Sri Lanka — COVID-19 exacerbates severe economic and financial stress

COVID-19 adds to environmental shocks, political crisis, security and geopolitical issues, public debt and balance of payments crises that have all contributed to Sri Lanka’s tight finances over the past few years. The IMF predicts real GDP to shrink 0.5% in 2020, which would be the weakest economic performance since 2001. This will weigh on export opportunities to Australia’s 34th largest export market, particularly in education, tourism and fruit and vegetables, where sales to Sri Lanka amounted to $1 billion in 2018-19.

The anticipated economic recession compounds the government’s already-high external financing needs. The government needs to make external debt service payments amounting to about US$4 billion per year in 2020 and 2021. The government’s ability to repay these obligations will be increasingly difficult in a period of volatile global capital flows, rising foreign currency bond yields and depreciation pressure on the Sri Lankan rupee (down 2.5% against the US dollar in 2020). The spread on Sri Lankan international sovereign bonds over US Treasuries has now widened to 2,500 basis points in mid-May, indicating a significantly higher cost and reduced access to much-needed external financing (Chart).

Sri Lanka’s request for emergency financial support from the IMF, under the rapid credit facility, will help ease debt servicing pressures. Even so, recent negative rating actions from private credit rating agencies Moody’s, S&P and Fitch highlight both heightened financing stress and macroeconomic instability.

Fig 6 Sri Lankan Bond Spreads