Eranga Jayawardena/AP Photo
People wait in line to buy fuel in Colombo, Sri Lanka, March 3, 2022.
In 2002, China lent Sri Lanka more than $1 billion for the Hambantota Port project, an ambitious development meant to attract container ships flowing across the Indian Ocean, one of the world’s busiest waterways.
After the port opened, Sri Lanka failed to keep up with interest payments. Beijing pressured the small island nation to hand it back as collateral in a 99-year lease to the Chinese. The port became a byword for debt diplomacy, the concern that China is saddling poorer countries with unpayable infrastructure debts and then seizing commercially and militarily strategic assets.
Yet today, Sri Lanka is again approaching China for $2.5 billion in lending, even as it pleads to restructure its existing borrowing. The country is caught in an escalating debt crisis, pushed over the brink by war in Ukraine and mounting food and fuel costs. Plus, prior to the pandemic the former president engaged in a series of “white elephant” infrastructure projects, like the port, which are coming back to bite.
“Coming out of the pandemic, they’re essentially bankrupt,” said Richard Kozul-Wright of the United Nations Conference on Trade and Development (UNCTAD). “They can’t pay.”
Sri Lanka is not only courting China. It is also in talks with the International Monetary Fund (IMF). And The Wall Street Journal reported that officials have met with investment bankers from Rothschild and Lazard to discuss raising cash through floating debt or asset sales. That could be the most dangerous path of all. A Chatham House analysis found that the country’s debt distress was more closely linked to borrowing on Western capital markets than any uniquely predatory lending from Beijing.
Cash-strapped Colombo’s current crisis reflects the bleaker reality facing emerging economies chasing international creditors: There are few good options. Chinese credit is expensive, and IMF aid is laden with conditions. India has just extended a $1 billion facility for imports of food and medicine, but its neighbor faces dwindling dollar reserves and a high debt burden that will not be easily unwound.
Now, sanctions on Russia for its violent war in Ukraine, coupled with the worst COVID-19 outbreak in China since the start of the pandemic, have extended trade disruptions and driven up the price of basic commodities.
THE LOOMING FOOD CRISIS is being cast as an inevitable consequence of an exogenous shock: war in the world’s breadbasket. But for the developing world, it could be caused as much by the economic and trade policy reaction of advanced economies—monetary and fiscal tightening—as by the war itself.
Developing countries like Sri Lanka face compounding crises as richer countries wind down pandemic-era monetary and fiscal supports and tighten their balance sheets. Strained post-pandemic budgets, high debt, and low foreign-exchange reserves are a flammable mix.
The macroeconomic conditions now sparking food riots are the subject of a new trade and development report by Kozul-Wright’s group at UNCTAD released yesterday, titled “Tapering in a Time of Conflict.” The group’s economic-outlook projections have a highly predictive track record, and this latest report revises down growth expectations for 2022 in light of new risks to the global economy.
Sri Lanka, whose debt crisis is several years in the making, is a useful illustration of key dynamics. Remittances and exports collapsed during the pandemic, which also disrupted the crucial tourism sector. The growth slowdown strained the budget and depleted foreign-exchange reserves, leaving Colombo now struggling to import oil and food.
The shortages are acute. Two men in their seventies died while waiting in line for fuel, Al Jazeera reported. Milk prices have increased, and school exams were canceled due to shortages in paper and ink.
As Sri Lanka struggles to service the $45 billion in long-term debt it owes, of which over $7 billion is due this year, it could join countries that have defaulted during the pandemic, including Argentina and Lebanon, which is heavily dependent on wheat imports.
The pattern illustrates the procyclical dynamics of developing-world finance: Under looser monetary conditions, capital moves in fueling debt run-ups, like the ones that financed the former president’s white elephant projects. It flees just as quickly.
THE REPORT’S TITLE refers to the period in 2013 when the Federal Reserve and the European Central Bank (ECB), having pulled out of the 2008 financial crisis, dialed back their bond-buying. In a so-called “taper tantrum,” investors pulled out of emerging markets like Brazil and Turkey in favor of advanced economies, where bond yields had started to look more attractive.
