29 September, 2021

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Sri Lanka’s foreign debt crisis forecast for 2021

Sri Lanka’s foreign debt crisis is forecasted to last way longer than expected and is expected to cause an even more severe economic crisis than it is now. Sri Lanka’s foreign debts have often been messed up with the Chinese debt trap controversy agencies and experts have predicted certain downgraded activities for Sri Lanka’s sovereign credit ratings. Many international organizations have set Sri Lanka somewhere at the bottom of the economical growth calendar. Sri Lanka does not seem to be happy about those changes and blames it on the ill-informed models.

Having a tough economic situation is not new to Sri Lanka. Its foreign debt stock accounted for more than half of Sri Lanka’s GDP back in 1995. Though from that time on it gradually began to decline. The reason for the decline was also the rapid economic growth experienced by the country. The foreign debt to GDP ratio eventually dropped to 30% in 2014, yet the public debt still continued to grow. The public debts were mainly financed by the international sovereign bond and loans from China.

Progress may not always be the same

Since 2014, foreign debt levels have been on the rise and reached 42.6 percent of GDP in 2019. This surge was a result of both Sri Lanka’s low economic growth rate and the issuance of ISBs to repay previous foreign loans obtained from 2007 to2014. During 2015-2020 ISB repayments were roughly $6.7 billion, which amounts to a little over 20 percent of the current foreign debt obligations, approximately $33 billion.

While the economic situation with Sri Lanka had to get better with time, currently it does not look optimistic at all. While the percentage of the debt to GDP ratio might be a smaller percentage than it used to be back in the 90s, in reality, it only got worse. With the rapid economic growth Sri Lanka has transferred from a low-income country to a middle-income country. While this is progress for a country, it also means that Sri Lanka can no longer access concessionary loans by multilateral agencies and bilateral donors. This means that the land which Sri Lanka had in the 90s had way better terms and conditions and was sufficient enough for the country to pay than it has now.

With the rapid economic growth and the country being moved to the following level, the new possibilities of economic calendar Forex trading have opened to the local and the foreign investors, as a certain action plan has been prepared and skilled financial experts will be able to make predictions using calendar tools. When the previous loans were no longer the option, many investors are now fascinated by the country and invest in foreign exchange currency trading. And from one side this is truly beneficial for the country’s popularity, it only encourages outflow of the local currency after all.

Sri Lanka, therefore, had to look for alternative foreign financing sources. In 2007, Sri Lanka issued its first International Sovereign Bond (ISB) worth $500 million and started raising money using international capital markets. Due to the heavy reliance on ISBs, Sri Lanka’s foreign debt composition changed completely. In 2004, commercial loans amounted to only 2.5 percent of Sri Lanka’s foreign loans, but by the end of 2019, 56 percent of the country’s foreign loans were commercial borrowings, most of which are ISBs.

Unlike the concessionary loans, the ISB are identified more as the commercial borrowings and have a very short payback period, which is about 5 to 10 years, while concessionary loans have an almost unlimited payback period. The interest rate also differs a lot, with IBC the interest rate is higher than 6% annually, while with concessionary loans it is 1% or even lower. On top of that, there are principal payments – in other words, the total borrowed amount of an ISB is settled at the bond maturity date, all at once, rather than being distributed over the years through annual repayments. Therefore, when an ISB matures, foreign debt repayment requirements skyrocket, resulting in a large foreign currency outflow.

The governmental engagement

Foreign currency maintenance in the country is currently one of the biggest issues. In order to somehow ease the situation the government decided to limit the ways of the foreign currency outflow from the country. This also concerns the forex industry of the country. According to www.axiory.com, one of the brokers, the trading volume of the traders from Sri Lanka has halved the previous year only. The reason for that is their limited ability to be engaged in the FX industry, in order to keep the currency within the country and somehow provide economic stability this way.

More than that, Sri Lanka’s government’s strategies have currently focused on import restrictions and currency swaps/ Due to the ongoing pandemic, the government was able to restrict a number of imports, including the halt on the vehicle import assisted in reducing the foreign currency outflow. Back in 2020 alone, this managed to reduce the outflow by $3.9 billion, which is a 20% more reduction than the year before. This also resulted in a roughly $2 billion drop in the trade debt.

The outflow of foreign currency was also lessened by the cheaper oil prices due to the global pandemic. The prices were lowered because of the restrictions on travel as well. And this acted as the largest factor in the decline of the trade deficit. In 2020, fuel imports were reduced by $1.35 billion, accounting for more than 60 percent of the trade deficit reduction. Yet it is unlikely that the government will receive this boon in 2021. With the increase of oil prices in the global market in comparison to 2020 and an expected post-COVID economic revival, fuel import bills will increase again, putting further pressure on foreign reserves in 2021.

Another strategy used by the country’s governmental representatives is the currency swap. Sri Lanka obtained a currency swap of $400 million from the Reserve Bank of India in June last year. But currency swaps are only a holding operation. This currency swap was extended for three months in November and the Central Bank of Sri Lanka settled the swap in early February.

The only real solution remains to ask for help from Chian, which is something that might worsen the situation even more. To look at everything else with a better perspective while most of all, the global pandemic has affected countries and has done more bad than good, for Sri Lank has definitely played the roles which were necessary for ceasing the debts and decreasing the trade deficit.

The solution of borrowing money from China does not seem to be a solution at all. At this moment, Sri Lanka’s treasury secretary has stated that the country is about to take a $1.5 billion swap facility from China. The second trench of the Foreign Currency Term Financing Facility proceeds from the China Development Bank is expected to happen before the second half of this year.

While looking at the whole situation with the eyes wide open and informed, the whole debt situation with Sri Lanka seems to be even more worrisome than it was in the 90s and is more hopeless than before. The country is slowly sinking in debts and while the people might not see it as troublesome at least from the current perspective, it shall soon show the outcome. The county will have to spend a significant amount of foreign currency earnings to repay the commercial loans, and most of it should happen by 2030.

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