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    Sri Lanka – the first emerging market economy in turmoil – more might to follow

    April 2022

    The economic crisis in Sri Lanka is deepening. The rupee has plunged to record lows against the dollar on the back of blackouts, food shortages and sky-high prices. The country may have as little as 500 million dollar left in foreign reserves though a 1 billion dollar bond repayment is due in just a few months. With the IMF (International Monetary Fund) ready to intervene, there is hope that the situation may stabilize. But fears in my opinion are growing that Sri Lanka could be the first in a series of emerging markets to descend into economic turmoil.

    The war in Ukraine represents another shock which, on the back of the pandemic, could be enough to send multiple countries into debt distress. The scope of the problem in my opinion is likely to be global, so solutions need to be of a similar size and scope. Unfortunately, garnering enough international political will to fix holes in the world’s framework for sovereign debt relief looks to be a Herculean task.

    Russia’s military operation in Ukraine in my opinion leaves developing countries facing a twofold shock. Spiraling oil and grain prices have put importing economies under pressure, with countries such as Egypt facing the prospect of drastically lowering their foreign currency reserves in order to pay for them. On top of this comes the prospect of monetary tightening in the developed world. In 2013, the merest hint from the US Federal Reserve (Fed) that it would scale back quantitatively easing (QE) – the so-called taper tantrum – was enough to move money out of emerging markets. What happens in the event of a significant unwinding of the Fed’s balance sheet remains to be seen. The prospects, however, are in my opinion not good: rates will rise, and some developing economies could find that their debt burdens become unsustainable. The path from there could be grim. Spending cuts are likely to be made in an effort to meet bond repayments as they become due. This kind of fiscal retrenchment tends to exacerbate poverty, cut off growth paths and cause unpredictable social upheaval. This course of events is not inevitable, though. To start with, the IMF should dust-off its pandemic playbook and offer rapid loans to vulnerable economies. This could be accompanied by less stringent conditions to match the urgency of the situation, ensuring that countries spend what is required to meet the challenges of the moment.

    In the medium term, gaps in the world’s approach to sovereign debt relief must be fixed. It is no longer sufficient to concentrate on the old Paris and London clubs of lenders -long gone are in my opinion the days of emerging market creditors being concentrated in this group. China now represents the biggest bilateral lender to developing countries by far and bonds have also been sold to a range of private investors. According to the World Bank, at the end of 2020, low and middle income countries owed five times as much to commercial creditors as they did to bilateral ones. These lenders will need to urgently co-operate if there is to be any hope of significant, proactive debt relief to emerging markets. The common framework agreed by the G20 in November 2020 offers a potential vehicle, but the wheel to make use of it is lacking. Creditors in my opinion still fear their agreement to offer concessions will just become a covert means of redistribution to other lenders unwillingly to play ball.

    At a time of increasing division and with priorities elsewhere, hope for rectifying these issues with the world’s sovereign debt framework may fade. It would in my opinion be a great shame if this were so. Economic turmoil in emerging markets does not need to result in serious crisis. It is clear what needs to be done.

    The task now is to find the necessary political will to do it.