Sri Lanka’s economic situation is a warning to Bangladesh

The fact that Bangladesh is able to bail out Sri Lanka, a middle-income country according to the World Bank classification since 1997, by extending up to $ 500 million – is a good morale booster.

But this episode is also an edifying tale for Bangladesh: if the government does not react now, the country could very well be in the place of Sri Lanka in a few years.

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The Achilles heel of both economies is the same: low tax base, overreliance on a single item for exports, and insignificant foreign direct investment.

What Bangladesh has on its side is time.

It is still a less developed country, which means that it has access to concessional loans from multilateral and bilateral lenders like the World Bank, the International Monetary Fund, the Asian Development Bank and the Japan International Cooperation Agency.

The loans have an extended term of 25 to 40 years as well as a reasonable grace period and an interest rate of less than 2%.

The victim of a civil war that lasted for a quarter of a century, Sri Lanka has relied heavily on this external debt to build its infrastructure – an economic practice, for the most part.

But by the turn of the century, following its transition to lower-middle-income country status in 1997, Sri Lanka’s access to these loans had declined, meaning it had to seek funds elsewhere.

In 2007, Sri Lanka issued its first International Sovereign Bond (ISB) – valued at $ 500 million – and increasingly began to turn to this channel of commercial borrowing.

BSIs have a 5-10 year repayment period, carry interest rates over 6%, and no grace period.

To complicate matters, there are principal payments: the total amount borrowed from an ISB is settled all at once on the bond’s maturity date; repayment is not spread over several years, as is the case with concessional loans.

Thus, when an ISB matures, a country’s foreign currency reserves are severely affected.

By the end of 2020, up to 50% of Sri Lanka’s outstanding external debt was tied to BSIs, according to its central bank data.

This would not have been a problem if the Sri Lankan government had the means to repay, if it had remedied the structural weakness of its economy when it began to rely heavily on commercial borrowing.

In 2019, Sri Lanka’s tax-to-GDP ratio stood at 12.2%, which is not too much better than Bangladesh’s at around 10%.

Its foreign direct investment figure fluctuates in the millions, while that of Bangladesh is in the first billions.

Its $ 88 billion economy is heavily dependent on tourism and clothing exports, leaving it at the mercy of external factors.

Bangladesh’s strong foreign exchange reserves are due to clothing exports and remittances sent by unskilled workers, both of whom are highly exposed to external shocks.

Sri Lanka has $ 3.7 billion in external debt maturing this year and around $ 4 billion in foreign exchange reserves at the end of April, hence the desperate rush for dollars.

To make matters worse for Sri Lanka, global credit rating agencies have unilaterally lowered its sovereign rating, so the option of issuing more BSIs to serve those maturing this year is irrelevant.

Fitch downgraded Sri Lanka’s sovereign credit rating to “CCC” last year, saying the country’s chances of default are “a real possibility.”

Rival rating agency Moody’s also downgraded Sri Lanka to an equivalent level.

“The problems Sri Lanka and Pakistan are currently facing did not emerge overnight,” said Ahsan H Mansur, executive director of the Policy Research Institute, a private think tank.

Bangladesh should therefore closely monitor developments in the crisis in both countries and learn from them.

In fiscal year 2018-2019, which is the latest data available from the Economic Relations Division, Bangladesh’s external debt-to-GDP ratio was 14.7%, compared to 13.2% in the 2015-2016 fiscal year.

While the ratio is well below the 40 percent threshold, Bangladesh’s external lending is on the rise.

“When a car loses control on an uphill climb, it is descending at an accelerated pace and there is nothing we can do about it. We’re not at that point yet,” said Mansur, a former economist with the International Monetary Fund.

Bangladesh is on track to become a middle-income country by 2024, so its concessional financing window will be closed by 2027. This is another aspect the government needs to consider.

Up to 84 percent of Bangladesh’s exports come from apparel shipments largely to developed countries in the west.

“We will be in trouble if we cannot diversify our exports sooner rather than later. Just because of the remittances, our reserves are high and we are comfortable on the external front.”

But the current dramatic trend in remittances is not sustainable, Mansur said.

“Once people start to travel freely, this trend will collapse and our foreign exchange reserves will contract.”

Bangladesh’s domestic position is very uncomfortable: the government’s debt service to revenue is high, according to Mansur, also chairman of Brac Bank.

“Our ability to pay cannot be assessed in terms of GDP because the private sector is taken into account. Debt must be paid by income and our income base is low. Our tax-to-GDP ratio is one of the worst. in the world.”

Mansur went on to urge the government not to borrow for every project.

“Except for very productive companies, the decision to borrow must be considered with rigor. Borrowing does not make sense for every project,” he said, citing the Rooppur nuclear power plant as an example. project that does not justify a loan.

But for projects like the Padma Bridge and the Karnaphuli Tunnel, the loan is valid because these would be able to pay back their costs during their lifetime.


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About Kristina McManus

Kristina McManus

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