Previous Quarterly Editions
Expropriation Risk: 62 61 63 63 ►Political Violence Risk:51 51 50 50 ►Terrorism Risk:55 57 57 57 ►Exchange Transfer and Trade Sanction Risk: 64 73 82 82 ►Sovereign Default Risk:57 83 83 83 ►
TREND ►
Protest intensity in 2022 and Q1 2023* 2022 Q1 2023Cost of living : Medium MediumAll protest: Low Medium
Cost-of-living protest risk in 2023*Wage protest: HighFood/fuel policy protests: Very 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 calculations, see the introductory essay.
In what is seen by some as good news, the IMF board approved a USD3 billion financing package for Sri Lanka in March 2023. However, the conditions associated with the loan could trigger another round of unrest, because they involve measures that could stoke inflation and subject a population already under severe stress to new austerity.
After Sri Lanka defaulted on external debt repayments in April 2022 – forcing it to approach the IMF for emergency funding and support in debt restructuring – the country had to wait for almost a year for the final approval of a financing package by the IMF board. Two factors delayed approval. The first was the reluctance of the Sri Lankan government, faced with popular protest, to accept the kind of conditions the IMF was reportedly imposing. The second was IMF approval of a financing package being contingent on financing assurances from the principal bilateral creditors – China, India, and Japan. Delays in providing such assurance, especially on the part of China, also stalled approval.
In this interim period, the Sri Lankan government implemented a number of policies to win IMF support. These, together with developments associated with the foreign exchange squeeze, set off an inflationary spiral. Prices of universal intermediates such as fuel were raised, to cover costs. The currency depreciated sharply, raising the costs on imported inputs and the prices of imported final goods. Prices of imported food items rose sharply, with shortages common. The government raised indirect taxes and reduced subsidies, also adding to the price rise. In the event, the point-to-point rate of inflation stood at 50% in December 2022.
While this inflation eroded real incomes of the poor and intensified popular anger, fatigue set in after the previous state leadership was forced to step down and flee.
Protest has also been reined in by the government’s harsh measures in the face of dissent. Spontaneous protest can break out if conditions worsen.
The possibility of deterioration is high. According to the IMF, the Sri Lankan economy is expected to contract by 8.7% in 2022. Despite this, the IMF’s adjustment package requires the Sri Lankan government to convert a primary deficit in its budget of 3.7% of GDP in 2022 to a primary surplus of 2.5% of GDP in 2025. With the economy having contracted and growth in the near term expected to be slow, even if the tax base is broadened and indirect tax increases imposed, the tax-to-GDP ratio is likely to remain subdued, necessitating significant cuts in expenditure to ensure fiscal consolidation.
Unemployment is likely to increase, and social protection expenditures will therefore fall. Despite the IMF claiming to have recommended a targeted social protection safety net, the sums provided for in its budgetary calculations are extremely low.
There is news of a revival of regional protests and student unrest. If the situation deteriorates, matters could escalate. President Ranil Wickremesinghe lacking any base in parliament and occupying his position only with support from the Sri Lanka Podujana Peramuna coalition led by the discredited Rajapaksa brothers, could also fuel significant political instability.
Though many see the IMF approval of an Extended Financing Facility loan as having paved the way for a resolution of Sri Lanka’s debt crisis, the restructuring process has a long way to go. Even with financing assurances from China, India, and Japan, private creditors, especially those subscribing to USD13 billion worth of international sovereign bonds, will have to take a significant reduction on values if debt is to be made sustainable.
Failing that, or if the government is unable to meet IMF conditions and loses out on the next tranche of the package, it may have no option but to default again. This would force significant losses for bondholders and other creditors. However, with an IMF arrangement in place, once repayments are resumed, it is unlikely there would be immediate default. But if the restructuring and rescheduling of debt is delayed considerably, Sri Lanka may have to walk out of the agreement with the IMF, default on debt and push for much greater reductions.
The crisis which led to the end of the Rajapaksa regime in July 2022, though marked by widespread protests, was largely non-violent. But after the ouster, a new government under Wickremesinghe, which lacks legitimacy has chosen to come down heavily on those seen as having been the leaders of the mass movement.
This, together with the return of the much-disliked Gotabaya Rajapaksa after fleeing Sri Lanka in July, in a context in which no resolution of the crisis and the hardship faced by the people is in sight, could trigger a round of political violence in a nation that has seen many rounds of violent political activity.
Sri Lanka has had a long history of civil strife, epitomized by the war between the government and the Liberation Tigers of Tamil Eelam. Following the Easter Sunday bombings of 2019 attributed to radical Islamists, Sri Lanka has been seen as a country prone to terrorist violence.
The crackdown against suspected Islamic terrorists and terrorist organisations brings other risks. There is widespread concern that the Prevention of Terrorism Act is being misused and the government is moving to replace it with a new anti-terrorism bill. Given the political conditions in the nation, there are fears doing away with the worst elements of the previous may see harsher conditions imposed. The act is yet to be deliberated on and passed by parliament.
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 realisation of targets set and policy conditionality compliance, it is unlikely the current government, which signed the Extended Financing Facility agreement, would opt for regulatory policies that would displease the IMF.
But in the event political changes pave the way for national elections, it is highly unlikely the current and/or immediate past leadership can return to power. A new leadership may well choose to repudiate IMF conditionality, leading to exchange controls and capital account regulation. That would adversely affect foreign investors.
With global conditions not conducive and balance of payments weakness still severe, another sovereign default is a strong possibility. Moreover, if the country is both unable to meet IMF conditions, leading to a halt on disbursements of future tranches of the loan, and/or if capital flows to Sri Lanka do not revive, it won’t meet payments to foreign creditors falling due in the coming months and years.
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