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Sri Lanka’s IMF bailout plan has taken a crucial step forward as the country, and the global lender reached a staff-level agreement on the first review of their 48-month fund facility arrangement on Thursday.
Once the IMF management and executive Board approve the review, Sri Lanka will gain access to about $330 mn. The completion of the review by the IMF’s Executive Board requires “the implementation by the authorities of all prior actions, and the completion of financing assurances reviews,” said the IMF.
In late September, the IMF had put Sri Lanka’s bailout plan on hold. Peter Breuer, IMF’s Senior Mission Chief for Sri Lanka, had acknowledged signs of stabilisation in the country but had reservations about its ability to achieve a full-scale economic recovery.
Looking back, Sri Lanka faced a severe financial crisis in 2022, primarily due to a significant depletion of foreign exchange reserves. However, since securing a $2.9 bn bailout package from the IMF program in March 2023, the country has made substantial progress in stabilising its economy.
The island nation successfully curbed inflation, with rates dropping from a peak of 70% in September 2022 to 1.3% in September 2023. Moreover, gross international reserves witnessed an increase of $1.5 bn from March to June of this year.
Despite these positive developments, the momentum of economic growth in Sri Lanka remains subdued, with real GDP contracting by 3.1% year-on-year in Q2 of FY23. As per the IMF, high-frequency economic indicators continue to offer mixed signals, indicating that the path to full recovery may still have challenges to overcome.
Sri Lanka in talks with China, India and Japan to restructure debt
Sri Lanka’s IMF bailout plan was back on track soon after the island nation reached an agreement last week with the Export-Import Bank of China to address approximately $4.2 bn of the country’s outstanding debt.
Sri Lanka’s finance ministry call the agreement “a key milestone in Sri Lanka’s ongoing efforts to foster its economic recovery”. “In the next few weeks, the Sri Lankan authorities and China EXIM bank will actively work on formalising and implementing the agreed parameters of the debt treatment,” the finance minister said after the agreement was finalised.
All in all, China holds the position of Sri Lanka’s biggest bilateral lender, having extended approximately $7.4 bn in loans to the country till the end of 2022, as per calculations by the China Africa Research Initiative.
Furthermore, President Xi Jinping conveyed to his Sri Lankan counterpart during their meeting in Beijing on Friday that China is ready to provide support to Sri Lanka without imposing political conditions and is interested in increasing its purchases of Sri Lankan exports.
Before the deal with the Export–Import Bank of China, Sri Lanka unveiled a comprehensive plan in early 2023 to exchange approximately $10 bn worth of defaulted local debt for new bonds. Also, the country has been in talks with Japan, China, and India since September 2022 to restructure its foreign debt.
Notably, the first review’s approval by the IMF board on its bailout plan for Sri Lanka hinges on the country’s progress in its debt restructuring with bilateral lenders such as Japan and India, alongside other bondholders.
Faced with this, Fitch Ratings has spoken about the impact of this debt restructuring on Sri Lankan banks. “The restructuring of Sri Lanka’s foreign-currency debt, including the defaulted sovereign bonds that banks hold, has not been completed, but we believe that incremental risks to banks’ capital from the restructuring are likely to be manageable, given their limited exposure to these bonds (3.6% of total assets at end-1H23) and high provision coverage,” said the credit rating agency.
“That said, access to foreign-currency wholesale funding remains challenged by the sovereign’s weak credit profile, but the stress on banks’ foreign-currency liquidity has largely eased relative to the crisis period,” Fitch added.
