Opinion
Nightmare Scenario: A Default on Sovereign Debt
A Pathfinder Perspective
On December 17, 2021, Fitch downgraded Sri Lanka’s rating to “CC”, the lowest rating prior to default. With external reserves at around $1.6 billion and almost $1 billion in debt-service payments coming due in January 2022 (and $7 billion during the coming year), the country faces a very real possibility of a sovereign debt default. If this were to happen, what would be the consequences for the economy, the poor, and society?
We can get an idea by looking at the experience of other countries that defaulted recently. Last year (2020) saw an unusually large number of countries defaulting on their sovereign debt. One of them, Lebanon—a country with sharp divisions along religious lines, a history of civil war, and an economy dependent on tourism and remittances—provides telling lessons for what might happen should Sri Lanka default.
A country defaults when it fails to meet the service payment on its sovereign debt. In the case of Lebanon (and almost every other sovereign default), the immediate consequence was that the country could no longer borrow abroad. In particular, it could not finance its current account deficit, which (like Sri Lanka’s) has always been high. A recent World Bank report documents how this resulted in a massive compression of imports (40 percent) that, in turn, triggered a sharp decline in economic activity. In one year, Lebanon’s GDP declined by 20 percent—one of the steepest drops in history. The exchange rate depreciated 129 percent. The pass-through effects of the currency depreciation meant that inflation has been accelerating: the 12-month inflation rate, which was 10 percent in January 2020, reached 158 percent in March 2021.
The economic slowdown and spike in inflation disproportionately hurt the poor and vulnerable. With food inflation at 254 percent in 2020 and poorer households spending about a third of their consumption on food, people are suffering. They stand in long lines for food, fuel and pharmaceuticals. Phone surveys in late 2020 showed that some 40 percent of households reported difficulties in obtaining food and other basic needs. About one in five manufacturing firms have closed and the remaining ones are operating at an average of 35 percent capacity. The unemployment rate, already high in Lebanon, has risen to 40 percent.
Most troubling is that the harsh economic conditions have led to violence in the streets. Eerily reminiscent of the civil war, armed clashes have broken out among sectarian militias. Beirut is seeing the worst violence in decades. Soon after the default, the government fell and was unable to reconstitute a coalition for 13 months.
To be sure, Sri Lanka is not Lebanon. And Lebanon’s problems were confounded by the August 2020 explosion in the Port of Beirut that killed 218 people. Yet, the many similarities in both countries’ circumstances before 2020 and Lebanon’s horrifying experience post-default point to one conclusion: Sri Lanka should avoid a sovereign debt default at all cost.
The Pathfinder Foundation invited Prof. Shanta Devarajan who was the World Bank’s Chief Economist in a number of regions to write this article as a sequel to the two previous ones titled ” Pulling back from the precipice: A Pathfinder perspective” & “Sri Lanka has no choice but to restructure external debt ” can view on https://pathfinderfoundation.org/ Readers’ comments via email to pm@pathfinderfoundation.org are welcome.
Shanta Devarajan is Professor of the Practice of International Development at Georgetown University, U.S.A. He was the Chief Economist of South Asia, Africa and the Middle East and North Africa at the World Bank.
The proposed expansion of the Kelani Valley railway line has prompted the squatters to demolish the buildings and the above photograph depicts the ad-hoc manner in which a building in the heart of Nugegoda town (No 39 Poorwarama Road) has been haphazardly demolished posing a risk to the general public. Residents say that the live electric wire has not been disconnected and the half-demolished structure is on the verge of collapse, causing inevitable fatal damages.
Over to the Railway Department, Kotte Municipality Ceylon Electricity Board and the Nugegoda Police.
Athula Ranasinghe,
Nugegoda.
On July 19, 1989, United Airlines Flight 232 departed Denver, Colorado for Chicago, Illinois. The forecast weather was fine. Unfortunately, engine no. 2 – the middle engine in the tail of the three-engined McDonnell Douglas DC 10 – suffered an explosive failure of the fan disk, resulting in all three hydraulic system lines to the aircraft’s control surfaces being severed. This rendered the DC-10 uncontrollable except by the highly unorthodox use of differential thrust on the remaining two serviceable engines mounted on the wings.
Consequently, the aircraft was forced to divert to Sioux City, Iowa to attempt an emergency crash landing. But the crew lost control at the last moment and the airplane crashed. Out of a total of 296 passengers and crew, 185 survived.
The National Transportation Safety Board (NTSB) declared after an investigation that besides the skill of the operating crew, one significant factor in the survival rate was that hospitals in proximity to the airport were experiencing a change of shifts and therefore able to co-opt the outgoing and incoming shift workers to take over the additional workload of attending to crash victims.
One wonders what would have happened if an overflying aircraft diverted to MRIA-Mattala, BIA-Colombo, Colombo International Airport Ratmalana (CIAR) or Palaly Airport, KKS during the doctors’ strike in the 24 hours starting March 12, 2025? Would the authorities have been able to cope? International airlines (over a hundred a day) are paying in dollars to overfly and file Sri Lankan airports as en route alternates (diversion airports).
Doctors in hospitals in the vicinity of the above-named international airports cannot be allowed to go on strike, and their services deemed essential. Even scheduled flights to those airports could be involved in an accident, with injured passengers at risk of not receiving prompt medical attention.
The civil aviation regulator in this country seems to be sitting fat, dumb, and happy, as we say in aviation.
Guwan Seeya
Plans to resurrect the Nanu Oya – Nuwara Eliya rail track are welcome. The magnificent views from the train have been described by H W Cave in his book The Ceylon Government Railway (1910):
‘The pass by which Nuwara Eliya is reached is one of the most exquisite things in Ceylon. In traversing its length, the line makes a further ascent of one thousand feet in six miles. The curves and windings necessary to accomplish this are the most intricate on the whole railway and frequently have a radius of only eighty feet. On the right side of the deep mountain gorge we ascend amongst the tea bushes of the Edinburgh estate, and at length emerge upon a road, which the line shares with the cart traffic for about a mile. In the depths of the defile flows the Nanuoya river, foaming amongst huge boulders of rock that have descended from the sides of the mountains, and bordered by tree ferns, innumerable and brilliant trees of the primeval forest which clothe the face of the heights. In this land of no seasons their stages of growth are denoted by the varying tints of scarlet, gold, crimson, sallow green, and most strikingly of all, a rich claret colour, the chief glory of the Keena tree’.
However, as in colonial times, the railway should be available for both tourists and locals so that splendid vista can be enjoyed by all.
Dr R P Fernando
Epsom,
UK
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