Economic stress in India's neighbourhood

Crises in Sri Lanka, Bangladesh and Pakistan reveal their structural weaknesses

Looking back, this month has been dominated by India’s emergence as the “voice of the Global South”, clearly reflected in its success in steering the G20 summit meeting back on track to the economic agenda, especially in bringing the contemporary development concerns to the fore.

While climate change issues and reforms of Multilateral Development Banks have gained maximum traction, an equally significant development has been the successful debt treatment agreement reached by Zambia with its creditors under the G20 Common Framework.  A coordinated mechanism has also been put in place to address debt restructuring for Sri Lanka, one of the three South Asian economies that have faced economic stress this year, the two others being Bangladesh and Pakistan. While the crises in these South Asian economies can be traced to some common immediate factors, they also reveal more fundamental economic weaknesses in their development processes. 

Sri Lanka entered the pandemic in a vulnerable economic state with reduced fiscal space, a high level of debt, and thin foreign exchange reserves. This was a consequence of a series of economic policy missteps in the preceding years, such as the drastic cuts in both income and value-added taxes in an attempt to stimulate a decelerating economy, prioritising imports, and the servicing of debt using forex reserves. The situation was aggravated by the suspension of reforms in fiscal rules and to increase central bank autonomy, and the undermining of key governance mechanisms and institutions. The consequent macroeconomic vulnerabilities, while limiting access to global capital markets, were reinforced when the earlier International Monetary Fund-Extended Fund Facility (EFF) expired in mid-2020. With forex reserves providing cover for only a month of imports at the end of 2021, the final blow to the economy was dealt by the Ukraine crisis and the ensuing high food and fuel prices. Sri Lanka formally defaulted on its external debt in May 2022. Although an agreement with the IMF for a 48-month EFF was reached in September 2022, it was finalised only by March 2023, reflecting the complexities of debt resolution and creditor coordination.

The desperate need for infrastructure and investment finance, alongside stretched systems of public finance management and limited progress in raising domestic revenue, has led many low-income developing countries to borrow from an expanded set of creditors as opposed to the predominant composition in the past of lending by official creditors of the Paris Club and multilateral lending agencies. The share of lending by private creditors in long-term public and publicly-guaranteed debt of low-income developing countries has noticeably increased over the last decade. A major share of lending is done bilaterally, predominantly by China. Apart from the fact that the terms of lending  from private and/or bilateral lenders may not be as favourable or transparent compared to those by official creditors, a disparate group of lenders also increases the complexity of restructuring debt in times of crisis. In the case of Sri Lanka, for example, coordination among the external creditors and maintaining parity across bilateral creditors has proven to be an onerous task. 

In Pakistan, the crucial difference is its long-standing history of excessive dependence on external finance and a lack of commitment to undertake reform measures even after struggling with frequent macro-economic crises. Earlier this year, faced with a multi-decade high inflation rate and very strained balance of payments on account of surging energy prices and adverse terms of trade, Pakistan was on the brink of a sovereign debt default and economic meltdown. Persistence with an accommodative fiscal policy stance further aggravated the deteriorating economic situation.  Thus, found wanting in taking timely action towards tightening government expenditure and revenue mobilisation in response to the crisis, as also in implementing the necessary economic reforms, such as correction in the exchange rate and interest rates under the 2019 IMF programme, Pakistan faced a difficult dialogue with the IMF in its negotiations for a fresh loan.  Several months after the onset of the crisis, Pakistan was able to secure only an emergency nine-month Stand-by Arrangement (SBA). Disbursement of the remaining SBA amount as well as the scope for negotiating a fresh loan with the IMF next year will depend crucially upon Pakistan’s ability to implement sound macroeconomic policies and a sustainable debt structure.

Bangladesh, a major long-term success story in South Asia in terms of economic growth and, more significantly, human development, is a starkly different case. The country was able to make a relatively quick recovery during the pandemic owing to a successful vaccination drive, government support, and some resurgence of global demand for its readymade garment (RMG) exports in early 2021. However, the economy suffered a major setback with the Ukraine crisis and the consequent inflationary pressures, energy shortages, revenue shortfalls, ballooning trade deficit and falling remittances. Having undertaken several large infrastructure development projects, financed by foreign loans, mainly from China, in the last few years, the possibility of a potential repayment problem, in the face of depleting forex reserves, was apparent. Thus, compelled by circumstances and foreseeing the possibility of an impending crisis, the Bangladesh government approached the IMF in July 2022 for a loan facility over a three-year period. Furthermore, to its credit, the Bangladesh government, in an apparent admission of its fiscal overreach, has already slowed down the more expensive infrastructure projects and is seeking funding from non-Chinese sources.

While immediate course correction has been accomplished in the three economies, growth prospects remain fragile, particularly in Pakistan and Sri Lanka, with only a very modest recovery predicted over the next financial year. In Bangladesh, growth momentum was moderated by the fall in external demand. Inflation continues to be a concern for all three economies and the management of domestic public finances remains crucial to a sustained recovery. Longer-term prospects, however, call for deep structural reforms in these economies. While Pakistan has profound legacy issues, including misdirected government expenditure coupled with the inability to develop a sustainable growth path, Bangladesh and Sri Lanka need to diversify their production base to reduce their single-sector dependence for foreign exchange earnings — tourism in the case of Sri Lanka and RMG for Bangladesh. Furthermore, Sri Lanka needs to overcome the challenge of an ageing demographic profile and its implications for labour force growth and productivity, while Bangladesh faces serious challenges in tackling climate change vulnerabilities.

The writer is professor of economics, School of International Studies, JNU, and author of India’s Trade Policy in the 21st Century, Routledge: London, 2022. The views are personal