Now, as the Federal Reserve hikes interest rates, it could once again suck capital back from developing countries to the Global North, causing currency depreciation with dangerous knock-on effects. Meanwhile, contractionary monetary policy in rich countries can dampen domestic economic activity and lower demand.
UNCTAD stops short of forecasting the outcome of interest rate hikes by the Fed and European Central Bank. Another taper tantrum is hard to predict, the report argues, since it would be set off by herd behavior in markets, not just fundamentals. But even absent quick capital withdrawal, developing countries are being urged to readopt austerity budgets that could send them into recession.
The upshot, the report explains, is that the developing world will undergo a painful adjustment one way or the other, whether “by volatile liquidity-driven cross-border financial flows, or by the slower grind of diminished policy space, fiscal and monetary tightening and squeezed incomes.”
Yet even monetary tightening in the advanced world is not preordained—or even necessarily the right solution to inflation caused by real supply disruptions.
“The inflation is coming from multiple causes, but the response is orthodoxy. You have inflation from war, but we’re choosing monetary tightening, heading into recession purely as a policy choice,” said Pavlos Roufos, a doctoral candidate in German economic policy who wrote a book on the Greek debt crisis.
The coming months beg the question of what anti-inflation politics will materialize, both in emerging markets and in the core advanced economies.
“If you look at it from the perspective of capital, inflation is always bad, because it means wealth is being debased. If you look at it from the perspective of workers, inflation just means you have to find ways to meet the costs of reproduction. In the past, that has meant people went to [political] struggles,” Roufos said. Inflation can galvanize bottom-up protests that translate into material gains for workers.
But proponents of top-down Keynesian fiscal stimulus should pay attention to the actual public response to inflation, Roufos argued, where pro-labor movements will not necessarily materialize. The emerging anti-inflation politics could instead emphasize hard money.
A DEBT SERVICE SUSPENSION initiative initiated by the G20 in response to the pandemic saw pitiful results: In total, over the last two years, it has suspended some $10.3 billion. Some additional debt could still be suspended, since the program was extended through the end of 2021. But in the first year of the pandemic alone, low-income countries accumulated a debt burden totaling $860 billion, according to the World Bank.
The United States also extended swap lines—trading dollars for foreign currency—to major overseas central banks during the latest crisis. That cemented the U.S. role at the heart of the global financial system, even as the People’s Bank of China struck currency swap agreements denominated in yuan with more than 30 central banks in developing countries.
The report’s findings imply that tools for funneling dollars to the developing world are in need of a deeper restructuring. Yet even one-off injections of aid have been slow to materialize.
Progressives in Congress have for months urged a new issuance of special drawing rights (SDRs), an international reserve asset issued by the IMF that can be exchanged for dollars. Just as dollars are backed by the U.S. government, SDRs are backed by the full faith and credit of IMF member countries—so they don’t require any budgetary expenditure, just authorization. And unlike IMF loan programs, freshly issued SDRs come with no strings attached.
The IMF injected $650 billion of aid through the SDR program last summer. Like much of the global financial architecture, SDR quotas are disproportionately tilted toward rich countries: Africa in its totality receives less SDRs than the German Bundesbank. Still, there are efforts to redirect SDRs issued to rich countries, and the share that does go toward developing countries can improve their creditworthiness and help them make crucial purchases.
Development economists say another infusion is now needed to ease the latest price shock. A reissuance passed the House, but seems unlikely to clear the Senate. In its recommendations for executive action, the Congressional Progressive Caucus proposed a new issuance of SDRs to help developing countries “purchase vaccines, treatments, protect public health budgets, and spur global demand for U.S. exports.”
The emphasis on reviving global demand is astute, since tightening monetary policy and squeezed fiscal space will be moving budgets in the opposite direction. But the fight for rebuilding resilience through countercyclical investment looks increasingly uphill.
The final and looming threat previewed by the report is the climate emergency, which could be a threat multiplier that “will exceed the willingness of the Federal Reserve in its recently adopted role of unofficial lender-of-last resort.”
Although the war has put a pause on decarbonization efforts, Kozul-Wright said, “the interaction of finance, fuel, and food pressures look like a disturbing preview of what lies ahead in a warming world.”
