Sri Lanka faces solvency issues on unsustainable debt, IMF says

A surge in global crude prices and the loss of tourists because of the war in Ukraine exacerbated the country's foreign exchange crisis

People queue to buy oil for home use at a petrol station in Colombo, Sri Lanka, amid surging prices and shortages. AFP

Sri Lanka faces “solvency” issues because of risks stemming from unsustainable debt levels that jeopardise the nation’s economy, the International Monetary Fund has said.

“Based on staff analysis, the fiscal consolidation necessary to bring debt down to safe levels would require excessive adjustment over the coming years, pointing to a clear solvency problem,” the IMF said in its Article IV consultation report, released in Washington on Friday.

The full report provides further analysis of the South Asian island nation’s debt and finances. A summary of the document released earlier this month said Sri Lanka faced unsustainable debt levels and needed a “credible and coherent” strategy to restore stability.

The country’s “debt overhang”, along with persistent fiscal and balance-of-payments shortfalls, “will constrain growth and jeopardise macroeconomic stability in both the near and medium term”, the report said.

“Rollover risk is very high,” the IMF said. “[Foreign] debt service needs of $7 billion each year will require access to very large amounts of external financing at concessional rates and long maturities, sustained over many years.”

Since the IMF board considered the staff report in late February, a surge in oil prices and the loss of tourists because of the war in Ukraine exacerbated its foreign exchange crisis, forcing the government of President Gotabaya Rajapaksa to seek IMF aid.

Negotiations on a possible aid package are expected to start in April, when Finance Minister Basil Rajapaksa, a brother of the president, travels to Washington.

The spiralling crisis has also led the country to raise interest rates, devalue the local currency and curb non-essential imports.

Sri Lanka has about $2bn of reserves against $3.9bn of foreign-currency debt due for the remainder of 2022, Bloomberg calculations based on central bank data show. This includes $1bn of sovereign bonds maturing in July.

The Central Bank of Sri Lanka stands ready for closer engagement with the IMF, working jointly with the government “in order to ensure that the benefits of such an engagement outweigh any costs associated with the same, from the perspective of the general public, and the business and investor community”, the monetary authority said on Saturday.

Sri Lanka has to be “prepared to manage the negatives”, central bank governor Ajith Nivard Cabraal said on Thursday, referring to entering an IMF programme. He did not elaborate.