In the short term, Sri Lanka's government will likely prioritize strong tax collection and sustain raised interest rates to inspire creditor confidence and adhere to IMF-recommended reforms; but in the long term, stalled debt negotiations may lead to delays in restructuring, potentially impacting future IMF disbursements and hindering economic recovery efforts. On April 16, Sri Lanka announced it had failed to reach an agreement with the country's bondholders regarding the restructuring of approximately $12 billion in debt. The announcement followed a meeting between Sri Lanka's finance ministry and members of the Steering Committee and the Ad Hoc Group of Bondholders, which comprises some of the largest private holders of the South Asian country's debt. Despite reportedly having constructive discussions, the finance ministry said the two sides failed to reach an agreement due to disputes over the bondholders' proposal for debt repayment, which government negotiators said differed from the IMF's analysis of the country's debt. This comes amid previous criticisms from the IMF that the private bondholders' proposal did not fit within the total amount of financing needed, potentially due to insufficient debt relief. However, the Ad Hoc Group differed in its assessment and called for the issuance of a macro-linked bond as part of new securities for existing bondholders, thwarting efforts to find a compromise. Nonetheless, Sri Lanka has expressed an intent to resume discussions with bondholders to reach a mutual agreement in the coming weeks, before the next IMF program review, possibly in June.
- The Sri Lanka Ad Hoc Group of Bondholders consists of private investors who hold the country's international sovereign bonds. The Steering Committee represents the ten largest bondholders in Sri Lanka.
- Before the Sri Lankan government's recent meeting with bondholders, the IMF informally assessed Sri Lanka's debt restructuring proposals to ensure they were aligned with the country's IMF-supported program and that the debt treatment scenario matched the program's sustainability targets.
- In November, Sri Lanka and a coalition of its bilateral creditors, such as Japan, France and India, reached a preliminary agreement to restructure $5.9 billion of the South Asian country's outstanding public debt. This agreement followed a previous deal with the Sri Lankan government reached with the Export-Import Bank of China in October concerning approximately $4.2 billion in loans.
- In February, Sri Lankan Foreign Minister Ali Sabry stated that the government had set out to finalize a deal on restructuring its approximately $12 billion debt to bondholders by May.
Amid Sri Lanka's recent success in reducing inflation and increasing GDP growth, the government will likely prioritize increasing tax collection and maintaining monetary policies that stabilize prices and foster creditor confidence. Sri Lanka's debt restructuring efforts coincide with the IMF's staff-level agreement it reached with the IMF in March, following the second review of the country's $2.9 billion four-year bailout program. While awaiting approval from its executive board to release the next tranche, the IMF has, in recent months, acknowledged Sri Lanka's progress in addressing economic challenges, notably in implementing reforms that have led to rapid disinflation and reserve accumulation. Over the past year, the Central Bank of Sri Lanka has focused on raising interest rates and controlling liquidity in an effort to curb inflation and improve borrowing, lending and economic activity. According to the bank, this tightening of its monetary and fiscal policies, combined with Colombo's concurrent efforts to reduce government spending and increase taxes, has helped improve economic growth and lower energy and food prices in the country. To sustain this momentum and tackle Sri Lanka's debt issues while facilitating strong reserve accumulation, the IMF has advised Sri Lanka to swiftly reach restructuring agreements with bondholders and continue implementing its IMF program recommendations. Those recommendations include implementing measures to improve the government's tax collection, such as introducing a progressive property tax, removing tax exemptions in industries like tourism and agriculture, and enacting mechanisms to actively combat tax evasion. Additionally, the government's future monetary policy will likely focus on keeping inflation under control, building on the central bank's recent success in curbing prices.
- The World Bank now projects Sri Lanka's economy to grow by 2.2% in 2024, after contracting by 7.3% in 2022 and 2.3% in 2023. Sri Lanka's annual inflation rate is also expected to fall to 7.8% in 2024, down from 17.4% in 2023 and the whopping 46.4% inflation rate the country recorded in 2022.
Sri Lanka's stalled debt negotiations will not impact the release of the third tranche of its IMF loan, as long as the government keeps negotiating with bondholders in good faith. Following its March review of Sri Lanka's program, the IMF indicated that the government next needed to finalize agreements with official creditors and reach agreements in principle with the country's main external private creditors in a ''timely manner'' in order to restore Sri Lanka's debt sustainability over the medium term. However, the Ad Hoc Group's proposal to tie repayments to the country's future macroeconomic growth through macro-linked bonds (MLBs) remains a significant obstacle toward reaching such agreements. The bondholders' proposed plan would link bond repayment to macroeconomic indicators, such as GDP growth or inflation, introducing uncertainty and risk for both the government and investors. The Sri Lankan government views this as risky, as positive economic growth could lead to higher repayment obligations, straining the country's finances. A potential compromise could involve either limiting the extent of linkage between repayments and macroeconomic indicators, or including a detailed mechanism for adjustments to the MLB terms based on agreed-upon macroeconomic indicators. That said, as long as the government continues to negotiate with bondholders in good faith, the current lack of progress in debt negotiations is unlikely to prevent the IMF from approving the next $337 million tranche of Sri Lanka's $2.9 billion bailout. Indeed, after the recent failed attempt at securing a debt restructuring deal, the IMF reiterated its support for Sri Lanka, encouraging continued discussions for an agreement consistent with the parameters of the IMF-supported program and official creditors' interests.
- In the context of debt negotiations, an agreement in principle is a preliminary understanding between the creditor and payer that covers the key terms and conditions of debt restructuring. While not an officially legally binding deal, this agreement outlines the general framework for the final agreement, paving the way for more detailed negotiations and allowing parties to formalize the terms into a legally binding agreement.
If, however, Sri Lanka does not make notable progress toward reaching a debt restructuring deal and/or fails to adhere to other IMF recommendations in the coming months, there is a chance the IMF could delay future disbursements, which would exacerbate the country's economic challenges — something the government will seek to avoid ahead of upcoming elections. In the long term, without an agreement in principle in place with the country's private creditors, Sri Lanka's debt restructuring process could be delayed, which could, in turn, eventually jeopardize the country's access to future IMF disbursements. If Sri Lanka fails to meet other IMF conditions — such as improving revenue administration, enhancing anti-corruption efforts to boost tax collection, and maintaining cost recovery in fuel and electricity pricing — the fund could also potentially delay disbursements. Such a delay would risk deepening the country's economic challenges, as the loss of crucial IMF funding would likely force the government to exhaust its foreign reserves and take out additional loans from other creditors, leaving Colombo more cash-strapped and in even greater debt. This would risk hindering Sri Lanka's economic recovery efforts, hurting investor confidence, and postponing the country's path to debt sustainability. Such a scenario would prove particularly problematic for Sri Lankan President Ranil Wickremesinghe ahead of the country's September presidential election, given that his reelection campaign has focused on addressing Sri Lanka's debt woes. With Wickremesinghe focused on securing another term, his government is thus politically incentivized to keep Sri Lanka's economy on its current positive trajectory, in order to signal its commitment to debt sustainability to both the IMF and Sri Lankan voters. This will increase the likelihood that Colombo reaches an agreement with private bondholders ahead of the election, which would pave the way for the IMF to provide more funds to Sri Lanka conditional on Colombo continuing to comply with other IMF-recommended policies, such as the aforementioned tax reforms.