Is Sri Lanka’s economic crisis a canary in the coal mine?

This is an audio transcript of the Behind the Money podcast episode: Is Sri Lanka’s economic crisis a canary in the coal mine?

Michela Tindera
Earlier this month after reporter Antoni Slodkowski arrived in Sri Lanka. It wasn’t long after the videos you might have seen on social media emerged, showing swarms of people taking over the presidential palace in the city Colombo. Videos of people hanging out in palace bedrooms (protest sounds on the background) and swimming in the outdoor pool.

Antoni Slodkowski
Basically, these are images of a revolution, essentially, a takeover of the government and that prompted the former president Gotabaya Rajapaksa to hop on a plane in the middle of the night and flee.

Michela Tindera
That’s Antoni. The reason that some Sri Lankans stormed the presidential palace is because the country is in the middle of an economic crisis. In recent years, the Sri Lankan government has made a series of bad economic choices, and the pandemic and the war in Ukraine have now made things even worse.

Antoni Slodkowski
So, I mean, to illustrate this, I would take you to the stronghold of the former president Gotabaya Rajapaksa in Hambantota, which is about a three hours’ drive south of Colombo, where I went. And I met a man there who’s been waiting in line to get fuel for 18 days. That’s 18 days. And this man is unable to go home because there are no buses going back to his village. He’s sleeping on the side of the road or being eaten by mosquitoes inside his tuk tuk that he drives. He’s obviously not earning any money. He’s eating once a day. He has a pregnant wife and a one-and-a half-year-old son. And he’s incredibly worried about their future. I mean, if I were to really reflect what these people say, we wouldn’t be able to broadcast it because it would probably be just beeped out. These people have no fuel. They have no opportunity to buy food. They can’t travel. They’re stranded.

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Michela Tindera
The economic crisis in Sri Lanka is impacting the daily lives of millions on this island in the Indian Ocean. But there are some indicators that show that this situation isn’t isolated. On today’s episode, we’re looking at what’s happened in Sri Lanka and examining whether or not it could be a canary in the coal mine for other economies around the world. I’m Michela Tindera from the Financial Times, and this is Behind the Money.

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Hi, Jonathan. Thanks for coming on the show today.

Jonathan Wheatley
Hi there. You’re very welcome.

Michela Tindera
So, Jonathan, you cover emerging markets around the world for the FT. So how did this all happen?

Jonathan Wheatley
Well, things as often happens when things go wrong, things happen slowly at first and then very quickly. And things have been happening slowly for quite a long time in Sri Lanka since the end of the civil war in 2009. There has been a lot of corruption and mismanagement in government. They’ve tried to do things that make them popular but just don’t sort of match with reality. So they, in 2019, they introduced a bunch of tax cuts that at a time when they really needed the revenue. And famously, also that year, they banned imports of synthetic fertiliser. That was seen, as it was presented, as a bid to make Sri Lanka a pioneer in organic agriculture. It was probably more motivated by the need to save the $300mn or $400mn they were spending on imported fertilisers and couldn’t afford. But farmers were thrust overnight into a situation of having no fertiliser. It was catastrophic. Sri Lanka basically ran out of cash as we, as we saw when they banned the fertiliser imports. They were having to scrimp and save wherever they could. But since the pandemic, and especially since the war in Ukraine, things have accelerated. And the war in Ukraine meant that their reserves were just run down to the floor. They no longer had money to import vital goods like medicines and fuels and food. Schools were closed because people couldn’t afford the transport to get them there. Online learning didn’t work because families couldn’t afford to pay for the data that they needed. Nine out of 10 families in Sri Lanka have been missing meals. They’ve just run out of money. And there were, there were protests. There were what you might call even terrorist incidents. People setting fire to churches. So that put an end to whatever was left of the tourism economy. And it just got worse and worse until it finally boiled over.

Michela Tindera
So then in the meantime, Sri Lanka’s government had this debt. How much exactly?

Jonathan Wheatley
Sri Lanka owes . . . it’s hard to say how much in fact. The latest IMF report on the country is several months old now, and it talks about debts at the end of 2020, foreign debts of about 32bn. We reckon it’s probably got more like 51bn in foreign debts at the moment that it just can’t pay.

