Debt Financing for Development: The Sri Lankan Experience

Throughout the first six decades of the post-independence era, Sri Lanka relied on traditional forms of foreign financial assistance, albeit at fairly modest volumes, from multilateral and bilateral donors. But, beginning with its debut issue of a five-year USD 500 million international sovereign bond (ISB) in 2007, the composition of Sri Lanka’s outstanding external debt stock has transformed swiftly from concessionary to non-concessionary loans obtained on commercial terms, with maturity periods of 5–10 years. This is the result of both demand and supply factors for international borrowings. On the demand side, external financing needs rose sharply post-war, for both economic and political reasons to fund a huge infrastructure development programme and provide a peace dividend. On the supply side, the adoption of unconventional monetary policy in advanced economies as a response to the global financial crisis resulted in an unprecedented lowering of interest rates, prompting private and institutional investors to search for higher yields in emerging economies. Second, China emerged as a major source of development finance, with Sri Lanka seen as a particularly attractive destination due to its strategic position at the tip of South Asia. This chapter examines the drivers of this dramatic transformation of Sri Lanka’s debt financing strategy and discusses the implications for macroeconomic management in a global context where there are rising concerns about the vulnerability of emerging economies to financial and economic shocks, particularly interest rate increases in developed economies that can reverse capital flows into developing countries. We argue that as some of these favourable conditions begin to change and the global context becomes more challenging, the resilience of the Sri Lankan economy will be severely tested as it prepares to amortise a dramatic spike in external debt settlements during 2019–2022.