SL’s creditors must ensure debt cancellation for the country to rise again

International financial institutions (IFIs), such as the IMF and the World Bank, are not currently living up to these responsibilities, at a time when they are most urgently required in the Sri Lankan case of debt repayment or cancellation, a group of 182 global economists and academics, some from Sri Lanka, have said in a statement issued on Sunday.

It said debt negotiations in Sri Lanka are now at a crucial stage. All lenders—bilateral, multilateral, and private—must share the burden of restructuring, with assurance of additional financing in the near term. “However, Sri Lanka on its own cannot ensure this; it requires much greater international support. Instead of geopolitical manoeuvring, all of Sri Lanka’s creditors must ensure debt cancellation sufficient to provide a way out of the current crisis,” the statement said.

It said Sri Lanka, along with many other low- and middle-income countries, has experienced a series of financial shocks due to both external and internal factors. Global forces have caused food and energy import costs to soar and interest rates to rise, even as the currency has devalued significantly. These shocks, along with a history of policy mismanagement—and specifically the deregulation and openness that encouraged irresponsible borrowing, enabled illicit financial flows out of the country and assisted political corruption—have intensified external debt and balance of payments crises.

Over the last decade of liquidity expansion and low interest rates in the world economy, private lenders provided loans to low- and middle-income countries, at higher interest rates than for advanced countries. These higher rates were purportedly due to greater risk exposure that could make debt repayment more difficult in such countries. That risk has now materialised, firstly through a global pandemic, and then the price shocks and interest rate increases of 2022.

Private creditors own almost 40 per cent of Sri Lanka’s external debt stock, mostly in the form of International Sovereign Bonds (ISBs), but higher interest rates mean that they receive over 50 per cent of external debt payments. Such lenders charged a premium to lend to Sri Lanka to cover their risks, which accrued them massive profits and contributed to Sri Lanka’s first ever default in April 2022. Lenders who benefited from higher returns because of the “risk premium” must be willing to take the consequences of that risk. ISBs are now trading at significantly lower prices in the secondary market. In this context, giving private bondholders an upper hand relative to sovereign debtors in the Paris Club and the IMF’s required debt negotiations violates the basic principles of natural justice, the statement said.

“The IFIs are not currently living up to these responsibilities, at a time when they are most urgently required. In Sri Lanka they encouraged the very policies of more open capital accounts and deregulation that have led to the current crisis. They have been slow to respond to the crisis, and are apparently requiring onerous policy and fiscal conditionalities, such as moving to a primary fiscal surplus in a very short time, even as the economy continues to plunge,” it said.

The implications are already evident in the recent Budget of the Sri Lankan government, which has unrealistic revenue assumptions that are unlikely to be met. Revenue shortfalls would then necessitate further “austerity” and likely cuts in essential public spending. The Budget also proposes public asset stripping and privatisation of strategic lands, marine resources, energy, transport and telecom infrastructure and public enterprises. These policies will harm the most vulnerable groups in Sri Lanka, exacerbate poverty and inequality, and lead to further economic decline. Instead the focus should be on legal and regulatory changes to stem the illicit outflow of capital through transfer pricing and trade mis-invoicing over the past 15 years, which is estimated to be far more than the aggregate foreign debt of Sri Lanka, and on taxation of wealth and consumption of the super-rich.

The Sri Lankan case will provide an important indicator of whether the world—and the international financial system in particular—is equipped to deal with the increasingly urgent questions of sovereign debt relief and sustainability; and to ensure a modicum of justice in international debt negotiations. It is therefore crucial not only for the people of Sri Lanka, but to restore any faith in a multilateral system that is already under fire for its lack of legitimacy and basic viability.