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Region

Deep in Debt

Sri Lanka is caught in a mire of foreign debts and the crisis will not go away soon.

By Daniyal Talat | September 2021


Sri Lanka’s foreign debt challenges are really not unusual; they have been linked to concerns about defaulting commitments and the Chinese debt dilemma on several occasions. In 2021, Sri Lanka’s debt rating was downgraded by all three major rating agencies: Sandard & Poor Fitch and Moody’s. This was to do with the weakening position of its finances and its inability to pay back its external debts. The Covid-19 pandemic prompted 3.6% decline in Sri Lanka’s GDP in 2020, which was, in fact, the largest decline since the country won independence from Britain in 1948. When the pandemic struck in early 2020, the island’s economy was already reeling from the impact of the 2019 Easter Sunday bombings, which had reportedly killed approximately 279 individuals.

Sri Lanka’s capacity to service its massive foreign debt has been questioned by international rating agencies since the country’s foreign reserves plummeted in the 2020. The federal government’s debt climbed to 101% of GDP last year, up from 86.8% the year before, underscoring the country’s massive economic problems.

From 2005 to 2015, Colombo borrowed billions from Beijing, building a huge debt for expensive infrastructure investments. Due to China’s vast Belt and Road initiative, Chinese influence in the South Asian country has risen dramatically in recent years, causing concerns amongst regional powers and Western democracies. In 2017, Sri Lanka was forced to hand over its strategic Hambantota Port on a 99-year lease to a Chinese company, after it was unable to service the $1.4 billion debt.

Sri Lanka’s foreign debt crisis is more than only its huge borrowing from numerous international sources and frequently leads to significant balance of payment (BOP) difficulties. The underlying reasons for the current crisis include structural flaws, such as trade contraction, insufficient tax revenue, and a lack of foreign direct investment (FDI).


The current condition of international debt is vastly different from that of the 1990s and early 2000s. Sri Lanka’s capacity to receive concessionary loans from international organisations and bilateral donors has dwindled since it was upgraded to a middle-income country. As a consequence, Sri Lanka has to seek alternative international finance sources. It issued its first $500 million International Sovereign Bond (ISB) in 2007 and began obtaining funds through international capital markets. As a consequence of its heavy reliance on ISBs, Sri Lanka’s foreign debt configuration changed drastically. During 2004, commercial loans made up roughly 2.5% of such loans; by the end of 2019, they had increased to 56%.

Sri Lanka is on the verge of a crippling balance-of-payments catastrophe. The harsh truth is that these debt concerns cannot be rectified with relatively brief measures.

Depending on a variety of considerations, Sri Lanka’s foreign debt condition in 2021 seems highly alarming. One of the reasons is the government’s continued refusal to seek IMFs help. Both the 2009 and 2015 BOP crises could not have been avoided without the IMF’s help. Investors, bankers and others are concerned about Colombo’s assertion that it would not seek IMF assistance again. Sri Lanka’s inability to raise funds through international capital markets (i.e., by issuing fresh ISBs), which was formerly Colombo’s preferred method of resolving ISB maturities, is another cause for concern.

With Sri Lanka’s poor sovereign credit ratings and the on-going pandemic, issuing ISBs does not appear to be a simple choice (indeed, it appears to be nearly impossible in the near term). Consequently, when the tourist sector came to a halt as a result of the pandemic outbreak, contemporary foreign currency outflows were badly affected. The tourism sector accounts for around 20% of Sri Lanka’s export revenue (both products and services), and the pandemic’s powerful impact on its economy, which is anticipated to continue this year, will make managing the country’s exchange reserves status much more difficult.

When all the pieces of the puzzle are placed altogether, it becomes clear that Sri Lanka’s foreign debt challenges will only worsen. The country is on the verge of a crippling balance-of-payments catastrophe. The harsh truth is that these debt concerns cannot be rectified with relatively brief measures, which the current government appears to be adopting. The only long-term answer is to address the system’s structural flaws. These problems won’t go away in a year or two. Due to existing government debts expiring each year until 2030, Sri Lanka would have to pay large amounts from its foreign currency income to settle commercial loans. This may not be an entirely comfortable experience.

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