Sri Lanka’s Economic crisis and Debt trap dilemma

sri lanka banner flag 2702727

The island nation is facing financial meltdown. Sri Lanka’s Economic crisis escalated with its declaration about the failure to repay its debt of more than $83 billion.

Reasons behind Sri Lanka’s Economic crisis

sri lanka sri lanka national flag 7748118
sri lanka sri lanka national flag 7748118

Twin deficit

The island nation is facing a sustained twin deficit. Twin deficit(Budget shortfall +Current Account Deficit). Country’s national expenditure is more than its national income and the production of its tradable goods and services is inadequate.

Populist measures

Economic crisis deepened due to the populist measures of the government to win the elections. The government had promised deep tax cuts in its 2019 election campaign.

Pandemic

This was followed with the pandemic year which gave a blow to the nation’s most lucrative tourism industry, also eroding Foreign worker’s remittance to all time low.

Ukraine crisis

Fuel prices increased due to UKraine crisis. The government had inadequate foreign currency to pay for its imports and fuel. This resulted in frequent power cuts of about 12 hours a day. Due to shortages and hyperinflation citizens protest also increased.

As a result of this, the country’s forex plummeted to about 70% in just 2 years and credit rating agencies moved to downgrade the country.

Financial assistance to Sri lanka

The Sri Lankan government has made a plan to approach the IMF. but in the interim it has sought assistance from China and India. 

Sri Lanka and India have signed a $1 billion credit line for importing essentials. 

China is the biggest bilateral creditor to Sri Lanka. It has provided the Central Bank of Sri Lanka with a $1.5billion swap and $1.3 billion syndicated loan to the government. Sri Lanka has also reached an agreement with EXIM Bank of China to cover $4.2 billion of its debt.

IMF has stated that Sri Lanka would be eligible for loan if it secures a financial assurance of debt sustainability from its bilateral creditors.

Concerns with debt negotiations

Sri Lanka has started negotiating with its key bilateral creditors in order to meet the conditions of IMF. India and Paris club group of creditors has already written a financial assurance to IMF. 

China’s written assurance is pending which is causing delay in IMF lending to Sri Lanka. China intends to get a preferential term and it has also gone for bilateral negotiations with confidential term in the past.

Concern for India 

If China does not join a common platform of debt negotiation with India and other Paris club group, then China will enter into its own custom made bilateral agreement. China can take advantage in deepening its ties with Sri Lanka. It can use its ‘Debt-trap diplomacy’. This can increase China’s hegemony in India’s neighbourhood.