January 28, 2023

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Sri Lanka crisis is a warning to other Asian nations

Sri Lanka became the first country in the Asia Pacific in 20 years to default on foreign debt. [Source: BBC News]

Sri Lanka is in the midst of a deep and unprecedented economic crisis that has sparked huge protests and seen its president quit after fleeing the country – but other countries could be at risk of similar troubles, according to the head of the International Monetary Fund (IMF).

“Countries with high debt levels and limited policy space will face additional strains. Look no further than Sri Lanka as a warning sign,” said IMF Managing Director Kristalina Georgieva on Saturday.

She said developing nations had also been experiencing sustained capital outflows for four months in a row, putting their dreams of catching up with advanced economies at risk.

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Sri Lanka is struggling to pay for crucial imports like food, fuel and medicine for its 22 million people, as it battles a foreign exchange crisis. Inflation has soared about 50%, with food prices 80% higher than a year ago. This year, the Sri Lankan rupee has slumped in value against the US dollar and other major global currencies.

Many blame ex-president Gotabaya Rajapaksa for mishandling the economy with disastrous policies whose impact was only exacerbated by the pandemic.

Over the years, Sri Lanka has built up a huge amount of debt – last month, it became the first country in the Asia Pacific region in 20 years to default on foreign debt.

Officials had been negotiating with the IMF for a $3bn (£2.5bn) bailout. But those talks are currently stalled amid the political chaos.

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But the same global headwinds – rising inflation and interest rate hikes, depreciating currencies, high levels of debt and dwindling foreign currency reserves – also affect other economies in the region.

China has been a dominant lender to several of these developing nations and therefore could control their destinies in crucial ways. But it’s largely unclear what Beijing’s lending conditions have been, or how it may restructure the debt.

Where China is at fault is, according to Alan Keenan from International Crisis Group, is encouraging and supporting expensive infrastructure projects that have not produced major economic returns.

“Equally important has been their active political support for the ruling Rajapaksa family and its policies…These political failures are at the heart of Sri Lanka’s economic collapse, and until they are remedied through constitutional change and a more democratic political culture, Sri Lanka is unlikely to escape its current nightmare.”

Worryingly, other countries appear to be on a similar trajectory.

The landlocked East Asian nation of more than 7.5 million people has been facing the risk of defaulting on its foreign loans for several months.

Now, a rise in oil prices because of the Russian invasion of Ukraine has put further strain on fuel supplies, pushing up the cost of food in a country where an estimated third of people live in poverty.

Local media outlets have reported long lines for fuel and said some households have been unable to pay their bills.

Laos’ currency, the kip, has been plunging and is down by more than a third against the US dollar this year.

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Higher interest rates in the US have strengthened the dollar, and weakened local currencies, increasing their debt burden and making imports costlier.

Laos, which is already heavily in debt, is struggling to repay those loans or pay for imports like fuel. The World Bank says the country had $1.3bn of reserves as of December last year.

But its total annual external debt obligations are around the same until 2025 – equivalent to about half of the country’s total domestic revenue.

As a result, Moody’s Investor Services downgraded the communist-ruled nation to a “junk” grade last month, a category in which debt is considered high risk.

China has loaned Laos huge amounts of money in recent years to fund big projects like a hydropower plant and a railway. According to Laotian officials speaking to Chinese state media Xinhua, Beijing has undertaken 813 projects worth more than $16bn last year alone.