Michela Tindera
And who are their creditors?

Jonathan Wheatley
It owes probably more than half of that to multilateral agencies like the World Bank and the IMF and other development banks. It owes a big chunk to foreign governments. The biggest of all is China or the various lenders that lend money from China, policy banks, commercial banks, development agencies, whatever.

Michela Tindera
So in May, they defaulted on that debt. What happened next?

Jonathan Wheatley
Well, the default in May was followed pretty rapidly by a descent into political chaos. But the two events aren’t necessarily linked. What was upsetting the population is the same thing that was making it impossible for the country to pay its debts, which was just a cash crisis in the public accounts, just running out of money. Since then, they have defaulted. The president fled the country, and then turned in his resignation by email from Singapore.

Michela Tindera
And what exactly does a default mean or look like for a country like Sri Lanka?

Jonathan Wheatley
Well, governments try to avoid default because the people they default on become unwilling to lend to them. And a lot of developing countries really rely on their access to foreign commercial lending markets, especially the bond market. And they really want don’t want to lose access to that. Once you default on a bond, your rating goes into default, which means that any asset manager that’s managing other people’s money and putting it into bonds isn’t allowed to buy your bonds. So you are automatically locked out of bond markets. And it just means you don’t have access to commercial credit for however long it takes to work it out.

Michela Tindera
And you mentioned before that China is one of Sri Lanka’s creditors. And so what is China’s role now?

Jonathan Wheatley
What has to happen before you have any, any restructuring can actually go ahead is you need to have some kind of broad agreement among the main creditors. And inevitably that includes China, but it also includes other bilateral lenders, and it includes the commercial lenders such as bondholders. And the big question now is whether China is going to get engaged in that kind of collegiate approach to really doing substantial proper debt work, work outs. It has, just in June, finally, after much delay, agreed to co-chair the creditor committee for official bilateral creditors so itself and various other creditors to Zambia, which defaulted in 2020.

Michela Tindera
Yeah.

Jonathan Wheatley
So it’s agreed to do that. We have to wait and see whether it’s going to agree to get involved in something like that with Sri Lanka and all the other problematic cases that are going to come up in the coming months.

Michela Tindera
A lot of people are calling what has happened with Sri Lanka the canary in the coal mine. I was wondering if you could explain what that means.

Jonathan Wheatley
Now, if you look at who’s in a bad position, particularly now since 2020, it’s really those who are in a particularly bad position beforehand. So the ones the big ones that have defaulted are Zambia and Sri Lanka. They had pre-existing troubles and those problems in general are quite particular to those countries. But when you add them up, you’ve got a lot of countries with their own particular problems and that creates a systemic problem across certainly frontier if not into some of the middle-income countries like Sri Lanka.

Michela Tindera
OK, so if Zambia defaulted in 2020 and now Sri Lanka in 2022, is there any indication of what comes next?

Jonathan Wheatley
Well, one way of answering that question is to see where the markets are identifying problems. And if you look at what’s happened to the prices of emerging market bonds over the past few months, you see something really quite extraordinary. This year has been off the scale in terms of the way that the yields on emerging market bonds have ballooned. What that means is investors, when they’re not only at the point of lending to an emerging economy but the point of buying and selling its bonds on the secondary market, they want to get a certain return on their investment. And the prices of those bonds have collapsed, which means investors are less and less willing to buy them. And the yields, the amount of return that they offer, the amount that investors are willing to accept in return for buying them, have gone through the roof. So if you look at what’s happened to some of the, the bonds of the most vulnerable countries just in the past few months, I mean, this year, Ukraine’s bonds, the yield on Ukraine’s bonds has gone up by 35 percentage points since the beginning of this year. That’s an extraordinary leap. Other countries, El Salvador, Sri Lanka, Sri Lanka’s third-rated among, the third-ranked among the ones whose yields of most blown up, Argentina, Pakistan, Ghana, Kenya, Nigeria . . . The list goes on.

Michela Tindera
Is there kind of like a common denominator among those countries as to why that’s happened?

