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Sri Lanka’s cabinet has approved a proposal to restructure the bankrupt country’s domestic debts of $42bn, a controversial decision that the government says is necessary to comply with the terms of its IMF bailout.
Sri Lanka, which defaulted on its foreign debt last year, secured a $3bn, four-year lending programme with the fund in March and is in negotiations with creditors including China, India and Japan to restructure its foreign debts, amounting to another $42bn as of the end of 2022.
But President Ranil Wickremesinghe’s government had been reluctant to restructure the country’s local-currency liabilities over fears that the hit to banks, pension funds and other financial institutions that hold the debt would derail Sri Lanka’s nascent economic recovery.
Wickremesinghe’s office announced late on Wednesday that the cabinet had approved a domestic debt restructuring proposal and would submit it to parliament for approval on Saturday, without providing further details.
Officials argue that Sri Lanka will not be able to meet the conditions of its IMF programme, such as lowering its debt-to-GDP ratio and gross financing needs, without also restructuring domestic debt.
The government has declared successive holidays between Thursday and Monday in order to prevent a run on banks following the decision. In a speech on Tuesday, Wickremesinghe tried to reassure the public that its plan “poses no harm to bank depositors and will not lead to a collapse of the banking system”.
Sri Lanka last year became the first Asia-Pacific country to default in more than two decades after running out of foreign currency because of economic mismanagement and the fallout from the Covid-19 pandemic.
Wickremesinghe’s predecessor, Gotabaya Rajapaksa, was forced to resign and flee the country after mass protests over shortages of food and fuel.
Sri Lanka has since become a test case for how to juggle the challenges facing many distressed low and middle-income countries.
In particular, efforts to restructure its foreign debts have been slowed down by tension between the so-called Paris Club — made up of established lenders such as Japan — and China, whose importance as a creditor to the developing world has surged over the past decade.
Beijing, Sri Lanka’s largest bilateral creditor with about $7bn in debts, had for months resisted agreeing to restructure along the IMF’s terms. It has also not joined a committee of creditors designed to speed up the restructuring process.
The IMF has so far released $333mn of funds, with the rest due in a series of disbursements over the coming four years. In order to secure the next tranche later this year, Sri Lanka needs to show it has made significant progress in restructuring its debts.
Officials argue that a domestic debt restructuring is vital to share the pain among creditors. Dimantha Mathew, research head at brokerage First Capital in Colombo, said authorities should be able to focus on debts held by Sri Lanka’s central bank, rather than commercial lenders and other financial institutions, which will help limit the economic fallout.
“We don’t think they will touch the finance sector, since we’re already looking at a recovery,” he said. If not, he added, growth would risk being “hampered”.