Sri Lanka’s debt crisis is a warning to the world

For anyone trying to understand the widespread social anger seen in Sri Lanka in recent days, the village of Gota-Go is a good place to start. The growing collection of tents pitched outside President Gotabaya Rajapaksa’s office in the capital Colombo serves as a rallying point for thousands of people who have taken to the streets. On Monday, Christian nuns demonstrated outside the site, as Buddhist monks and Muslim men joined nearby. All are expressing their anger at high inflation, lack of services and public services, poor health care and a wider economic crisis.

Prime Minister Mahinda Rajapaksa, the president’s brother, has offered to speak to the protesters, but the situation is not expected to improve anytime soon. For now, no viable opposition can be found and failing state institutions as well as broader mismanagement and corruption show no signs of abating.

Above all this looms an impending default in the repayment of foreign debt, which, if it occurs, will aggravate the crisis. The situation became more critical when the country’s central bank governor said on Tuesday that Sri Lanka would temporarily suspend payments, so that its limited foreign exchange reserves could be spent on essential imports.

Next week, the country will begin talks with the IMF to ease the situation. However, IMF officials will not only care about Sri Lanka, as the fund faces similar situations in emerging economies around the world. The World Bank has said that up to 12 developing countries may be unable to service external debt within the next year.

This is perhaps not surprising. The World Bank also reports that Covid-19 has driven global debt to its highest level in 50 years. If the pandemic lays the groundwork, the war in Ukraine could become the perfect trigger for an acute crisis in a number of countries, as supply chains are further strained and commodity prices continue to rise. Developing economies account for 40% of global GDP, increasing the risk of contagion to the rest of the world.

Without managing what they owe, economies at risk will spend more and more of their already low national income on debt repayment, not development. Once the burden becomes too heavy, it becomes difficult to escape a vicious cycle of defects. Lebanon, which defaulted in March 2020 and whose financial crisis continues to worsen, is a good example. Overreliance on imports also aggravates the situation for many of these countries.

The solutions are complex and unappealing to corrupt or incompetent governments. At home, the coffers have to be filled, often by raising taxes, which must then be collected more efficiently from citizens and made harder to dodge by big business who profit from lax regulation.

But beyond their control, international financial systems must evolve to function better. First, expert advice should be offered early on to break unsustainable cycles and build resilience in the face of unpredictable global crises. The operations of international organizations must also evolve. The IMF debt service relief program has spent billions throughout the pandemic and has helped 90 countries, which is extremely important to maintain as much economic stability as possible. It should be extended as part of a longer-term assessment of the current state of the global economy.

It is clear that Covid-19 is still a health crisis, which is why it must always be considered an economic crisis as well. Gota-Go Village may be a very local protest, but many of the issues that drove people to set it up are replicated in a number of countries around the world. And if its organizers are not listened to, the ensuing economic instability they suffer from could also go global.

Posted: April 14, 2022, 03:00

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Robert P. Matthews