debt crisis Archives

Right now, the economic situation in Sri Lanka is grave. It has piled up external debt over the years, has run out of its foreign reserves, and is facing a food crisis. Two superpowers are plotting a strategic game amidst the crisis— India and China. In this piece, we discuss the economic crisis, what led to it, and how it could possibly impact India.

The Situation

Simply put, Sri Lanka has taken a lot of loans from other countries. It accumulated a massive amount of debt over time. Between 2011 and 2021, Sri Lanka’s total external debt has more than doubled. The total debt owed by Sri Lanka in fiscal 2020 was USD 49.2 billion. This was close to ~57% of Sri Lanka’s total GDP. Sri Lanka did pay back a tiny part of the debt over time. In the process, it depleted its foreign exchange (forex) reserves. For a developing country like Sri Lanka, a forex reserve would help in three ways:

To maintain confidence in its monetary policy and exchange rate in the foreign market for its own currency, the Sri Lankan Rupee (LKR).

To pay back the debt that it took from other countries.

For having a greater buying power that would enable Sri Lanka to import goods.

India was in a similar situation in 1991. It had nearly depleted all of its forex reserves that would roughly last three weeks. That is when the government decided to liberalize and privatize the Indian economy to attract foreign investment.

Coming back to Sri Lanka. The country is now facing a severe food shortage. Imports of essential goods were banned. These included motor vehicles, clothes, cosmetics, and even Sri Lanka’s staple item, turmeric. Sri Lanka imports 7,000 tonnes of turmeric every year, out of which 5,000 tonnes come from India. This has sent the price of turmeric skyrocketing, causing a row in Sri Lanka. Even its primary source of foreign currency was shut during the COVID-19 pandemic, the Tourism Industry.

Sri Lanka has banned the import of fertilizers as well. The government is encouraging farmers to undertake ‘Organic Farming’. This fertilizer ban has caused a decline in crop production while impacting farmers’ financial conditions. Shortage of food has sent its prices skyrocketing.

Sri Lanka has the daunting task of boosting economic growth, increasing forex reserves, and cutting down on its external debt. All of this is combined with the uncertainty of COVID-19. However, amidst Sri Lanka’s grim economic situation, two countries seem to play a tug of war amidst Sri Lanka’s grim situation, India and China.

China At Play

China is playing what is known as debt-trap diplomacy. In a debt trap move, China would target countries with poor economic conditions yet are rich in resources and raw materials. Chinese companies, banks, or financial institutions would then lend money to these countries for unsustainable projects, at commercial interest rates. Countries desperate enough for financial assistance would accept this deal, hoping to replenish forex reserves and boost economic activity. Unable to pay back the loan on time, these countries would then be ‘compelled’ to lease their essential assets to China. One such example is Sri Lanka’s port, Hambantota.

Sri Lanka intended to develop the Hambantota seaport in Southern Sri Lanka. The only country that showed a willingness to fund the project was China, through its EXIM Bank. The bank extended loans to Sri Lanka between 2007-2016. For the first phase of the project, the bank lent USD 307 million to Sri Lanka at an interest rate of 6.3%, a considerably high interest rate.

Sri Lanka did manage to complete the project, but there was no ship traffic to the port because of a rock in the sea bed that was blocking the way for ships. In 2016, low on forex reserves and unable to pay the loans, Sri Lanka was left with no choice but to lease it to China for a period of 99 years. There are reports that China is planning to turn around the project into a multipurpose port by 2022. Recently, a Chinese ship with radioactive material was intercepted by Sri Lankan authorities at Hambantota port. Is it possible that China is planning to convert it into a strategic military base?

When China took control of the Hambantota seaport, India initiated talks with Sri Lanka to run a joint venture and operate Hambantota Airport. This was an indicator of a power tiff between rivals India and China.

What’s At Stake For India?

China has benefited immensely from Sri Lanka’s economic crisis. Close to 10% of Sri Lanka’s external debt is owed to China. In fiscal 2020, China beat India in being Sri Lanka’s top import partner. Although Sri Lanka forms a tiny portion of India’s export basket, its location is strategically crucial.

India and China haven’t had the best trade relationships lately. China has now strategically surrounded India from all sides by acquiring important seaports and routes in all directions. This will not only give its Navy an advantage but will also help China in advancing its shipping route positions. Sri Lanka has till now been a small yet significant ally to India, in terms of diplomacy, military support, and trade. Nevertheless, China seems to be courting Sri Lanka.

India has had a bumpy relationship with Sri Lanka lately. In Feb 2021, India refused to extend a currency swap facility to Sri Lanka. Sri Lanka was allegedly responsible for the death of three Tamil Nadu fishermen that had apparently strayed into Sri Lanka waters.

To get out of a similar forex crisis in 1991, India took the help of the International Monetary Fund (IMF) but faced severe economic restrictions. Eventually, India got out of the crisis, and the rest is history. Sri Lanka has refused any help from the IMF and continues to take loans, grants, and currency swaps with China. Moving ahead, Korea, India, China, and even the Asian Development Bank have extended their support to Sri Lanka through grants and currency swaps. Banning imports cannot be the solution in the long term to maintain stability within the country. Sri Lanka will have to undertake some austerity measures to ensure sustainable growth.

