Russo-Ukrainian War Spillover: Sri Lanka Defaults on External Debts

Sri Lanka has announced that their country would default on its external public debt as its foreign reserves are depleted. It is the first time in history Sri Lanka would default on its debts due to a combination of bad policy decisions and spillovers from the Russian invasion of Ukraine.

S&P Global Ratings and Fitch Ratings have said that Sri Lanka’s default is now a certainty and that “a sovereign default process has begun.” The country is due to pay its $78 million interest payments on its international sovereign bonds. If they do not pay within the 30-day grace period, it would mean they are defaulting for the first time since its independence from the UK in 1948. However, they already said they are not able to pay.

Sri Lanka announced their inability to pay last Tuesday and said it would “temporarily default” on its $35.5 billion foreign debt and its $7 billion payments due this year because of its fiscal and economic difficulties. Last March, Sri Lanka’s foreign reserves fell to $2 billion leading to significant import cuts, which then led to a shortage of fuel, as per a report by The Financial Times. Making things worse for them, its currency, the Sri Lankan rupee, has fallen 37% against the US dollar.

This has led the governor of the country’s central bank to ask for donations in sterling, US dollars, and euros to help import food, fuel, and medicine.

Sri Lanka is just one of the countries experiencing spillover effects of the war. Developing countries all around the world have been feeling the effects of the Russian invasion of Ukraine. Due to the rising fuel prices caused by the war, developing countries struggle with the increasing cost of fuel, which would then increase the prices of food.

After long months of power cuts, rising fuel prices, and food and medicine scarcity, the Sri Lankan people have had enough. They took to the streets to protest and urge their President, Gotabaya Rajapaksa, to immediately resign. He was accused of exacerbating their bad economy due to his administration’s various policy decisions.

Anger filled the streets of Sri Lanka, where people from all walks of life joined the protest, telling their President to go home and resign. If successful, the Sri Lankan people would usher in a new era for possible systematic change in their government.

https://twitter.com/WallStreetSilv/status/1512455481587027968

However, it is not just the Russian invasion that is to blame. With the COVID-19 pandemic damaging Sri Lanka’s economy, coupled with the effects of the Russian invasion, Sri Lanka worsened its economy to the point of a crisis. Many Sri Lankans are also pointing toward China’s debt-trap diplomacy as the country took heavy loans from China to fund its infrastructure projects.

“Sri Lanka has had an unblemished record of external debt service since independence in 1948,” the Sri Lankan Finance Ministry said.

“Recent events, however, including the effects of the Covid-19 pandemic and the fallout from the hostilities in Ukraine, have so eroded Sri Lanka’s fiscal position that continued normal servicing of external public debt obligations has become impossible,” they explained.

Sri Lanka: COVID-19 problems, Agricultural Woes, and the Russian Invasion

How did this all happen? The reason behind their default can be blamed on an intertwined number of elements, one being the Russian invasion, another being their COVID-19 policy decisions, and their agricultural sector.

Sri Lanka is one of the world’s fourth-largest tea exporting countries in the world. They are producing around 374,785 tons of it per year. It is next to Kenya, India, and China with regard to its tea producing capacity. The only difference is that Sri Lanka’s tea-producing industry is one of the main sources of foreign exchange for the country and contributes as much as 2% of its GDP.

Its main market for its tea is Iraq, Turkey, and Russia. In fact, Russia is Sri Lanka’s 3rd largest market for their teas. But it can be remembered that Russia’s banking system was removed from the SWIFT system. Seven Russian banks were blocked from the global banking system due to their invasion. As a result, the Sri Lankans cannot export it to Russia as they cannot get paid.

This leaves a high number of their farmers without income as the tea leaves would have nowhere to be exported. Sri Lanka exported 632 million pounds of tea last year, worth $1.3 billion. Without Russia, this number would tremendously decrease, leading to more problems with their country’s foreign reserves, which had been experiencing problems before the invasion.

What makes this worse is that their COVID-19 recovery plan revolved around tourism and exports to replenish its foreign currency reserves. Sri Lanka’s tourists mostly come from Russia and Ukraine as its third. However, both countries are unable to travel to Sri Lanka due to the war. Those are two of their main industries dead brought by the Russian invasion.

“Ukrainian and Russian tourists were coming in significant numbers as the arrivals from other nations had dropped,” said Hotels Association of Sri Lanka official M Shanthikumar to the Financial Times. “Their absence now due to war could cause a huge slump again.”

When the COVID-19 pandemic struck, the Rajapaksa government banned all fertilizer imports in an attempt to prevent the depletion of their foreign reserves under the guise of a 100% organic farming nation. While that does sound good at first glance, this led to their agricultural sector declining in production, which led to the need to import more food. This left tea and rubber farmers dead in the water as their profits significantly dropped, which led to lower export incomes. Less income from exports means less money could be used to import food, leading to a food crisis. Also, less income for their people means they wouldn’t be able to buy food and other essential goods.

With no money to buy food and the limited number of food and medicine available, the prices of these items shot up, leaving the country in a serious food and economic crisis.

🇱🇰🪧 06.15 PM: On one of Sri Lanka’s most prominent public holidays – The Sinhala and Tamil New Year, thousands of protesters continue their cause for #SriLankaProtests against #SriLankaEconomicCrisis #lka #SriLanka pic.twitter.com/gIIrfMMFiE

— Dasuni Athauda (@AthaudaDasuni) April 14, 2022

However, these factors alone were not where their economic woes had begun. Sri Lanka has had a bout with its foreign exchange reserves for decades. They’ve heavily relied on their exports for economic gain. They began to export garments along with their teas as well as relying on tourism and overseas Sri Lankan workers for remittances. This means that any decline in their exports or remittances would put their country in an economic shock.

Put together the COVID-19 economic woes, policy decisions that decreased their agricultural productivity, no tourists from two of their top international visitors who are currently in a war, rising fuel prices, and 16 IMF loans to pay back. It is no wonder why Sri Lanka is on the brink of not being able to pay its external debt.

The Sri Lankan government will be talking to the IMF for a solution to their crisis, which makes it the 17th time it is taking a loan from the international body.

“The government intends to pursue its discussions with the IMF as expeditiously as possible with a view to formulating and presenting to the country’s creditors a comprehensive plan for restoring Sri Lanka’s external public debt to a fully sustainable position,” their statement read.