July 18, 2023: President Wickremesinghe launches a policy which aims for Sri Lanka's financial recovery. What is debt crisis?
According to President Ranil Wickremesinghe, Sri Lanka is expected to recover from its severe financial crisis and exit bankruptcy by September,2023.
The country has been facing its worst financial situation in many years.
The President expressed confidence in this positive turnaround and has launched the domestic debt restructuring framework.
Sri Lanka has a total debt of $42 billion (approximately INR 3,436.54 crore), which includes money borrowed within the country. The country is facing a financial crisis and has defaulted on its foreign debt.
What is debt crisis?
But first let's understand debt in context to a Nation:
Imagine a nation, like a big country, as a group of people living together, just like a family living in a house. Now, this "nation" has some big projects or important things it needs to do, like building schools, hospitals, roads, and keeping the country safe. But sometimes, the money they have is not enough to do all these things.
To make up for the money they don't have, the nation can borrow money from other people, just like how your parents might borrow some money from the bank when they want to buy a new car or a house. This borrowed money is called "debt" for the nation, and it's like a big loan that they have to pay back later.
Now, just like your parents have to pay back the bank with some extra money called "interest," the nation also has to pay back the borrowed money with some extra money as interest. This helps the people who lent the money to the nation feel like it's worth the wait and risk of giving away their money.
Sometimes, nations might have more debt than they can easily pay back, and that's when people start worrying about it. It's a bit like having too much money owed to different people, and it becomes challenging for the nation to manage it all.
Governments work hard to keep the nation's debt in control and not let it get too big because having too much debt can make things more complicated, just like how having too many loans can be tough for a family. They try to balance spending on important things with the need to repay the debt, just like your family has to balance their expenses with paying back their loans.
So, the nation's debt is like a big loan that it borrows to do important things, and they work hard to manage it responsibly, just like how your family manages their finances to take care of everyone and plan for the future.
And now debt crisis:
A nation's debt crisis happens when the country owes a lot of money that it cannot easily pay back. It's like when a person borrows too much money and struggles to repay it. The nation's debt crisis can make it difficult for the government to provide essential services and can affect the country's economy and people's lives. To resolve a debt crisis, the government needs to make careful financial decisions and work with other countries and organizations to find solutions. It happens when the government consistently spends more money than it earns in revenue through taxes and other sources.
Key factors leading to a debt crisis include:
- Excessive Borrowing: The government borrows extensively to fund various projects, programs, and services, but fails to generate enough income to cover the debt and interest payments.
- Economic Challenges: A stagnant or declining economy can reduce tax revenues and limit the government's ability to generate funds to repay debt.
- High Interest Rates: If the nation's debt becomes risky to lenders, they may demand higher interest rates, making debt repayment even more challenging.
- Unsustainable Spending: The government may engage in excessive spending without considering its long-term sustainability.
- Investor Confidence Loss: If lenders and investors lose faith in the country's ability to repay its debt, they may stop lending money or demand extremely high interest rates.
Consequences of a debt crisis include:
- Austerity Measures: The government may be forced to implement strict spending cuts on essential services, which can lead to public discontent.
- Currency Devaluation: To cope with debt, a country might devalue its currency, leading to inflation and affecting the purchasing power of its citizens.
- Higher Unemployment: Economic instability can lead to job losses and hinder economic growth.
- International Intervention: In severe cases, international organizations may step in to provide financial assistance, but this often comes with strict conditions.
To avoid a debt crisis, governments must manage their finances prudently, balance spending with revenue generation, and prioritize sustainable economic growth.
Back to the article:
To address this, Sri Lanka has introduced a plan to restructure or modify part of its domestic debt. If successful, this will help the country manage and repay its debt more effectively. The outcome of this restructuring is crucial for Sri Lanka to negotiate with its lenders and improve its overall financial situation. This plan is essential for Sri Lanka, as it defaulted on its foreign debt in May last year.
According to the President, the domestic debt plan is very important for Sri Lanka. By implementing this plan, the country can lower its interest rates and improve its negotiations with lenders like China, Japan, and India.
The President mentioned that this is the best outcome they can achieve, and it will take a few months for the interest rates to go down.
Additionally, once the plan is in motion, development assistance will start flowing into the country. Sri Lanka's economy is expected to decrease by 2% in 2023, based on the government's estimates, following a reduction of 7.8% last year.