Monday, June 27, 2022
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Sri Lanka is the first domino to fall in the face of a global debt crisis

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The departure of Sri Lanka’s prime minister, Mahinda Rajapaksa, follows weeks of protest and a deepening crisis. There is no bankruptcy system for states but if there was then the south Asian country – down to its last $50m (£40m) of reserves – would be first in line to use it.

A team from the International Monetary Fund (IMF) this week started work with officials in Colombo over a bailout that will include a tough package of reforms as well as financial support. But as the IMF and its sister organisation, the World Bank, know full well, this is about more than the mismanagement of an individual country. They fear Sri Lanka is the canary in the coalmine.

Across the world, low- and middle-income countries are struggling with a three-pronged crisis: the pandemic, the rising cost of their debt, and the increase in food and fuel prices caused by Russia’s invasion of neighbouring Ukraine.

David Malpass, the World Bank’s president, explained his concerns at the organisation’s spring meeting last month. “I’m deeply concerned about developing countries,” Malpass said. “They are facing sudden price increases for energy, fertiliser and food, and the likelihood of interest rate increases. Each one hits them hard.”

Related: Sri Lanka’s PM resigns after weeks of protests over economic crisis

The UN has sought to quantify the problem. Its trade and development arm, UNCTAD, said in a recent report that there were 107 countries facing at least one of three shocks: rising food prices, rising energy prices or tighter financial conditions. All three shocks were being faced by 69 countries – 25 in Africa, 25 in Asia and the Pacific, and 19 in Latin America and the Pacific.

The list of countries that look vulnerable is long and varied. The IMF has opened rescue talks with Egypt and Tunisia – both big wheat importers from Russia and Ukraine – and with Pakistan, which has imposed power cuts because of the high cost of imported energy. Sub-Saharan African countries being carefully watched include Ghana, Kenya, South Africa and Ethiopia. Argentina recently signed a $45bn debt deal with the IMF, but other Latin American countries at risk include El Salvador and Peru.

For months there has been speculation that Turkey would be the first domino to fall, but despite an annual inflation rate of 70% and an unconventional approach to economic management, it is still standing. Unlike some other countries under threat, Turkey is able to feed its own people.

Richard Kozul-Wright, director of the globalisation and development strategies division at UNCTAD, said: “Countries have domestic problems but most of the shocks have nothing to do with those. The pandemic and the war had nothing to do with these countries, but have led to a huge increase in borrowing.”

The World Bank said almost 60% of the lowest-income countries were in debt distress or at high risk of it before Russia’s invasion of Ukraine, while the cost of servicing borrowing is rising steeply, particularly for those countries that have amassed debts in foreign currencies. The war in Ukraine has led to investors seeking out the haven of the US dollar, pushing down the value of emerging market currencies. Higher interest rates from the Federal Reserve, America’s central bank, have compounded the problem.

Emerging market crises are nothing new, but Kozul-Wright said the international community was ill-prepared to deal with a looming debt problem. “The system can only deal with these problems country by country,” he said. “But these are systemic issues and currently there is no way of dealing with them systemically.”

That may prove costly. Sri Lanka is the first country to buckle under the mounting economic pressures triggered by the war in Ukraine. It is unlikely to be the last.

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