Sri Lanka could be the first of many emerging market economies to collapse
Sri Lanka is a country which has lived through multiple catastrophes since winning its independence from Britain in 1948. Most calamitously, there were three decades of civil war between the majority Sinhalese and the minority Sri Lankan Tamils.
Yet throughout this troubled history, the government in Colombo has never reneged on its debts. But with protesters on the streets complaining about soaring food and fuel prices and the leadership of the ruling family, the finance ministry felt it had few other choices but to suspend payments.
It stressed the country’s uninterrupted record of paying its way through thick and thin, adding that to continue to do so ‘was no longer tenable.’
Sri Lanka is no Argentina, which has formally defaulted on its debt nine times since 1827 and twice in recent decades.
As the country seeks to deal with what IMF boss Kristalina Georgieva describes as ‘crisis on top of crisis’ – the pandemic followed by the war in Ukraine – it decided it has no other choice but to try to reshape the financial and economic landscape.
In spite of past strife, Sri Lanka with its highly talented, well-educated government elites, is not the first nation which would be thought of as sparking a global meltdown.
Its difficulties, however, mirror a huge build-up of debt, social inequality, poverty and hunger across emerging markets and the developing world during Covid.
The Western nations have been so focused on their own health and economic disruption in the pandemic that the rest of the world barely has received any attention.
A report, just compiled by the UN trade and development arm Unctad, warns ‘we are on the brink of a global debt crisis.’ Before the Ukraine war, developing countries were on average spending 16pc of export earnings on servicing debt. The figure among smaller and island states is twice that. To place matters in perspective, Germany’s debt obligations when they were reorganised (effectively written off) by its creditors in 1953 never exceeded 3.4 per cent of exports.
Unctad warns that the combination of rising global interest rates, turbulence on commodity markets and surging bond yields could lead to the kind of outcomes which nearly brought the Western financial system to a shuddering halt at the start of 2020. Western central banks were forced to shore up markets with massive injections of cash.
Sri Lanka, like all countries, has its particular problems. There is a flare up of direct protest against the democratically elected president Gotabaya Rajapaksa and his brother Mahinda who is prime minister and who served as president from 2005-2015.
Patience with nepotism is wearing thin amid domestic chaos. In the last few weeks, as the global energy emergency intensified, Sri Lanka’s 22million citizens have been battered.
There have been power cuts lasting 13 hours each day, long queues for petrol and cooking gas and a 20 per cent hike in food prices.
All of this, together with a pandemic-induced collapse of tourist revenues, has left the nation’s finances imperilled. Sri Lanka’s total debt stands at $35billion but it is the make-up which is intriguing.
Some $4billion must be repaid this year including a $1billion sovereign bond. The country has sold $12billion of its sovereign or government bonds globally. But the majority of its debt is described as bilateral or commercial which suggests that there are banks and privately-held bond funds potentially nursing very damaging losses. In the secondary markets, Sri Lankan bonds have been changing hands at 40 cents on the dollar.
In itself, a Sri Lankan bond default is a mere tremor. But the IMF, in its financial stability reports, has been warning for some time that the build-up of emerging market and developing country private sector debt, some of it embedded in globally-traded bond funds, could be a danger to the stability of global finance.
As was the case with the US sub-prime mortgages before the financial crisis, much of this debt has been sliced and diced, packed up into digestible parcels and sold onto investment funds.
As IMF boss Georgieva points out, the catastrophic economic losses in Ukraine will spread far and wide, particularly hurting the lives, finances and economies of food and fuel importing nations in Africa, the Middle East, Asia and even Europe.
For the lowest income countries – some 60 per cent of which are, like Sri Lanka, in debt distress – restructuring (a polite word for forgiving and writing off debt) will be required.
The Sri Lankan default is the pebble dropped in the lake. Other nations will face similar problems of capital flight, falling exchange rates and what is known as a ‘taper tantrum’. As the Federal Reserve and other central banks raise the cost of borrowing, investors will divest themselves of emerging market investments and credit will dry up.
The danger becomes a cascading series of country collapses. Sri Lanka may be first in the queue and the current disruption may be enough for it to reshape its political patriarchy. There is no escaping the fact that Putin’s aggression is heaping new and dangerous problems on the world’s most vulnerable populations with a serious blowback for the West. (money)