Context: Sri Lanka is finalising a debt treatment plan with India and the Paris Club. Sri Lanka is likely to get a moratorium of up to six years as well as a reduced interest rate during the repayment period.
More information from the news:
- Official Creditor Committee (OCC): As many as 17 countries that have extended loans to Sri Lanka formed the Committee in 2023 for ease of debt restructuring negotiations. China stayed out of the platform, but has been attending its meetings as an observer.
- Sri Lanka defaulted on its nearly $50-billion external debt in 2022. The country has been engaging with its diverse lenders to work out a debt treatment plan that is compatible with its pace of recovery.
- Sri Lanka made considerable progress in negotiating a deal with its bilateral creditors, however, the private creditors holding the largest chunk of Sri Lanka’s foreign debt continue to pose a challenge.
- IMF assistance:
- Sri Lanka is to receive the next instalment of the International Monetary Fund’s assistance, as part of the $3 billion package it obtained last year, to recover from the unprecedented financial crash in 2022.
- Sri Lanka had an agreement with the Fund on the second review of its four-year Extended Fund Facility (EFF) arrangement.
About Paris Club:
- An informal group of officials from major creditor countries.
- Find co-ordinated and sustainable solutions to the payment difficulties experienced by debtor countries.
- Debtor countries undertake reforms to stabilize and restore macroeconomic and financial situations and therefore, Paris Club provides an appropriate debt treatment.
- Provides debt treatments to debtor countries in the form of rescheduling:
- Debt relief by postponement or, in the case of concessional rescheduling, reduction in debt service obligations during a defined period (flow treatment) or as of a set date (stock treatment).
- Created gradually from 1956: with first negotiation between Argentina and its public creditors in Paris.
- Creditor delegations are generally led by a senior delegate from the Ministry of Finance.
- Twenty-two Permanent Members of the Paris Club: Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, Israel, Netherlands, Norway, Russia, South Korea, Spain, Sweden, Switzerland, United Kingdom and the United States.
- Observer members:
- Invited to attend the negotiating sessions of the Paris Club but they cannot participate in the negotiation itself, nor sign the agreement that formalizes the result of negotiation.
- International Monetary Fund (IMF); World Bank; Organisation for Economic Co-operation and Development (OECD); United Nations Conference on Trade and Development (UNCTAD); European Commission; African Development Bank; Asian Development Bank; European Bank for Reconstruction and Development (EBRD); Inter-American Development Bank (IADB)
- Conditionality: Only negotiates debt restructurings with debtor countries that:
- Are expected to provide a precise description of their economic and financial situation.
- Implemented and are committed to implementing reforms to restore their economic and financial situation.
- Demonstrated track record of implementing reforms under an IMF program.
- Means country must have a current program supported by an appropriate arrangement with the IMF, example: Extended Fund Facility, Poverty Reduction and Growth Facility
- Level of the debt treatment is based on the financing gap identified in the IMF program.
- Negotiations:
- Debtor country signing an agreement with its Paris Club creditors should not accept from its non-Paris Club commercial and bilateral creditors terms of treatment of its debt less favourable to the debtor than those agreed with the Paris Club.
India’s constructive role in supporting Sri Lanka during the recent economic crisis:
Sri Lanka’s worst economic crisis is attributed to a mix of external shocks (such as the Covid-19 pandemic and the Russia-Ukraine conflict shock) and poor macroeconomic management by the ex- Government.
- In January, 2024, India became the first country to have submitted its letter of support for financing and debt restructuring of Sri Lanka to the International Monetary Fund.
- India’s financial and humanitarian support worth USD 4 billion to Sri Lanka is far in excess of the total anticipated Extended Fund Facility of the IMF.
- India extended multi-pronged assistance through multiple credit lines, deferred loans and grants and currency support, in line with India’s ‘Neighbourhood First’ policy.
- Use of Rupees for trade settlement is further helping Sri Lanka’s economy.
- In 2023, India was the largest source of tourists for Sri Lanka with over 100,000 tourists.
International Monetary Fund (IMF):
- Major financial agency of the United Nations, and an international financial institution.
- Headquarters: Washington, D.C., United States.
- Role:
- Lender of last resort to national governments; Leading supporter of exchange-rate stability.
- Management of balance of payments difficulties and international financial crises.
- Mission:
- Foster global monetary cooperation; Secure financial stability; Facilitate international trade; Promote high employment and sustainable economic growth; Reduce poverty around the world.
- Established in 1945 at the Bretton Woods Conference.
- Special Drawing rights (SDR):
- The IMF created the SDR as a supplementary international reserve asset in 1969.
- SDR was defined as an equivalent to a fractional amount of gold that was equivalent to one US dollar.
- Fixed exchange rates ended in 1973: IMF redefined the SDR as equivalent to the value of a basket of world currencies.
- It is not a currency but an asset that holders can exchange for currency when needed.
- Individuals and private entities cannot hold SDRs; IMF members and the IMF itself hold SDRs.
- Funding:
- Funding by 190 member countries.
- Two major sources: Quotas and Loans.
- Quotas: pooled funds from member nations, generate most IMF funds.
- Size of members' quota increases according to their economic and financial importance in the world.
- Amount of financing a member can obtain from the IMF (called as access limit) thus depends upon its quota.
Extended Fund Facility (EFF) of the IMF:
- Lending facility, established in 1974.
- Provides financial assistance to countries so as to address medium and longer-term balance of payments (BOP) problems because of structural weaknesses that require time to address.
- Help countries implement medium-term structural reforms and offer longer program engagement and a longer repayment period.
- Eligibility:
- All member countries facing actual or potential external financing needs.
- Most often used by advanced and emerging market countries
- Low-income countries sometimes use the EFF together with the Extended Credit Facility (ECF).
- ECF: medium-term financial assistance to low-income countries (LICs) with protracted balance of payments problems.
- It is one of the facilities under the Poverty Reduction and Growth Trust (PRGT).
- Conditionality:
- Countries’ policy commitments are expected to focus on structural reforms to address institutional or economic weaknesses.
- Disbursements conditional on the observance of quantitative performance criteria.
- Approved for periods of 3 years, but can be extended to 4 years to implement deep and sustained structural reforms.