Ukraine Crisis Risks Pushing Sri Lanka Closer To Default

(Bloomberg) -- With Covid shutting off tourism from much of the West, Russia and Ukraine had become an increasingly important source of foreign currency for Sri Lanka. The conflict threatens to turn off that tap as key bond repayments come due.

Almost a quarter of all tourist arrivals into Sri Lanka this year were from Russia and Ukraine -- rising to 30% if you include Poland and Belarus, official data show. Russia, which was the third-biggest buyer of Sri Lankan tea over the past two years, rose to second place in January. 

While detailed breakups on spending aren’t yet available, tourism and tea earned Sri Lanka more than $260 million in foreign currency this year. Every dollar is important because the nation’s overall FX reserves fell 25% to $2.36 billion in January. Sri Lanka looks set to face a funding requirement of $5.7 billion in 2022, including the money needed to plug the current account deficit, according to estimates from Bloomberg Economics.

Much of the reserves stockpile comprises bilateral aid such as swap lines from China and India, and Sri Lanka was looking to boost non-debt flows. The island nation is already running Asia’s fastest inflation, and foreign investors are concerned that if Sri Lanka doesn’t restructure its overseas debt or devalue the rupee that is currently pegged to the dollar, it could miss repayments such as on a bond maturing in July. 

“Balance of payments is the main issue, reserves are dwindling, the currency isn’t being allowed to adjust and if they avoid raising fuel prices then losses at the state-owned enterprises will mount,” said Kenneth Akintewe, head of Asian sovereign debt at abrdn. “Securing some source of foreign funding is even more urgently required now, but given the risk of fairly imminent default, that is easier said than done.” 

The 5.875% bond maturing in July fell one cent to 74 cents on the dollar Monday, the lowest in more than a month. The 7.55% 2030 note dropped three cents over the past week to a record low of 46 cents on the dollar.

Sri Lanka’s policy makers have reiterated that they are seeking to refinance rather than restructure the notes. “We hope the conflict won’t escalate,” Central Bank of Sri Lanka Governor Ajith Nivard Cabraal said by phone Monday, adding that the authority was assessing the situation. He didn’t elaborate.

What Bloomberg Economics Says...

“Russia’s invasion of Ukraine has increased the probability that Sri Lanka could default on its dollar-denominated debt. This raises the urgency for Sri Lanka to seek assistance from the International Monetary Fund”

-- Ankur Shukla, India economist 

For the full report, click here

The Ukraine tensions have already “badly affected the Sri Lankan economy” and local oil prices may need to go up in time, Cabinet spokesman Ramesh Pathirana said last week.

Buyers from Russia have warned of “affordability issues” because of the steep depreciation of the ruble, said Dinesh Fernando, chief operating officer of Ceylon Tea Brokers Plc in Colombo. A few Ukrainian buyers have also told exporters to hold shipments until further notice, he said.

The impact on prices would be seen at the auctions later this week, Fernando added.

The ruble was indicated 29% lower versus the dollar in offshore trading on Monday after President Vladimir Putin put the nation’s nuclear forces on higher alert as the U.S. and European allies announced plans to sanction Moscow’s central bank and cut off some Russian banks from the SWIFT financial messaging system.

“After the pandemic, Central Europe has been a major source of arrivals, especially from Ukraine and Russia,” said M. Shanthikumar, president of the Hotel Association of Sri Lanka. “Obviously that will now not happen because of the conflict,” he said, adding that there had been cancellations from these destinations.

Inflation accelerated to 15.1% in February, the government reported Monday, faster than the 14.6% estimated in a Bloomberg survey. Price pressures are being stoked by crop failures on top of import restrictions to conserve dollars and high global prices of key commodities. 

(Updates with inflation in final paragraph)

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