Sri Lanka’s default indicates problems facing other developing countries

Protesters gather during a demonstration in Colombo, Sri Lanka, on Thursday, April 28, 2022. – Bloomberg

Sri Lanka’s imminent default on 12.6 billion in foreign bonds is a warning signal to investors in other developing countries that rising inflation is poised to take a painful toll.

The South Asian nation has been running through a 78 78 million grace period since gaining independence from Britain in 1948, marking its first sovereign debt default. Its bonds are already trading deep in the troubled region, with holders reaching close to 60 cents in dollars for losses. The government said last month that it would stop repaying foreign loans.

All the debt crises are unique to the situation in Sri Lanka – the details here include an unpopular government led by an almighty family, the unresolved consequences of 30 years of civil war and violent street protests. But the island’s story is beginning to be seen as a bellwether for emerging markets where deficits have risen due to inflation, including world-record-high food costs, with the potential to destroy the national economy.

“Sri Lanka’s default is a bad omen for emerging markets,” said Guido Chamorro, co-head of Pickett Asset Management’s emerging-market hard-currency lending, which holds Sri Lankan bonds. “We hope the good times stop. Slower growth and more difficult funding conditions will increase the default risk, especially for border countries. “

Sri Lanka, the $ 81-billion economy on India’s south coast, has been in turmoil for weeks amid a year-on-year inflation of 30%, a declining currency and an economic crisis that has left the country short of the hard currency it needs to import. Food and fuel. Anger over the situation – brought on by years of excessive debt to fund inflated state companies and liberal social benefits – has erupted into violent protests.

Massive arson and clashes have been reported from different parts of the country, and the homes and properties of several government lawmakers have been set on fire. At least nine people, including a member of parliament, were killed in the violence.

Sri Lanka is currently without a finance minister, which could complicate efforts to overcome the crisis as the government struggles to restore security and get a bailout from the International Monetary Fund (IMF). At the same time, it is BlackRock, Inc. And a restructuring with lenders, including the Ashmore Group.

The country’s dollar bonds are among the worst performers in the world this year, with only Bitcoin-based notes from Ukraine, Belarus and El Salvador worse. The government failed to hand over about $ 78 million coupons to mature debt holders on April 18, 2023 and 2028, prompting the S&P Global Rating to declare an election default. Fitch Ratings and Moody’s Investor Service have not yet announced their official defaults, despite issuing their own warnings.

After the grace period for this payment ends on Wednesday, negotiations with lenders could begin in earnest, a process that would be key to winning help from the IMF. The country has previously said it needs 3 3 billion to 4 4 billion this year to pull itself out of the crisis.

The country’s $ 1 billion debt this July rose 0.24 cents to 42.73 cents on Wednesday, reaching a record 42.5 cents last week, according to data compiled by Bloomberg.

But such an agreement will not be easy to complete quickly. Although President Gotabaya Rajapaksa has already called on one of his political opponents to take over as prime minister following the resignation of his brother Mahinda Rajapaksa, instability remains. Even after the 30-year civil war that ended in 2009, divisions remain deep and the central bank governor has threatened to resign if political stability does not return soon.

“We are in a liquid situation that is very dangerous for Sri Lanka,” said Matthew Vogel, London-based portfolio manager and head of sovereign research at FIM Partners.

The risk of duplication
As Sri Lanka struggles with instability, its problems provide a warning to other emerging markets where the burden of heavy debt is being transformed into economic problems and social unrest. The challenge is compounded by the fact that the Federal Reserve and other major central banks have raised interest rates to curb inflation, which has led to higher borrowing costs.

Trang Nguyen, executive director of emerging market strategy at JPMorgan Chase & Co., said:

At least 14 developing economies tracked in a Bloomberg gauge have debt yields of more than 1,000 basis points on the US Treasury, a threshold for bonds to be considered miserable.

Other countries, including Egypt, Tunisia and Peru, are already under increasing pressure from rising food and energy prices. It risks becoming a major debt collapse and another threat to the fragile recovery of the world economy from the epidemic. Pakistan, Ethiopia and Ghana are also at risk of pursuing the case, Bloomberg Economics said last month.

“This could be the beginning of a trend across the Sri Lankan border and in emerging markets where governments face a debt crisis – and perhaps default on their obligations,” said Brendon McKenna, a strategist at Wells Fargo in New York who said Pakistan and Egypt were particularly vulnerable. “As prices rise, many of the fundamentally weaker countries with dollar-denominated debt may struggle to repay bonds.” – Bloomberg

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