Sri Lanka Braces for Critical Week in Bid to Stabilize Economy

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Sri Lanka’s leaders face critical tests next week of how they plan to pull the South Asian nation out of an economic tailspin, with a bond payment due followed by an interest-rate decision, as well as a presidential speech that will lay out policy priorities as the island faces spiraling inflation, shrinking reserves and wary investors.

While policy makers have said they have allocated resources to service $500 million of bonds maturing Jan. 18, they haven’t yet disclosed how they plan to repay $1 billion of debt that’s due in July. President Gotabaya Rajapaksa is expected to address parliament Tuesday when he will possibly outline plans to address the challenges facing the economy.

Two days later, the Central Bank of Sri Lanka will get this year’s first opportunity to address Asia’s highest negative real rates, which dim the appeal of the nation’s already junk-rated assets at a time when global central banks are turning hawkish. The monetary authority will need to balance between the need for imported capital and the risks to economic growth from tightening too much.

The CBSL is likely to resist any change to policy settings now as growth still remains weak with omicron threatening economic activity, said Saurav Anand, economist for South Asia at Standard Chartered Plc. On the external front, the forex reserves situation is far from comfortable, he said.

Sri Lanka’s credit score was this week cut deeper into junk by S&P Global Ratings, which cited the likelihood of a further deterioration in the nation’s external financial position, affecting its ability to service debt this year.

The nation’s forex pile stood at $3.1 billion last month after drawing down a $1.5 billion swap facility from China, with central bank Governor Ajith Nivard Cabraal seeing the possibility of more support from Beijing to meet debt obligations. Colombo separately secured a $400 million currency swap from India, besides getting $500 million of Asian Clearing Union settlement deferred.

Still, investors like Carlos de Sousa, who oversees a $3.8 billion developing-nation bond fund at Vontobel Asset Management SA in Zurich, expect the South Asian country to run out of money to pay creditors by mid year. Sousa is now waiting for Sri Lanka to default to load up on the nation’s debt. 

The 7.55% dollar bonds maturing in 2030 were steady while the dollar debt maturing July this year was also little changed at 70 cents on the dollar.

Despite Sri Lanka’s weak external position, the country maintains a deep-seated reluctance to seek help from the International Monetary Fund as that would involve austerity measures.

The nation also faces a ballooning import bill amid global price gains and as the government tries to make up for a shortfall of everything from food to fuel. The government last week unveiled a $1 billion relief package as President Rajapaksa sought to temper growing public anger over surging prices of essentials such as food and medicine.

Sri Lanka’s cabinet this week approved importing 300,000 tons of rice from India in a bid to cool prices that have risen in part due to crop losses. Import controls and a government ban last year on chemical fertilizer use and agro-chemical import, which was revoked amid farmer protests, have led to depleted harvests and escalated prices.

But governor Cabraal expects inflation -- driven by what he sees as supply-side shocks -- easing in the coming months. He’s also betting on the Sri Lankan economy expanding by 5.5% this year, despite challenges posed the pandemic.

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