IMF deal could be turning point for the mess Sri Lanka is in

London/Colombo — Sri Lanka’s IMF bailout plan could be a turning point in its worst economic crisis, but far from stable politics and a need to get debt relief from competing powers China, India and Japan means some of the hardest work is still to come.

President Ranil Wickremesinghe knows a lot of circles will need to be squared for the IMF’s $2.9bn lifeline to become a reality. Spending cuts, tax hikes and debt writedowns are a common formula for bankrupt countries, but crisis veterans say there are some difficult elements in Sri Lanka.

An impoverished population that forced former president Gotabaya Rajapaksa to flee in July still needs to accept Wickremesinghe, seen by many as of the same political ilk and a man who faces a bristling opposition.

The country’s borrowings are so complex that estimates of the total range anywhere from $85bn to well over $100bn. To get it to a sustainable level Beijing, New Delhi, Tokyo, multilaterals and global asset managers must all swallow losses.

“This is one of the biggest messes I’ve seen,” said Renaissance Capital’s chief economist, Charles Robertson, who has watched emerging market crises unfold for decades.

“The government destroyed its revenue base with unsustainable tax cuts, it tried to hold the currency when tourism revenues collapsed and now it has no reserves in the bank and a population facing widespread poverty,” Robertson said.

Estimates from the UN say the crisis has left more than a quarter of Sri Lanka's 22-million population struggling to secure adequate, nutritious food.

The IMF’s four-year rescue plan, which was provisionally agreed last week, demands serious fiscal repair work and more autonomy for the central bank, which was ordered to frantically print money under Rajapaksa.

To hit the IMF’s target of lifting its primary budget surplus to 2.4% by 2025, Sri Lanka would need to get its economy growing by about 6%, something not achieved for five years. This year it is expected to contract at least 8%.

Assurances

Just as challenging, the IMF wants Colombo to secure “financing assurances” — fund-speak for debt relief and new loans — from regional heavyweights China, Japan and India, who have long jostled for influence.

The World Bank estimates Beijing’s lending, which has funded costly projects from ports to a stadium, adds up to $7bn, or 12% of Sri Lanka’s $63bn external debt. Japan has provided another $3.5bn while India has given $1bn.

Without “assurances” from those countries, the fund’s money cannot flow, IMF mission chief Peter Breuer said.

“Finding creative ways to have a collaborative platform to advance these debt restructuring discussions is very useful,” Breuer said. “How debt relief is distributed among creditors that is something we don’t insert ourselves into.”

The crisis has culminated in Sri Lanka’s starkest crisis and first debt default since independence from Britain in 1948. The rupee almost halved in value since the central bank abandoned its peg in March, basic goods have become scarce and inflation is now running at 64%.

Economists say the restructuring could have been far simpler if the country had been part of the Group of 20 “Common Framework” plan — a programme set up at the height of Covid-19 to help debt-crippled countries. At the time, Sri Lanka was classified as a middle-income country and did not qualify.

China automatically provides debt relief alongside Paris Club countries and private sector creditors under that arrangement. Colombo’s absence from the set-up means an alternative is needed.

Step up Japan, which is pushing for China, India and others to join talks. Beijing, which did not respond to a request for comment, has not yet signalled if it will, though there are hopes its lead role in Zambia’s restructuring may encourage it to do so. India has not commented so far.

Pessimists worry though that if China does not take a writedown others will not either, including global asset managers that hold nearly $20bn of Sri Lanka’s international bonds.

“China is the largest creditor country. Without its participation, any scheme won’t succeed,” a Japanese government official who requested anonymity said.

Another problem is what to do about the country’s $50.5bn of “local” debt, mostly dominated in rupees and largely held as capital by commercial banks and local pension funds.

Sanjeewa Fernando, head of research at CT CLSA Securities, said it will not be a straightforward decision, especially with elections looming in 2024. “From a realistic point of view, banks are preparing for a 40% haircut (on Sri Lanka’s international bonds and ‘development’ bonds which are also dominated in dollars) as a base case scenario,” he said.

Even that might not be enough though, given the IMF wants the debt-to-GDP ratio slashed to under 100% from 140% now.

That would put domestic debt in play, but David Beers, a senior fellow at the London-based Centre for Financial Stability who has compiled a global database of sovereign defaults, said there are always trade-offs.

“If the domestic debt is predominately held by domestic banks and you get haircuts, then that eats into their capital,” Beers said, adding that they might then require bailouts, which add to the government’s costs again.

Reuters