Sri Lanka crisis: A warning to Pakistan and Bangladesh

Sri Lanka is in the midst of a deep and unprecedented economic crisis that has sparked huge protests and seen its president quit after fleeing the country - but other countries could be at risk of similar troubles, according to Kristalina Georgieva, Managing Director, International Monetary Fund (IMF).

"Countries with high debt levels and limited policy space will face additional strains. Look no further than Sri Lanka as a warning sign," said Kristalina.

She said developing nations had also been experiencing sustained capital outflows for four months in a row, putting their dreams of catching up with advanced economies at risk.

Sri Lanka is struggling to pay for crucial imports like food, fuel and medicine for its 22 million people as it battles a foreign exchange crisis. Inflation has soared about 50%, with food prices 80% higher than a year ago. The Sri Lankan rupee has slumped in value against the US dollar and other major global currencies this year.

Many blame ex-President Gotabaya Rajapaksa for mishandling the economy with disastrous policies whose impact was only exacerbated by the pandemic.

Over the years, Sri Lanka had built up a huge amount of debt - last month, it became the first country in the Asia Pacific region in 20 years to default on foreign debt.

Officials had been negotiating with the IMF for a US$3 billion bailout package. But those talks are currently stalled amid the political chaos.

The same global headwinds - rising inflation and interest rate hikes, depreciating currencies, high levels of debt and dwindling foreign currency reserves - also affect other economies in the region.

China has been a dominant lender to several of these developing nations and therefore could control their destinies in crucial ways. Buy it's largely unclear what Beijing's lending conditions have been, or how it may restructure the debt.

Where China is at fault, according to Alan Keenan from International Crisis Group, is in encouraging and supporting expensive infrastructure projects that have not produced major economic returns.

"Equally important has been their active political support for the ruling Rajapaksa family and its policies... These political failures are at the heart of Sri Lanka's economic collapse, and until they are remedied through constitutional change and a more democratic political culture, Sri Lanka is unlikely to escape its current nightmare."

Worryingly, other countries appear to be on a similar trajectory.

Pakistan

Fuel prices in Pakistan are up by around 90% since the end of May, after the government ended fuel subsidies. It's trying to rein in spending as it negotiates with the IMF to resume a bailout program.

The economy is struggling with the rising cost of goods. In June, the annual inflation rate hit 21.3%, the highest it has been in 13 years.

Like Sri Lanka, Pakistan also faces low foreign currency reserves, which have almost halved since August last year.

It has imposed a 10% tax on large-scale industry for one year to raise US$1.93 billion as it tries to reduce the gap between government revenue and spending - one of the IMF's key demands.

"If they are able to unlock these funds, other financial lenders like Saudi Arabia and the United Arab Emirates may be willing to extend credit," Andrew Wood, sovereign analyst at S&P Global Ratings said.

Former Prime Minister Imran Khan who vowed to fix some of these problems, was ousted from power although the faltering economy is not the only reason for that.

Again China plays a role here, with Pakistan reportedly owing more than a quarter of its debt to Beijing. "Pakistan appears to have renewed a commercial loan facility vis-a-vis China and this has added to its foreign exchange reserves and there are indications they will reach out to China for the second half of this year," Mr Wood added.

Bangladesh

With reserves dwindling, the government has acted fast to curb non-essential imports, relaxing rules to attract remittances from millions of migrants living overseas and reducing foreign trips for officials.

"For economies running current account deficits - such as Bangladesh, Pakistan and Sri Lanka - governments face serious headwinds in increasing subsidies. Pakistan and Sri Lanka have turned to the IMF and other governments for financial assistance," said Kim Eng Tan, a sovereign analyst at S&P Global Ratings.

"Bangladesh has had to re-prioritize government spending and impose restrictions on consumer activities," he said.

Rising food and energy prices are threatening the pandemic-battered world economy. Now developing nations that have borrowed heavily for years are finding that their weak foundations make them particularly vulnerable to global shock waves.