Sri Lanka’s reluctance to call on the IMF has helped plunge it into an economic abyss

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Sri Lanka’s worst economic crisis has sparked an unprecedented wave of spontaneous protests as the island nation of 22 million grapples with prolonged power cuts and shortages of essentials including fuel and medicine.

Sri Lankan President Gotabaya Rajapaksa’s government is coming under increasing pressure for its mismanagement of the economy, and the country has suspended payment of its foreign debt in a bid to preserve its meager foreign exchange reserves.

On Monday, Sri Lanka will start talks with the International Monetary Fund (IMF) for a loan program, even as it seeks help from other countries, including neighboring India and China.

How did we get here ?

The economic mismanagement of successive governments has weakened Sri Lanka’s public finances, leaving its national expenditure to exceed its income, and the production of tradable goods and services insufficient.

The situation was exacerbated by the major tax cuts enacted by the Rajapaksa government shortly after taking office in 2019, just months before the COVID-19 crisis.

The pandemic has wiped out parts of its economy – mainly the lucrative tourism industry – while an inflexible exchange rate has undermined remittances from its foreign workers.

Rating agencies, concerned about public finances and its inability to repay large external debt, downgraded Sri Lanka’s credit ratings from 2020, ultimately excluding the country from international financial markets.

But to keep its economy afloat, the government still relied heavily on its foreign exchange reserves, eroding them by more than 70% in two years.

In March, Sri Lanka’s reserves stood at just $1.93 billion, not enough to cover even a month’s worth of imports and leading to growing shortages of everything from diesel to some food items.

JPMorgan analysts estimate the country’s gross debt service to be $7 billion this year, with a current account deficit of around $3 billion.

What did the government do?

Faced with a rapidly deteriorating economic environment, the Rajapaksa government chose to wait, instead of acting quickly and seeking assistance from the IMF and other sources.

For months, opposition leaders and pundits urged the government to act, but it held firm, hoping tourism would rebound and remittances recover.

Newly appointed Finance Minister Ali Sabry said in an interview earlier this month that Sri Lanka’s top government and central bank officials did not understand the seriousness of the problem and were reluctant to bring in the IMF. Sabry, along with a new central bank governor, was recruited into a new team to deal with the situation.

But, aware of the beer crisis, the government has asked for help from countries including India and China. Last December, the then finance minister traveled to New Delhi to arrange $1.9 billion in credit lines and swaps from India.

A month later, Rajapaksa asked China to restructure repayments of around $3.5 billion in debt owed to Beijing, which in late 2021 also provided Sri Lanka with a 1.5 billion yuan-denominated swap. dollars.

What happens next?

Finance Minister Sabry will begin talks with the IMF for a loan package of up to $3 billion over three years.

An IMF program, which typically imposes fiscal discipline on borrowers, is also expected to help Sri Lanka secure an additional $1 billion in assistance from other multilateral agencies such as the World Bank and the Asian Development Bank.

In total, the country needs about $3 billion in bridge financing over the next six months to help restore the supply of essential items, including fuel and medicine.

India is willing to provide Sri Lanka with an additional $2 billion to reduce the country’s dependence on China, sources said.

Sri Lanka has also requested an additional $500 million line of credit from India for fuel.

Also with China, the government is in talks for a $1.5 billion line of credit and a syndicated loan of up to $1 billion. Besides the swap last year, Beijing also provided a $1.3 billion syndicated loan to Sri Lanka at the start of the pandemic.

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