Emerging markets start to crumble: Sri Lanka nears default

On Tuesday, April 12. The central bank of Sri Lanka reported that the repayment of external debt according to the established schedule is no longer possible. The government is trying to actively use its dwindling foreign exchange reserves to import basic necessities such as fuel, leaving the repayment of coupon payments overboard until better times.

To date, it is known that the reserves of the island state have decreased by more than two-thirds, as tax cuts and the coronavirus pandemic have severely damaged its economy, which depends on tourism. Government spending caused by debt has become a heavy burden on the island's economy.

It has not been calm inside the state for a long time: street protests against the shortage of fuel, electricity, food and medicines have been going on for more than a month.

"We need to focus on the main imports and not worry about servicing the external debt," the head of the central bank of Sri Lanka, Nandalal Weerasinghe, told reporters. "It has come to the point that paying off the debt is difficult and impossible."

The head also said that payments will be suspended until the country comes to an agreement with creditors and with the support of a loan program with the International Monetary Fund (IMF). On Monday, Sri Lanka begins formal negotiations with the world lender on the provision of emergency loans to support priority needs.

This year, the country has repayments on foreign debt in the amount of about $4 billion, including $1 billion international sovereign bonds maturing in July. Two coupons are due to be paid on Monday.

Murtaza Jafferji, the broker's representative, believes that we are talking about an inevitable default: "This is positive for the economy, because we used scarce resources in foreign currency to service our debt when we could not afford it. This will free up funds for our own citizens..."

He said Sri Lanka's decision covers about $25 billion of bilateral and commercial debt, including about $12 billion of international sovereign bonds.

Senior sovereign markets strategist Timothy Ash said that "my only surprise is that it took so long for the Colombo administration to come to terms with the reality on the ground."

"It is logical to declare a moratorium on payments until they develop a program with the IMF and agree on terms with bondholders," Timothy believes.

Sri Lanka's dollar-denominated sovereign bonds showed significant gains on Tuesday, with long-term issues rising by more than 1 cent in dollars, according to data from Tradeweb.

According to Refinitiv, the government's hard currency bonds are mostly trading at extremely problematic levels of just under 40 cents on the dollar, while bonds maturing on July 25 last traded at a price of just over 50 cents.

Governor Weerasinghe said the repayment call was accepted in good faith, stressing that the country of 22 million people has never violated its obligations to pay the debt.

Although the Russian-Ukrainian conflict has drawn the attention of economists, it should be noted that the impact of the pandemic has not been canceled. China is using unprecedented measures to restrict movement in large cities that have become targets of infection. All this affects the exports of one of the largest suppliers of raw materials and finished goods, again affecting supply schedules and increasing shortages in international markets.

In addition, the borrowing burden of developed countries is flowing into emerging markets and third world countries, forcing them to be the first to fall under the onslaught of inflation.

Obviously, we will see a similar picture in some other regions, especially among small states whose opportunities are limited by the lack of export diversification.