Sri Lankan crisis: Political… to Financial?
Sri Lanka is facing a banking and currency crisis, according to economist Carmen Reinhart, a Professor at Harvard university and one of the world’s foremost authorities on financial crises. The learned economist spoke to the writer on whether Sri Lanka’s political crisis could evolve into a financial crisis.
How likely is a financial crisis in Sri Lanka?
Currently Sri Lanka is already facing twin crises – a banking and a currency crisis (the rupee is down almost 20 per cent in 2018). The bulk of Sri Lanka’s external debts are dollar denominated, including Sri Lanka’s loans from China. So, there is a lot of foreign currency exposure, as the rupee slides. And there are risks that Sri Lanka could end up with a sovereign debt crisis also. The recent downgrades in credit ratings highlights that new borrowing (even to service existing debt) will be expensive. Creditors, at a minimum, need to know who to negotiate with. In Sri Lanka – political upheaval makes that difficult.
How much of Sri Lanka’s current crisis is a result of what is happening globally in international capital markets?
From 2003 to almost 2013, China grew at over 10 per cent and US interest rates were low. That was an exceptionally benign environment for emerging markets. Now Chinese growth rates are lower and US interest rates have moved higher. As we revert to the ‘norm’, emerging markets – including Sri Lanka – are under higher stress. During the last decade, as international investors searched for higher yields, several low-income developing countries issued sovereign bonds in international capital markets. These high-yield bonds now add to the current debt burden.
Can countries emerge from a ‘twin crisis’?
Being able to emerge from an economic crisis depends on many factors, in part, on a country’s governance. If a country takes a loan, there is the question of how loan proceeds are used. Are the loans taken in “good times” used to stimulate economic growth (and eventually to repay debt)?
The answer to that question can influence how quickly a country can emerge from a crisis. Some countries have successfully emerged from financial crises – Thailand post-1997 is a good example- faster than others.
Can Sri Lanka sell public assets in the case of a default crisis?
Unlike other assets (hard currency reserves, for instance), physical assets are not very liquid, especially during a crisis of confidence. Of course, it can be done, but it may involve “firesale (very low) prices.” Political uncertainty also complicates matters if it raises uncertainty about ownership rights and expropriation risks. The “firesale” aspect I am referring is evident in many crises, including the US subprime mortgage crisis. Loans to US homeowners were collateralized by the market value of the house, but when housing prices started falling, many homeowners defaulted on their loans and the “foreclosures” sales were at “firesale” prices. The risk is that Sri Lanka’s public assets will not attract much interest during a crisis, except perhaps at very depressed prices. (The writer is a Master in Public Policy student at Harvard Kennedy School).