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The backstory: Sri Lanka, a South Asian island with a population of 22 million, is in the midst of its most severe economic crisis in years. With COVID, high energy prices, populist tax cuts and inflation soaring over 50%, it's been a real struggle for the economy. The situation took a turn for the worse in May 2022 when Sri Lanka defaulted on foreign debt payments for the first time in its history. As of March this year, the nation's external debt had swollen to US$36.09 billion.
Seeking a way out of this mess, Sri Lanka turned to the International Monetary Fund (IMF) last year. It managed to secure a preliminary agreement for a bailout package of US$2.9 billion. Then, in July, its Parliament gave the green light to a domestic debt restructuring plan, a big step towards securing that IMF lifeline. It's important to note that China holds the largest share of Sri Lanka's debt, US$7.4 billion, with India, Japan, the World Bank, the Asian Development Bank and some commercial loans making up the rest.
More recently: In June, Sri Lanka kickstarted a domestic debt restructuring program, basically trading around US$10 billion of its debt for new bonds. But things hit a speed bump during the first review of its IMF bailout package last month. It couldn't seal the deal because of concerns over not having enough money in the government's bank. So, the IMF hit pause on the second chunk of the bailout money, totaling US$330 million.
The development: China has announced a preliminary agreement with the island nation concerning its China-related debts. The specifics of this agreement are still under wraps, but it was confirmed by China's Foreign Ministry earlier this week. The deal was reached in independent talks apart from what’s going on with the IMF and other creditors.
Sri Lanka's finance ministry is pretty pleased about this, as the country sees it as a potential lifeline for its struggling economy. Meanwhile, the IMF, along with Paris Club members, including Japan, and other lenders like India, are gearing up for talks in Morocco this month about a debt restructuring plan for Sri Lanka. The idea is to reach an agreement that’s fair for all creditors and doesn’t favor payments to one over another.
"This debt restructuring plan is essential for Sri Lanka to meet the target set by the IMF agreement to reduce debt from the current 128% of GDP to 95% of GDP by 2023," said State Minister of Finance Shehan Semasinghe to Parliament in July. "We are doing this while protecting banks, depositors and pensions."
"I express my gratitude to the IMF and our international partners for their support as we look to get the economy back on track for the long term through prudent fiscal management and our ambitious reform agenda," said Sri Lanka's President Ranil Wickremesinghe in a statement in March.
"Without fresh dollars to import essential goods, an economic turnaround is impossible," said Sergi Lanau, deputy chief economist at the Washington-based Institute of International Finance. "In the medium term, implementing reforms under the IMF program and successfully restructuring debt should improve Sri Lanka's outlook."