GS Paper II

News Excerpt:

Sri Lanka has reached an "agreement in principle" with India and the Paris Club, including Japan, on a debt treatment plan.

About the news:

• The Official Creditor Committee (OCC) and Sri Lanka have agreed on main parameters consistent with the Extended Fund Facility (EFF) arrangement with the International Monetary Fund (IMF).
• China, Sri Lanka's largest bilateral creditor, chose not to participate in the OCC but attended meetings as an observer.
• Japan and India, emphasized the need for creditor parity and transparency, urging other bilateral creditors, including China, to share information transparently.

Significance of the agreement:

• IMF Conditionality: The agreement between Sri Lanka, India, and the Paris Club aligns the debt treatment plan with the parameters of the Extended Fund Facility (EFF). The successful conclusion of this agreement is a prerequisite for accessing the next tranche of the IMF's nearly-$3 billion recovery package
• Crisis-Driven Default: Sri Lanka defaulted on its nearly $51 billion foreign debt during a crippling economic crisis. The comprehensive restructuring of loans is essential to kickstart an economic recovery program supported by the IMF.
• Commitment to principles: The agreement with the OCC reflects a commitment to the principles of ensuring a fair and transparent approach to debt treatment.
• Creditor Coordination: The agreement signifies coordination among official creditors, including India and the Paris Club, in addressing Sri Lanka's debt challenges. This coordination is crucial for implementing a cohesive and effective debt treatment plan.

Background:

Economic Crisis in Sri Lanka:

• Signs of Distress:  In early 2022, Sri Lankans started experiencing power cuts and shortages of basics such as fuel. The rate of inflation rose to 50% a year. Foreign debt increased from US$11.3 billion in 2005 to $56.3 billion in 2020.
• Fuel Shortages and Service Disruptions: The country ran short of fuel for essential services such as buses, trains and medical vehicles because it did not have enough reserves of foreign currency to import any more.
• Factors Behind Debt Crisis:  Numbers of factors are supposed to be responsible for Sri Lanka’s debt crisis such as Government's Mismanagement, Covid impact on tourism, heavy dependence on China, Prohibition of Fertilizer Imports, Foreign reserve scarcity, etc.
• Default Decision: In response to the crisis, Sri Lanka decided to default on its foreign debt of nearly $51 billion.
• IMF-Led Recovery Strategy: The economic recovery program, backed by the IMF's nearly $3 billion recovery package, became crucial to address the crisis.
• OCC: Major lenders formed the Official Creditor Committee (OCC) in May 2023 to address Sri Lanka's request for debt treatment.

India’s support to Sri Lankan debt crisis

•  India extended multi-pronged assistance of about USD 4 billion to it in 2022.
•  Multiple credit lines and currency support are in line with India’s ‘Neighbourhood First’ policy.
•  India was Sri Lanka’s largest trading partner in 2022. Sri Lanka’s exports to India have also grown.
•  The use of Rupees for trade settlement is further helping Sri Lanka’s economy. 
•  In 2022, India was the largest source of tourists for Sri Lanka with over 100,000 tourists.
• India is working with the Paris Club on a debt treatment plan.

Suggested measures

• Independent Central Bank: Ensure the independence of the Central Bank to maintain a stable monetary policy.
• Tax reforms: Implement tax reforms focusing on widening the tax base rather than just increasing tax rates.
• Global supply chains: Focus on becoming part of global supply chains, leveraging trade liberalization, increased foreign direct investment (FDI), and strategic trade agreements.
• Factor Market Reforms: Implement reforms to address land ownership issues, including proper land valuation systems and reducing government ownership to encourage private sector development.
• Overcome Twin Deficits: Prioritize fiscal consolidation as a medium-term measure to address both government budget and trade deficits.

Conclusion

Sri Lanka requires wide-ranging economic and political reforms for long-term sustainable growth to service its debt obligations and to emerge from this crisis stronger.  Implementing the above measures collectively can contribute to addressing Sri Lanka's economic crisis and pave the way for long-term sustainable growth.

Mains PYQ

‘India is an age-old friend of Sri Lanka.’ Discuss India's role in the recent crisis in Sri Lanka in the light of the preceding statement. (UPSC 2022)