😮 Sri Lanka to go Bankrupt?
With inflation and debt rising Sri Lanka's financial position is getting worse by the day. Here's how this economic crisis began.
Have you ever wondered what would happen if an entire country went bankrupt?
Well, Sri Lanka is dangerously close to finding out the answer to this question.
Our neighbour in the south has been dealing with a massive economic crisis since last year, which has pushed inflation up to a record high of 11.1% (this puts into perspective our inflation rate of 5.59%).
The country's foreign exchange reserves have also come down to $3.1 billion (for comparison, India has forex reserves worth $632.7 billion), meanwhile, it has debts worth over $7.3 billion!
Experts are now stating that the island nation will run out of foreign reserves soon and will be unable to pay off its loans.Â
So, how did Sri Lanka get into such a bad situation? And what will happen if it does go bankrupt?
Sri Lanka's Economic Crisis
The story, as usual, begins with the Covid pandemic.Â
You see, Sri Lanka is majorly dependent on tourism. It accounts for 10% of the country's GDP. So, when the pandemic hit, the country's growth slowed down and its economy was impacted. Its forex reserves went down from $7.5 billion in 2019 to $2.8 billion in 2021.Â
However, demand for foreign reserves was and continues to be high because the nation relies heavily on imports. This has pushed the cost of foreign currency high, and the value of Sri Lankan currency has fallen in comparison.Â
Plus, since the country doesn't have enough money to pay off shipments of food and other goods, deliveries are cancelled or delayed. This has caused many items to be short in supply, and this low supply plus high demand has further pushed prices.
And to make matters worse, the country also banned the use of chemical fertilizers last year. Though this sounds like a great initiative, it led to crop losses. The initiative has since been revoked. Â
This whole situation has driven over 5 lakh people into poverty in the country since the pandemic began! And it has made it impossible for Sri Lanka to pay off its debts.
The Government's Initiatives
Many experts had seen this crisis coming for some time now. How?Â
You see, when a country's debt is higher than its GDP for five consecutive years, it is expected that it will experience a slowdown in growth.
And looking at Sri Lanka's debt to GDP ratio, it wasn't difficult for economists to predict doom.
But surely the Sri Lankan government must be doing something to tackle this crisis. Right?
Yes. It declared an economic emergency last year and deployed the army to ration the supply of essential goods. This was done to ensure no hoarding would happen and everyone would get the basic products at a moderate price. But the move hasn't helped much.
The government is also trying to boost its foreign exchange reserves by hosting currency swaps. What are those? They are exactly what they sound like: two countries coming together and swapping their currencies. It recently exchanged currency worth $1.5 billion with China and $400 million with India.Â
What's in it for China and India though? Why exchange your robust currency for one that is devaluing?Â
Well, they were motivated partly by goodwill and partly by their own interests. You see, India is one of the largest exporters to Sri Lanka. It exported goods worth $3.22 billion to the country in 2020. If Sri Lanka is not in a position to import goods from us anymore, it will impact our economy. Â
And, China has already loaned over $3.5 billion to Sri Lanka. If it defaults on this loan, it will be a major setback for China. So, China is motivated to help the country bounce back.
Okay, but what if the country goes bankrupt despite all these efforts?Â
And according to experts it definitely will. They think there is no way it will be able to pay off the $1 billion loan repayment due in July.
Well, many countries in the past have gone bankrupt, that is, defaulted on major loans (a country cannot really go bankrupt the same way humans or companies do). And creditors can't really do much. They cannot seize the country's assets like they would in case a company has defaulted.Â
So, what's the solution? They renegotiate the terms of the loan by pushing back the payment date or decreasing the interest. Basically, creditors often have to take a loss.Â
Sounds unfair? Don't worry, the defaulter is not spared.
What happens when you and I fail to pay our loans on time? Our credit rating goes down, right? The same thing happens with the defaulter. And Sri Lanka's credit rating has already been downgraded to C.
So, now it will have few people willing to loan it money and any loans that do come its way will be very costly, further worsening the situation.
Plus, many creditors may put sanctions on trade, making imports and exports difficult.
Ultimately, the whole economy, which is already suffering, takes a further hit, with poverty and unemployment increasing substantially. It's ultimately the people who suffer.Â
But don't you worry, there is still hope. Many countries like Russia and Iceland had once defaulted on their loans. But they managed to make a solid recovery.
Moreover, Sri Lanka is still trying to avoid a default by hook or by crook. To pay off its loans it is taking more loans from China. However, many blame China’s loan policy for Sri Lanka’s downfall.
You see, China has been giving many developing countries easy loans under its Belt and Road infrastructure initiative. Critics claim that China knows that these countries will never be able to pay off this loan, thanks to their economic conditions. The loans are simply a ploy to take control of these countries’ assets. For instance, to pay off part of its debts, Sri Lanka had to give state-owned China Merchants a 70% stake in its Hambantota port. So, is taking another loan from China the best option for the country?
What do you think the future holds for Sri Lanka? Will it manage to pay off its debts?
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