Asian Economy: Some improvements, but vulnerabilities remain

There are several difficulties, including Sri Lanka’s designation as a middle-income economy, which disqualifies it from applying for relief under the Common Framework.

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Houses and Apartment Complexes seen from the top of Colombo, Sri Lanka, on August 7, 2023. The current metro area population of Colombo in 2023 will be 633,000, a 1.12% increase from 2022. The metro area population of Colombo in 2022 was 626,000, a 1.13% increase from 2021. The metro area population of Colombo in 2021 was 619,000, a 0.98% increase from 2020. (Photo by Thilina Kaluthotage/NurPhoto)

Financial risk has eased in several Asian countries. After announcing that it would suspend external debt repayments indefinitely in April 2022, Sri Lanka secured final approval from the IMF for a US$2.9bn package in March 2023. The government hopes to negotiate an extended grace period for its foreign debt, with the prime minister, Ranil Wickremesinghe, seeking a ten-year moratorium. However, there are several difficulties, including Sri Lanka’s designation as a middle-income economy, which disqualifies it from applying for relief under the Common Framework. In addition, Sri Lanka owes a significant amount of debt to China, which is reluctant to agree to a haircut or to participate in a multilateral restructuring initiative. Conditions in the banking sector remain challenging, with some of Sri Lanka’s biggest banks having extensive exposure to foreign-currency-denominated government securities. The sovereign debt default threatens to undermine these banks’ balance sheets, heightening the risk of a crisis.

A last-minute staff-level agreement by the IMF in late June to unlock a new stand-by arrangement (SBA) worth US$3bn has helped Pakistan to avoid a debt default. The SBA will help the government to get through the national election (due to be held by October 2023) without risking a default. Access to fresh loans will shore up Pakistan’s foreign-exchange reserves, and allow the country to pay for critical industrial raw materials, thereby giving some traction to faltering industrial activity. However, the chronic twin deficits on the balance of payments and fiscal accounts (linked to a very narrow tax base), lacklustre economic activity, and limited appetite for other creditors to assist Pakistan mean that the next government will have to start negotiating for another IMF package sooner rather than later. The fresh IMF package will lend some support to the currency, but ongoing investor concerns about Pakistan’s debt sustainability will weaken the rupee.

Excerpts from the No return to cheap money: How tight financing conditions will affect country risk published by Economist Intelligence

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