Previous Quarterly Editions
Expropriation Risk: 63 63 64 63 ▼Political Violence Risk:50 50 49 51 ▲Terrorism Risk:57 57 57 57 ►Exchange Transfer and Trade Sanction Risk: 82 82 82 82 ►Sovereign Default Risk:83 83 82 82 ►
TREND ►
Protest intensity to date* 2022 2023 Medium HighUnrest risk in 2024**Cost of living: Very High Anti-austerity: High
*Note: Protest intensity is calculated based on ACLED. **Risk levels are calculated by WTW. Where data are missing no risk level will be displayed. For details of 'anti-austerity' calculations, see the essays in the introduction; for details of 'cost-of-living' calculations, see the previous edition of the Index.
Sri Lanka features among countries that were severely hit by the COVID-19 pandemic and the inflation in global food and fuel prices following the Russian invasion of Ukraine in 2022. A collapse in foreign exchange reserves reduced access to imports, spurring shortages and price increases, and inflation was worsened by a sharp depreciation of the currency that raised costs and prices of imported intermediates and consumption goods. The argument was that scarce foreign exchange was needed to service the foreign loans that a government, unpopular by then, had contracted for implementing large “prestige” infrastructural projects that yielded no foreign exchange benefits.
This was the first stage of austerity that imposed burdens on the mass of the people, who turned against the government. In time, the fall in reserves that made it impossible to service external debt accumulated over the previous decade led to default of service payments in April 2022. Finally, angry citizens gathered under a broad coalition named the “aragalaya” (struggle) and ousted the Rajapaksa regime, though it was replaced with a government backed by the same ruling coalition led by the Sri Lanka Podujana Peramuna.
The new government decided to turn to the International Monetary Fund (IMF) for a loan as a prelude to a process of restructuring debt and stabilizing the economy. The IMF loan, as is normally the case, came with conditions that led to further increases in the price of energy to cover costs and reduce subsidies, further depreciation of the currency and a curtailment of government expenditures (including those on welfare). This was the second stage of the austerity, presented as the inevitable pain ordinary citizens must suffer to deal with the crisis imposed by unforeseen, exogenous developments, including the pandemic and the Ukraine invasion.
These developments only angered the protestors even more. What was surprising, however, is that, following a harsh repressive response by the government, the protest lost momentum, partly because the people and Sri Lanka’s “new poor” returned to the urgent task of picking up the pieces of lives tattered by the crisis. Poverty had spiked, nutrition levels had collapsed and many citizens were left unsure of how to cover the coming days or weeks’ subsistence requirements of their families. The disappointment and anger with the ruling elites had not disappeared, but the devastation of the crisis left the poor with more immediate concerns of survival. It also made them willing temporarily to accept the harsh conditions that came with the little money (US$2.9 billion) promised in tranches under
a 48-month IMF loan, which in turn was presented as the only way of beginning to address the grave crisis.
But the hard task of restructuring the unsustainable debt of the government, especially the external debt that had to be serviced in foreign exchange, remains unfinished. The multilateral development banks, such as the Asian Development Bank and the World Bank (which held around a quarter of government external debt), insist that they be kept out of the restructuring exercise, because any reduction in or easing of the terms of the debt owed to them would reduce their AAA ratings and, therefore, their ability to borrow from international markets on terms that helped them implement their mandates.
Private creditors, who account for a large share (around 40%) of the Sri Lankan government external debt, who found that the debt they held was trading at huge discounts in the market, were unwilling to relent and accept similar discounts as part of the restructuring exercise. They preferred to hold out and squeeze out the best terms they could get from a beleaguered government. Furthermore, finally, an agreement on burden-sharing among the principal bilateral creditors was difficult to arrive at, because of the widely different shares in Sri Lankan official debt they held. China, in particular, seems unwilling to be party to a process that is controlled by the IMF, which the United States and Europe dominate.
Interestingly, the IMF has made the issue in Sri Lanka not just one of the unsustainability of external debt but also one of the unsustainability of all public debt, including domestic currency debt. Debt incurred in domestic currency is held largely by three sets of domestic players: the central bank, the commercial banking system and institutional investors, especially pension funds and insurance companies. The Sri Lankan central bank has deemed that the commercial banks still burdened with the task of restructuring the nonperforming assets accumulated before and during the crisis cannot take any more losses without turning insolvent. Therefore, the domestic component of the restructuring is required to be borne by the central bank and the pension funds.
The pension funds are the repositories of the savings of different classes of ordinary workers stretching from government employees to tea plantation workers. Having been devastated by the debt crisis and lost much of the real value of their savings due to high inflation, these workers are now being called upon to accept the wiping out of a huge chunk of the balance savings in their pension accounts. This threatens to unleash a new wave of protest, which carries with it considerable political risk.
TREND ▼
Though Sri Lanka’s agreement with the IMF requires it to pursue policies that are attractive to international capital to help stabilize the balance of payments, the risk of expropriation remains. To start with, there is a real possibility that Sri Lanka would fail to meet some IMF conditions and targets, which could delay or foreclose receipts of subsequent installments of the IMF’s loan. In addition, talks to arrive at a restructuring deal with bilateral and private creditors are showing limited or no progress. These could aggravate balance of payments stress and lead to another default, forcing significant losses for bondholders, creditors and other foreign investors.
TREND ▲
The Aragalaya movement was of significance because, unlike previous strife in Sri Lanka, it was not a reflection of ethnic or communal conflict, strengthened by the authoritarianism of the Sinhalese majority. That majoritarian and communal conflict gathered further strength when in August 2019 Sri Lankans experienced suicide attacks by Islamic terrorists.
These kinds of conflicts diverted attention from the day-to-day plight of poorer Sri Lankans. That changed with the debt crisis. Inflation and contraction of the economy with the accompanying loss of jobs and livelihoods, and minimal social protection, led to the emergence of sections identified as the “new poor.” The state was now faced with more widespread anger, which it supressed.
With the prospect of that movement being revived by the conflict over pensions, the elites may choose to exploit ethnic tensions to divert attention from a crisis they created. If that happens, the risk of political conflict in Sri Lanka would only heighten.
TREND ►Following the Easter Sunday bombings of 2019 attributed to radical Islamists, Sri Lanka has been seen as a country that is prone to terrorist violence. It does not help that the majority Sinhalese are turning more aggressive. This raises the risk of a resurgence of terrorist organizations and terrorist activity.
For the foreseeable future, the Sri Lankan rupee is likely to be under pressure and in continued decline. This has negative implications for those with foreign liabilities; however, with the IMF mandated to subject the country to surveillance, with periodic reviews of realization of targets set and policy conditionality compliance, it is unlikely that the current government would supersede the market and adopt interventionist and severe regulatory exchange and trade policies.
With global conditions not conducive and balance of payments weakness still severe, another sovereign default is a strong possibility in Sri Lanka.
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