Sri Lanka’s economy is collapsing. Could Australia be next?
Ok straight up. This has absolutely nothing to do with cricket. Sorry if that disappoints.
So I don’t know if you’ve caught this – it’s not getting all the much coverage in the media – but the Sri Lankan economy is in meltdown right now.
The country is facing power black-outs for 12 hours at a time. Energy prices for fuel and gas have doubled. The price of white-rice – the dominant staple – is up 93% on pre-Covid levels.
The economy is in trouble.
And the people have taken to the streets. Last week one person was killed and 13 people injured when police fired on protestors.
Things are getting hectic.
And what’s the story?
Well, it just seems to be a vanilla debt crisis.
Many people are pointing the finger at corruption at the political level. The Prime Minister and the President are brothers, so it’s probably not helping.
Some people have also accused China of laying a debt trap – funding white elephant projects that create no return and plunge the country into debt, which China then offers more debt to help fix.
Kind of like pay-day lending.
That has some populist appeal, but China only accounted for 17% of total foreign debt liabilities in 2019, so it probably isn’t making that big a difference.
No, it looks to me like this is a text-book sovereign debt crisis.
That is, the Sri Lankan government took on too much debt and now can’t pay it back. That’s created a run on the currency which has since collapsed. (This chart shows how many Rupees you need to buy one US dollar.)
When the currency collapses, that makes paying back the debt harder and also causes import prices to spike. Rising import prices make everything expensive, which is why you have inflation running at close to 19%, with food inflation topping 30%.
And how did it happen?
Well, just Ernest Hemmingway reckons he went broke, “slowly, then all at once,” this debt crisis has been a few years in the making.
Part of the story is a stagnating export sector. Exports, as a percent of GDP, fell from 39% in 2000 to 20% in 2010. Then Covid came and completely decimated the tourism sector, and exports fell further to 17%.
At the same time, the government deficit has been blowing out. This hasn’t been about increasing spending, but falling revenue, on the back of populist tax-cuts that effectively left some middle-class Sri Lankans paying no tax at all.
As a result, Government tax revenue fell from 18% of GDP in 1992 to 12.7% (2020), and then as the economy faltered, fell further to 8.4% 2020.
As a result of that, Sri Lanka’s creditors started to get nervous. That meant they did two things. First they increasingly wanted to be paid back in US dollars rather than Rupees.
The share of US dollar denominated debt jumped from 36% of total in 2012 to 65% in 2019.
Second, they wanted more return for their risk. The average duration fell (60% of loans to the government are for less than 10 years), and rates rose. This year, the Sri Lankan government has effectively been paying commercial rates, up around 6-7%.
Compare that with Australia where the government is paying in the zero-point-somethings.
With interest payments alone gobbling up 95% of revenue, Sri Lanka was in deep trouble.
At this point, they were in a debt spiral. They were replacing cheap debt with expensive debt, which was blowing out the repayment burden. At the same time, as the economy collapsed and creditors got nervous, the currency started to collapse.
That meant that all that US dollar denominated debt got more expensive.
Which meant they needed bigger loans to cover the interest, which caused the currency to fall, which made the debt more expensive…
And around and around we go.
So, Sri Lanka’s in trouble.
The question that I get is could this happen in Australia? We know that government debt has exploded since Covid, so could we follow Sri Lanka into crisis.
The big difference for Australia is that we have the luxury of issuing debt almost entirely in Australian dollars.
That is, Australia is what you call Monetarily Sovereign.
That means we’re never going to get into that spiral where a collapsing currency causes our debt to blow out.
And because we issue debt in Aussie dollars, and can therefore always just print more money if we need to pay off debt, there’s no practical scenario where we default.
Since that’s the case, borrowing rates are low and stay low.
The Aussie government will never have to go to commercial money markets cap in hand.
In that sense, we are very, very lucky.
Australia hey? Why would you live anywhere else?