Sri Lanka Is Now A Low-Income Country, Cabinet Approves Downgrade

India’s southern neighbour is now a ‘low-income country’. 

Earlier today (11 October), the Sri Lankan government approved the proposal to downgrade the country’s economic status to ‘low-income’.

The downgrade was to access concessional funding from international organisations, as per one of the cabinet ministers. 

Sri Lanka’s economy has been wrecked by the double whammy of the pandemic and the war in Ukraine. The recent interest rate hikes have made matters more difficult.

Already, Sri Lanka is engaged with creditors, hoping to get long-term relief on the loans. 

However, concessional loans are important for Sri Lanka for a number of reasons.

As a country classified in the ‘low-income category, the island nation will be able to access long-term loans with a low rate of interest, thus giving them the much-needed room to reverse their economic fortunes. 

Across the 1990s, Sri Lanka’s foreign debt was made up of concessionary loans, sourced from the likes of the World Bank, and Asian Development Bank and they came with a long payback period and low-interest rates, giving the government a strong cushion for repayment. 

Thus, at that point, the foreign debt, payable after 20 years, minimum, was not at all a threat to the servicing capacity of Sri Lanka.

However, as is the case with the all-free lunches, the concessionary loan spree also came to an end in the 2000s and the country had to move towards commercial borrowings with a significantly higher rate of interest, and without the ease of payback. 

This is where the problem began. As per the data of Sri Lanka’s Central Bank, in 2004, commercial borrowings made up less than 5 per cent of the total foreign debt with over 95 per cent of foreign debt in concessionary loans.

By 2010, commercial borrowings were close to 40 per cent of Sri Lanka’s foreign debt, and by 2019, more than 55 per cent. 

The commercial borrowings were in the form of ISBs or International Sovereign Bonds that were used to raise money from the global markets. Usually, these bonds matured after 5-10 years, and also had an interest payment that was to be made regularly. 

As the bonds matured, the foreign debt only increased, and with every bond payment, a large outflow of foreign exchange was also happening.

In August 2022, Sri Lanka’s annual per cent change in consumer price index breached the 70 per cent mark, one of the highest in the world.

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