Sri Lanka Stumbles into a Solvency Problem

In the last few months, Sri Lanka has been tottering on the verge of insolvency, with its scheduled external debt repayment obligations far exceeding its limited foreign exchange reserves. All efforts to restructure the country’s external debt had come to naught after the international credit rating agencies reduced its sovereign rating to junk status. Unfortunately, firmly ensconced in its own echo chamber, the majoritarian government had largely ignored the early warning signs and stumbled straight into the impending doom.

The first sign of the emerging crisis was evident more than a year back when the country’s foreign exchange reserves shrunk to a 11-year low in February 2021. Though a currency swap with the People’s Bank of China helped tide over the immediate crunch, the problems have only aggravated since then. Sri Lanka’s foreign exchange reserves, which peaked at $7.6 billion in 2019, have more than halved to $3.1 billion in 2021 and are now set to further fall to $2.2 billion in 2022. Consequently, the share of imports covered by the forex reserves has steadily fallen from five months to 1.5 months and further to one month during the period, and any sudden improvement is very unlikely.