Explained: What is the economic crisis in Sri Lanka?

Dozens of Lankans have sought refuge in India to escape the crisis back home. Here's a look at what is happening in the island nation

Sri Lanka is in the throes of the worst economic crisis it has seen in decades, collapsing under the weight of its debt. While neighbours India and China have assured President Gotabaya Rajapaksa of assistance, citizens of the island nation have deserted the sinking economy and are showing up in dozens at Indian coasts.

Here's a look at key points to understand about this crisis.

What is happening in Sri Lanka?

The island's foreign reserves have hit rock bottom, with commercial banks unable to secure dollars to finance imports of food, fuel and medicines. Sri Lanka was in a deep economic crisis when the Covid-19 pandemic hit, reducing foreign worker remittances and crippling the lucrative tourism sector -- a key source of dollars for the economy.

The government imposed a broad import ban in March 2020 to save foreign currency. The shortages pushed food prices up 25 per cent last month, with overall inflation at 17.5 per cent -- the fifth consecutive monthly record high. Sri Lanka is also facing five-hour rolling electricity blackouts as thermal generators have run out of fuel.

Three international rating agencies have downgraded the island since late last year, on fears it may not be able to service its $51 billion sovereign debt.

The International Monetary Fund (IMF) in an analysis, pointed out that the country’s “debt overhang,” along with persistent fiscal and balance-of-payments shortfalls, “will constrain growth and jeopardise macroeconomic stability in both the near and medium term”.

“Based on staff analysis, the fiscal consolidation necessary to bring debt down to safe levels would require excessive adjustment over the coming years, pointing to a clear solvency problem,” the IMF said.

Also read: Lankan newspapers run out of newsprint due to forex crisis; suspend publication

Sri Lanka's debt profile

Sri Lanka has to repay about $4 billion worth of debt this year, including a $1 billion international sovereign bond maturing in July. But its reserves dipped to $2.31 billion as of end February, down around 70 per cent from two years ago.

The country, through repeated cycles of borrowing since 2007, has piled up $11.8 billion worth of debt through sovereign bonds (ISB), which makes up the largest part - or 36.4 per cent - of its external debt. The Asian Development Bank (ADB) is in second place with a 14.3 per cent share, having lent $4.6 billion. Japan is at 10.9 per cent and China at 10.8 per cent, with each having lent about $3.5 billion each.

The rest of the debt is owned by countries such as India and international agencies including the World Bank and United Nations

The China debt connection

China is Sri Lanka's fourth-biggest lender, behind international financial markets, the Asian Development Bank (ADB) and Japan.

Over the last decade China has lent Sri Lanka more than $5 billion for the construction of highways, ports, an airport and a coal power plant. But critics say the funds were used for white elephant projects with low returns, which China has denied.

President Gotabaya Rajapaksa asked China to help restructure debt repayments when he met Chinese Foreign Minister Wang Yi in January, but China is yet to respond to the request.

Repayments to China are estimated at about $400-$500 million, a finance ministry source told Reuters.

Before the pandemic, China was Sri Lanka's main source of tourists and the island imports more goods from China than from any other country.

Sri Lanka is a key part of China's Belt and Road Initiative (BRI), a long-term plan to fund and build infrastructure linking China to the rest of the world, but which others including the United States have labelled a "debt trap" for smaller nations.

Also read: Sri Lanka in talks with China for $2.5 billion credit support, says Chinese envoy to Colombo

What do experts say?

Some experts believe Sri Lanka should restructure its debt and establish a three-year repayment structure.

Doing so would save precious dollars and lessen the burden on Sri Lankan citizens who are facing shortages of imported goods such as milk powder, gas and fuel.

"Sri Lanka is unreasonably committed to repaying its debt. It is more prudent to press pause on debt repayment and take care of critical economic needs," Verité Research Executive Director and Economist Dr. Nishan de Mel said.

Fitch estimates the Sri Lankan central bank will also need to arrange for $2.4 billion to help state-owned and private firms in the country honour the debt obligations they have in 2022, over and above the $4.5 billion central government debt.

The country also needs around $20 billion for essential imports such as fuel, food and intermediate goods for exports.

Reserves have been at a critical level for months but grew to $3.1 billion at the end of December boosted by a $1.5 billion yuan currency swap from China.

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