Context: India did not wait for other bilateral creditors but did “what is right” for Sri Lanka’s economic recovery, visiting External Affairs Minister S. Jaishankar said on Friday, following talks with Sri Lankan President Ranil Wickremesinghe in Colombo.
About the News
- India sent written financing assurances to the IMF, becoming the first bilateral creditor of the island nation to officially support its crucial debt restructure programme after last year’s economic meltdown.
- The Fund’s provisional $2.9 billion package will be cleared only after Sri Lanka’s official creditors — China, Japan and India — have provided adequate financing assurances.
- Sri Lanka went virtually bankrupt last year as it grappled with severe foreign exchange shortages to pay either for essential imports or its foreign creditors. Since then, it has grappled with runaway inflation of food and fuel prices. It also suspended repayment of $7 billion in foreign debt due last year.
- Sri Lanka began debt restructuring talks with its creditors in September last year as warranted by its agreement with the IMF for the USD 2.9 billion facility over four years.
- It began negotiating with the IMF for a bail-out after having announced its first-ever sovereign debt default in April last year.
- The IMF facility would enable the island nation to obtain bridging finance from markets and other lending institutions such as the ADB and the World Bank.
IMF
- The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C.,
- It consists of 190 countries.
- Mission- “working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world”
What is debt restructuring?
- Debt restructuring is the process of renegotiating the terms of debt, so the payments of debt are more manageable. This can include extending the repayment period, lowering the interest rate, or reducing the overall balance owed.
IMF Financing Assurance
- An IMF policy developed in response to the external debt crisis of the late 1970s and early 1980s to help mobilize financial support from the international banking community for countries experiencing debt-servicing difficulties. Under the policy, the IMF would not make its resources available to a member undertaking an adjustment program until receiving assurances that the financing for the program would be forthcoming.
- Entering into debt distress is often a painful process, which may threaten macro-economic stability and set back a country’s development for years. Supporting member countries in managing debt risks and resolving debt distress is therefore at the heart of the IMF’s work.
- An IMF-supported program can support a member in the context of a debt restructuring by providing sound economic policies and new financing, enabling the return to macroeconomic viability.
What kind of financial assistance does the IMF offer?
- Unlike development banks, the IMF does not lend for specific projects.
- Instead, the IMF provides financial support to countries hit by crises to create breathing room as they implement policies that restore economic stability and growth.
- It also provides precautionary financing to help prevent crises.
- IMF lending is continuously refined to meet countries’ changing needs.
Causes of crises
The causes of crises are varied and complex. They can be domestic, external, or both.
- Domestic factors include inappropriate fiscal and monetary policies, which can lead to the large current account and fiscal deficits and high public debt levels; an exchange rate fixed at an inappropriate level, which can erode competitiveness and result in the loss of official reserves, and a weak financial system, which can create economic booms and busts. Political instability and weak institutions also can trigger crises.
- External factors include shocks ranging from natural disasters to large swings in commodity prices. Both are common causes of crises, especially for low-income countries. With globalization, sudden changes in market sentiment can result in capital flow volatility. Even countries with sound fundamentals can be severely affected by economic crises and policies elsewhere.
- The COVID-19 pandemic was an example of external shock affecting countries across the globe. The IMF responded with unprecedented financial assistance to help countries protect the most vulnerable and set the stage for economic recovery.
Types of crises
Crises can take many different forms. For instance,
- Balance of payment problems occur when a nation is unable to pay for essential imports or service its external debt.
- Financial crises stem from illiquid or insolvent financial institutions.
- Fiscal crises are caused by excessive deficits and debt.
- Often, countries that come to the IMF face more than one type of crisis as challenges in one sector spread throughout the economy.
- Crises can slow growth, increase unemployment, lower incomes, and create uncertainty, leading to a deep recession. In an acute crisis, defaults or restructuring of sovereign debt may be unavoidable.
Sri Lanka debt crisis
- The Sri Lankan economy has been facing a crisis owing to a serious balance of payments (BoP) problem.
- Its foreign exchange reserves were depleting rapidly.
- It was becoming increasingly difficult to import essential consumption goods.
- The country was unable to repay past debts.
Objective of the Sri Lanka debt restructuring scheme
- The objectives of Sri Lanka’s new Fund-supported program are to restore macroeconomic stability and debt sustainability, while safeguarding financial stability, protecting the vulnerable, and stepping up structural reforms to address corruption vulnerabilities and unlock Sri Lanka’s growth potential.
- Debt relief from Sri Lanka’s creditors and additional financing from multilateral partners will be required to help ensure debt sustainability and close financing gaps.
- Financing assurances to restore debt sustainability from Sri Lanka’s official creditors and making a good faith effort to reach a collaborative agreement with private creditors are crucial before the IMF can provide financial support to Sri Lanka.