Sinking external finances: The myth of an Indian rescue

• Sri Lanka is heading for a potential default, and the greater concern is whether it would be a disorganized default, which might happen when the government runs out of its temporary measures of liquidity infusion
• It is not clear how Sri Lanka would pay up US$ 6.9 billion of foreign loan payments next year. The Indian calculations of geopolitical leverage, a key concern for every Indian commentator, would also be temporary

The government has so far resisted the calls, including by its own ranks, to go to the International Monetary Fund for a debt restructuring program. Save the Ministry of Finance, the rest of the world seems to be believing that Sri Lanka is heading for sovereign default. The latest salvo was issued by Fitch Ratings, an international credit rating provider, which downgraded the country to ‘CC’, from ‘CCC’ due to the increased probability of a default event in coming months in light of Sri Lanka’s worsening external liquidity position.

The Central Bank responded - as it did during each previous instance - describing the ‘hasty’ downgrade has demonstrated Fitch’s failure to ‘recognize the positive developments taking place in Sri Lanka amidst a global pandemic.’

In the meantime, so much for ‘positive developments’, the latest data by the Department of Census and Statistics revealed that the economy had contracted by 1.5% in the third quarter. Earlier, the Central Bank’s own data revealed the foreign remittance had halved for a second consecutive month in October from the corresponding period a year ago. The Central Bank’s responses eerily sound familiar, taken from the government’s playbook in the UN Human Rights Council and seemed to be designed to cater to the local audience, much less a credible rebuttal.

 Sri Lanka is heading for a potential default, and the greater concern is whether it would be a disorganized default, which might happen when the government runs out of its temporary measures of liquidity infusion. The government has so far resisted the calls, including by its own ranks, to go to the International Monetary Fund (IMF)  for a debt restructuring program. Its strategy so far has been to resort to temporary fixes, such as currency swaps and short term borrowing from friendly nations. That had helped the government to postpone the inevitable going to the lender of last resort. However, the government’s measures as much as a temporary relief, is also procrastinating the financial crisis. Also, some of the much-awaited financial lifelines, such as a US$ 3.5 billion credit for purchasing oil from Oman had not materialized. Willing benefactors for far, such as Bangladesh did so out of solidarity, and are not willing to put the tab for a long term, nor do they have the financial capacity to do so.
China is an exception. Interestingly, some time back, the government’s spin doctors were confiding that Beijing had assured the China-friendly new government an unlimited source of loans, - and “payback when you can.”  China offered a currency swap and a US$500 million loan, nominal help, given China’s sheer scale. Since then, it has shown little interest in getting entangled in Sri Lanka. China’s lack of generosity should not be misconstrued as a response to a recent spat over a fertilizer cargo (to which Sri Lanka finally paid US$ 6.9 million to avoid an international arbitration process). The Chinese stance reveals its assessment of the hollowness of the Sri Lankan government’s modus operandi to solve its foreign exchange crisis.

It is in this context that the government turned to New Delhi, knowing well, that, unlike Chinese assistance, any rescue package from India would come with strings attached, including a renewed emphasis on devolution of power.

Finance Minister Basil Rajapaksa visited New Delhi with the begging bowl and met with his Indian counterpart Nirmala Sitharaman and foreign minister S.Jaishankar. After the visit, Indian media reported that India had agreed on a ‘four-pillar initiative’ to address the economic crisis in its smaller neighbour. The package included an Indian line of credit for food, medicines and fuel purchases, a currency swap agreement to deal with Sri Lanka’s balance of payment issues, an “early” modernisation project of the Trincomalee oil tank farms, and a Sri Lankan commitment to facilitate Indian investments in various sectors. Indian observers, who have long fretted about China’s economic activity in Colombo also viewed this as their moment to snatch the island nation back from China’s grip.   Sri Lanka earlier requested a US$ 500 million from India for fuel purchase and a US$ 1.1 billion currency swap on top of a US $400 million swap that was earlier provided.

According to some Indian sources, Indian assistance would be substantial and would take into consideration the earlier Sri Lankan requests. Some news reports cite a relief package that includes a US$ 400 million currency swap, US$ 1 billion import loan for foods and medical supplies, US$ 500 million for fuel purchase and a US$ 440 million loan through India’s EXIM bank for water supply projects. If materialized, this would significantly alleviate the duress in external finances. Still, any relief would be temporary.

Sri Lanka’s fiscal duress is acute and cannot be addressed by the temporary fixes that the government has so far resorted to. These measures saw the government effectively eating into the country’s foreign reserves to pay off loans and interests. As a result, foreign reserves dropped to US$ 1.6 billion by November, a US $ 4 billion drop from the beginning of this year. Sri Lanka faces foreign-currency debt service payments, including principal and interest, of US$ 6.9 billion in 2022, equivalent to nearly 430% of official gross international reserves as of November 2021. Cumulative foreign-currency debt service, including interest and principal, amounts to about US$26 billion from 2022 through to 2026.

Indian assistance, no matter how generous, is a drop in this fiscal black hole. Much of the ‘positive developments’ that the Central bank has alluded are a figment of imagination. Remittance by the migrant workers, a key source of bridging the gap, is likely to decline further as the rupee is further depreciated despite an incredible peg of LKR 203 / US$.  In the parallel market, a USD is traded for Rs. 245. The spike of a new bout of Covid 19 Omicron mutations, would further delay the revival of tourism. Though export earnings have picked up, additional earnings are a fraction of the loss of tourism revenue and foreign remittance. Indian assistance would avert a potential collapse of the domestic economy, keeping lights on and medical and essential food items are in stocks. But, it would only postpone the inevitable.  Also, it is not clear how Sri Lanka would pay up US$ 6.9 billion of foreign loan payments next year. The Indian calculations of geopolitical leverage, a key concern for every Indian commentator, would also be temporary.

Colombo’s appeal for Indian help is driven much less by a rational economic calculation, but by sheer personal and political calculations to avert the unpalatable but inevitable going to the IMF. Same personal political calculations would stand in the way of any meaningful Indian effort to coax Colombo to constitutional reforms or the full implementation of the 13th amendment. Those are anathema to the Rajapaksa’s political interests just like going to the IMF.

Thus, except backtracking of any such undertaking at the first available moment. The stubborn truth is that there are no short-term fixes for Sri Lanka’s economic crisis, the weakness of external finances is as much a result of reckless borrowing, is also due to the limited export earnings of an increasingly uncompetitive economy. A debt restructuring program with the IMF would provide a long-term solution to Sri Lanka’s looming debt, and a template for microeconomics reforms, that may include many difficult and politically unpalatable conditions. 

Any country that has Sri Lanka’s long-term interest should not stand in the way of that eventuality.