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Fate of banks in a bankrupt Sri Lanka

20 Apr 2022

By Dinesh Weerakkody Sri Lanka technically became bankrupt when it announced a temporary suspension of repayment of all external debt of around $ 50 billion, saying the country can no longer honour its commitments owing to weak financial reserves caused by external and internal shocks.  This meant the Finance Ministry, with the stroke of a pen, said goodbye to an outstanding track record of servicing its external debt obligations since Independence, built by our forefathers. Making an announcement is an easy option for a bureaucrat at the Finance Ministry, but the repercussions are significant. This is why the country needs people with a vision and a palpable sense of the future to make decisions for the 22 million people, not retirees waiting to put their legs up.  As a prominent local newspaper pointed out, a “negotiated or soft default” is viewed as more respectable as opposed to a disastrous “hard default”. But surely, given that the immediate need was $ 70+ million, could we not have waited until we had negotiated a deal with the IMF to do it? Certainly there were better options in the short term.  Was Parliament consulted before such a serious and momentous decision was taken? The earlier arbitrary decision to float the Sri Lankan rupee pushed the rupee’s value down by 50% to Rs. 320 against the US dollar. Ironically, exporters have not gained significantly, the depreciating rupee has significantly increased the production costs of manufacturing, and there has been a big drop in production. The forex situation is certainly out of control.  Sri Lanka needs to manage the huge spikes in its exchange rate. Today, the Sri Lankan rupee is the world’s worst-performing currency, further aggravating the ongoing forex crisis. Unfortunately, most of the people who contributed to this state of mayhem remain in the saddle, and continue playing with the economy with limited knowledge and experience. The men who created the mess disappeared long before the dirt hit the fan for others to take the rap.  An independent Presidential Commission is a must in the future to investigate this debacle, and those responsible must be called out in public. We must also ensure that the institutional safeguards are back in place to prevent anymore one-man-shows. Today, 99% of the Sri Lankan public have become poorer because the crisis was mismanaged, despite several red flags being raised to those concerned by numerous experts. Implications for banks With the announcement, the credit rating agency Standard & Poor’s (S&P) immediately downgraded Sri Lanka to “CC” from “CCC”, and said a selective default (SD) rating is likely to be given once actual non-payment of foreign debt kicks in. There was no-one this time in the Government to say the announcement was unfair, ill-thought of, or biased, along with all the typical expletives.  Based on professional estimates, the country needs $ 4.5 billion in foreign currency injection from outside for the economy to survive through 2022. According to sources, India, the World Bank, and the Asian Development Bank (ADB) are willing to commit up to another $ 2 billion in financial assistance to Sri Lanka, while also supporting issues of food and energy security for the population.  Sri Lanka is certainly looking down the barrel of the gun, with inflation running over 30%, debt defaults, a depreciating currency, and limited forex inflows to import essentials. The banks too are facing the mother of all crises, very likely being forced to take a capital haircut on the International SOvereign Bonds (ISBs) – and possibly the Treasury Bond holdings – and forex impairments on the US dollar loan books.  Capital augmentation would be a challenge at best in today’s environment. Banks customers need to be shielded from the excesses of the banks’ management and incompetent boards. Legislation, along the lines of the Dodd-Frank Act and the Volcker Rule, needs to be introduced to ring-fence the hard-earned savings of banks’ customers. Super profits for banks will have to be a thing of the past. Banks will require boards with a deep understanding of banking to manage what is in store for them. A system overhaul is required to strengthen the banks.  Meanwhile, with an IMF bailout package still a distance away, the Government will have to look for short term options. In addition to all these issues, political instability is hurting tourism and Foreign Direct Investment (FDI). All this can be turned around by putting the right people in the right place. It is time for the Rajapaksa family to do the right thing by the country to resolve this crisis. The way forward Prominent journalists have stated that while Parliament, in responding genuinely to the cries of the people, is required to defeat the Government on the floor of the House and repeal laws that provide excessive powers to the President, it is equally vital that the leaders chosen in replacement should have clear plans for the future.  These words need to be taken seriously. The Opposition parties must forget their differences, stop fighting for their pound of flesh, and unite to bring some order back to the country and manage the pain the public will have to endure due to an IMF bailout. If not, those budding kings will have no country to rule, leave alone a political party to lead. So please don’t leave it to God to save Sri Lanka. (The writer is the immediate Past Chairman of the International Chamber of Commerce [ICC] Sri Lanka)  ………………………….  The views and opinions expressed in this article are those of the author, and do not necessarily reflect those of this publication.  


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