Whenever Sri Lankans engage in debate, two topics reign supreme: cricket and the state of the economy. But with a US$3bn bailout by the International Monetary Fund (IMF) in March 2023, Sri Lanka is undertaking an array of reforms to address the country’s economic challenges. Last year, the economy shrank by 7.8%, inflation in the first quarter of 2023 was around 50%, and foreign debt payments were suspended in April 2022. Cricket, it would seem, has now been pushed to the margins of conversation.
Such talk on the economy has given Sri Lankans the impetus to understand the complexities of finance – a central bank survey last year found that 58% of Sri Lankans were financially literate, compared with 35% in 2014.
Sri Lanka’s financing industry finds itself at the heart of what will be a transformative process
Debt unloading
Following its pre-emptive foreign debt default in April 2022, Sri Lanka’s financial landscape has undergone a series of radical changes. To allow foreign debt repayments to be resumed, the government is exploring how to reduce its debt burden through myriad initiatives including interest rate reductions and extended payback periods.
Sri Lanka’s financing industry finds itself at the heart of what will be a transformative process. The country’s banking and insurance sectors, along with the Employees’ Provident Fund and the Employees’ Trust Fund (Sri Lanka’s major pension and social security funds), collectively hold more than 80% of all domestic debt. Banks rely on income from coupon payments on rupee bonds, so any restructuring-driven reduction in coupon rates would have an immense impact on their profitability.
The central bank recently conducted a tolerance test to assess the resilience of local banks, the findings of which highlighted a lack of preparedness and the necessary buffers to mitigate the impact of a large-scale restructuring.
Both the IMF and the central bank are working towards minimising the impact on banks. In a positive development, there is even a possibility that the IMF may exclude banks from the process, as financial stability is crucial for the institution as well as the country.
Business headwinds
What of the implications for Sri Lanka’s businesses? Corporations are currently operating in a high-interest environment. The formation rate for startups has fallen, while higher taxes and import restrictions are proving challenging for established businesses, although the authorities are working on relaxing import restrictions as part of the IMF bailout requirements.
Small and medium-sized enterprises (SMEs), the backbone of the Sri Lankan economy, may find that funding is harder to come by as financial institutions exercise greater caution in lending, reducing the amount of credit available. A lack of access to loans, along with shelved expansion plans, and cashflow management issues may stymie growth. And those that are successful in accessing finance may find higher interest rates and borrowing costs prohibitive.
Some businesses will find opportunities in the post-restructuring environment
While some businesses may face difficulties, others may find opportunities in the post-restructuring environment, such as access to new funding sources. A stable macroeconomic environment will attract investments and stimulate economic growth. Businesses that are innovative, diversify their customer base and tap into new markets will find they are able to thrive.
Sri Lanka’s domestic debt restructuring is a defining moment that will shape the nation’s economic future. Key priorities will be effective execution, fiscal discipline, structural reforms, investment promotion, support for SMEs, and stakeholder collaboration. These measures will boost business confidence, attract investments, and create a conducive environment for economic recovery and growth. A shared vision and accountability are essential in shaping a positive economic future for Sri Lanka.
And success is crucial – if only to get Sri Lankans talking properly about cricket again as well as the state of the economy.