Turkey, a country with a population of just 8.2 crore people, has abundant natural resources. It is one of the most developed countries in the Mediterranean region and Middle-East. It has the 17th largest GDP in the world. As a country, Turkey prospered far better in the 21st Century than its neighbours. However, tables turned for Turkey after 2016.

The Turkish Lira(TRY/₺) recently fell 15% against the dollar after Turkish President Recep Tayyip Erdogan fired its central bank chief for “increasing interest rates,” something the President was totally opposed to. Earlier, Turkey had faced an economic and political crisis post-2016, a military coup, a financial crisis followed by the aftermath of the COVID-19 pandemic. In this piece, we summarize Turkey’s political and economic situation and what it means for the global markets.

Military Coup and The Debt Crisis

Turkey’s relationship with its current president has been pretty shaky since he was elected to office in 2014. A fraction of its military revolted against the Erdogan Government in 2016. It failed, and all involved were tried in court and sent to prison. Some were against the coup; some secretly supported it. Essentially, there was unrest in the country. The tension was because of social, economic, and political reasons put together. Turkey used to be one of the more economically and socially ‘liberal’ countries than its neighbors Syria, Iraq, Iran, and Armenia. President Erdogan was following a stricter and more ‘religious’ approach to governance.

Meanwhile, Turkey was grappling with a private debt crisis in 2018. After the 2008 economic crisis, there was a lot of money flowing in the market since the United States had lowered interest rates and spurred the economy with a stimulus package. The emerging economies like India and Turkey benefited from it and ended up receiving tons of foreign investment. Investors preferred investing in emerging markets since they got a better rate of return than the US markets. Most of the investment and growth in Turkey were fuelled by debt. People borrowed money to set up businesses hoping they would flourish.

Now there are three catches to the economic crisis,:

Catch #1: The US government had started rolling back its stimulus program and jacked up interest rates back at home. The foreign investors withdrew money from emerging markets to put them in domestic ones. This is known as Taper Tantrum. You can read more about Taper Tantrum over here.

Catch #2: Remember, the growth in Turkey post-2008 was fuelled by foreign debt. Suddenly, the development stopped, and there was no money to pay back the foreign debt. The amount of Non-Performing Assets increased. There was a large current account deficit for Turkey. Meaning, Turkey was paying more for its imports than it was getting from its exports.

Catch #3: While foreign investment was coming in, inflation went up. Naturally, if people have more money in their hands, then they are likely to spend more. This would increase the overall price of goods due to increased demand. As inflation went up, the purchasing power of the Turkish Lira went down. This affected the ability of businesses to pay back foreign debt which was in a powerful currency denomination like the Euro or Dollar.

In addition to this, there was political tension with Russia after it shot down a Russian fighter plane. Then there was a civil war in the neighbouring country Syria. The United States had jacked up duties on metal imports from Turkey. This kicked the value of Lira FURTHER DOWN. The price of the Lira has been pretty volatile since then.

Current Scenario

President Erdogan follows a very ‘orthodox’ interest rate policy. He is against high interest rates as he believes that the concept of interest is against Islam and that lowering interest rates will fuel economic growth. He isn’t totally wrong. However, decreasing the interest rates also increases inflation, impacting the purchasing power of the Turkish Lira and its stance against the Dollar in the global markets. What did Erdogan want? Simple, to keep Interest rates as low as possible.

As stated by Erdogan in a public forum, he believes that increasing interest rates will increase inflation. This goes against commonly accepted basic economics.

Erdogan has an authoritarian style of governance. He doesn’t like anybody going against his ideals. Naci Agbal, the former central bank chief, successfully curbed inflation by following specific monetary measures and increasing interest rates. Naci Agbal’s appointment as central bank chief proved to be Golden for the Turkish Lira. Turkish Lira grew ~17% since his appointment in November 2020. Inflation came down, stock markets went up, and public sentiment was bullish.

However, Naci Agbal was going directly against the orders of Erdogan. He was eventually taken off his position by Erdogan which didn’t go down well with the market. Eventually, the Lira against the US Dollar fell back to where it came from. It tanked 15% as investors that were bullish on Lira were now selling it and buying Dollars and so the economic crisis continues.

Does This Affect India?

India and Turkey had a bilateral trade of ~$9 billion as of 2019. Turkey imported goods and services worth ~$7.5 million from India. It mainly imported petroleum oils and oils obtained from bituminous minerals. India doesn’t extract or import crude oil but is a major exporter of processed/finished petroleum products, a portion of which it exports to Turkey as well. As Turkey’s purchasing power goes down, it might import less from India. That however keeps the value of the Indian rupee and the stock markets untouched.

However, there is another aspect to this. Turkey and India both count as ‘Emerging Economies’. A spillover effect can impact other economies. As investors sell the Lira for the Dollar, the Indian Rupee might get swept away in the process. This can be an impact in the near future in case the situation gets worse. Lately, India hasn’t had the best of political and diplomatic relations with Turkey. A vibrant economic synergy between the two countries can be created provided the countries put aside their political differences.