, major exports included synthetic rubber, synthetic resins, lubricants, galvanized steel sheets, and knitted fabrics, while major imports were knitted garments, naphtha, woven garments, other vegetable materials, and clothing accessories.