Jonathan Wheatley
You know, in past crises in emerging markets, it’s been very relatively easy to identify something that set things off across a region of the world or even across emerging markets as a whole. This time, unfortunately for journalism and simple explanations, it’s more complex. Around the emerging world, you have seen countries that before the pandemic had their own, the word is idiosyncratic that investors like to use. This is an idiosyncratic problem restricted to that country. Argentina, great example, an idiosyncratic problem. Several others around the world. The point is, I think, that there are so many idiosyncratic stories around the world that they start to become one story. And if you want to find one common thread, I think it is that since China joined the WTO and provided this massive boost to economic growth around the developing world for a good decade and decade and a half at the start of this century, since that faded, countries have struggled. Populations have become used to growth. Governments have been desperate to find ways of keeping it going. Often they’ve done it in ways that really won’t last, won’t stand the test of time, that they’ve been storing up fiscal troubles for the future. So a lot of the kind of economies have become more fragile, and the pandemic and now the war in Ukraine have exposed those difficulties. And that’s what we’re seeing on the bond markets that investors are saying these countries, these half dozen, this dozen, this maybe even two dozen, if you look at look at it by certain measures, these are the countries we’re worried about. They’re all there for their own reasons, but they’re all suffering the same kind of immediate battering from medium to short-term circumstances.

Michela Tindera
And, I mean, the US is playing a role in this, too, right? As the dollar strengthened, how has that impacted emerging markets?

Jonathan Wheatley
If you’re an importing country, tends to mean that you’re importing inflation because the price of the imported goods, if the dollar is strengthening against your currency, the price of those imported goods is going up. And Sri Lanka is a case in point. It’s a big importer. It needs to import vital supplies so those goods go up. That means domestic inflation goes up. That means if the central bank is doing its job, interest rates need to go up because you really, really, if you’re a developing country, do not want high inflation. Inflation is a tax on the poor. It’s a regressive tax, and that is toxic for a poor country, high inflation. So a central bank that’s doing its job really needs to raise interest rates in those circumstances. And that is bad for growth. That is bad for economic activity. If the cost of borrowing is going up, people don’t invest. So you’re caught in a bind. You’re caught in a double bind if what is happening now in the world happens. And that is the risk of stagflation, or even of which is a stagnant economy and rising inflation, or even the threat of recession and inflation. And there’s a very real risk that the US will go into recession and that ripples out across the world. So you’re in real trouble. You have to protect the poor from inflation. But by doing so, you put a brake on your own economy. And Sri Lanka is one of many countries that are facing that kind of horrible dilemma.

Michela Tindera
So then what happens next for Sri Lanka?

Jonathan Wheatley
The next thing that has to happen is there has to be an interim government in place before elections take place. You would hope there would be some kind of preliminary agreement brokered by the IMF between Sri Lanka’s creditors. But as I say, it’s very, very messy. And the chances of that happening quickly, I’m afraid, are pretty remote.

Michela Tindera
This might all sound like sort of a distant problem for a lot of our listeners in the US and the UK. Why should they care about this?

Jonathan Wheatley
If you want this sort of short-term, self-interested reason for carrying it is that some part of your pension pot is probably invested in emerging markets. It may be a relatively small amount, but it’ll still be a significant amount, and when emerging markets do well, then those investments do well and your retirement becomes more comfortable. But less immediately selfishly, you should care because an awful lot of people are suffering and going into poverty. You might want to care about global stability. We’re in a world at the moment where we don’t really know what’s coming next and how well a lot of important developing countries are doing around the world is very significant in the way geopolitics sizes up, which camps countries feel they want to be in, whether they feel sympathetic to this or that other potential global, global hegemony. So it does matter. It is significant. And populations and governments need to be, the governments certainly, need to be working hard to find solutions.

Michela Tindera
Thanks for coming on the show today, Jonathan.

Jonathan Wheatley
You’re very welcome. It’s a pleasure.

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Michela Tindera
Behind the Money is hosted and produced by me, Michela Tindera. Stephanie Horton is our contributing producer. Topher Forhecz is our executive producer. Sound design and mixing by Sam Giovinco. Cheryl Brumley is the global head of audio. Thanks for listening. See you next week.

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