Courtesy of STRATFOR’s Worldview, an interesting analysis of south Asia’s most vulnerable economies, namely Bangladesh, Sri Lanka and the Maldives:

In the coming months and years, Bangladesh, Sri Lanka and the Maldives will need to implement macroeconomic adjustment programs to maintain market confidence and retain access to external financing at a reasonable cost, which will prove politically challenging and could result in new episodes of social and political unrest in all three South Asian countries. In its most recent World Economic Outlook, the International Monetary Fund (IMF) highlighted the significant challenges that emerging and developing economies are experiencing, particularly in South Asia. Increasing interest rates in the United States and Europe have led to a strong U.S. dollar and higher debt servicing costs for the region’s most financially vulnerable countries, including Sri Lanka (which defaulted on its debt last year), Bangladesh (which requested an IMF bailout last July to avoid such a default) and the Maldives (which the IMF sees at high risk of debt distress). If the governments of these three countries implement wide-ranging structural and macroeconomic reforms in the coming years, the IMF foresees them returning to more sustainable (Sri Lanka) or even high economic growth (Bangladesh) and more manageable levels of debt. But that’s still a relatively big ”if,” given such reforms will likely be met with significant political pushback in each nation.

The COVID-related fiscal shock to expenditure and revenues after years of pre-pandemic overborrowing, the Ukraine-related uptick in global food and energy prices, and the fallout from the sharp tightening of global financial conditions have considerably weakened the financial position of many developing economies around the world.

The U.S. Federal Reserve has raised its policy rate to 4.75-5.0% from 0-0.25% over the past year, and the European Central Bank has raised its policy rate to 3.0% from -0.5% in the past 10 months.

The Fed expects real U.S. GDP to grow by only 0.4% this year, while the IMF projects the euro area’s real GDP to grow by only 0.8% in 2023. The projected economic slowdowns in the United States and Europe will weigh on South Asia’s crucial exports by dampening consumer demand in key markets (80% of Bangladeshi exports, for example, go to the United States and Europe).

Compared with Sri Lanka and the Maldives, Bangladesh’s economic growth outlook is both favorable and sustainable, assuming its government follows through on IMF-mandated structural and especially macroeconomic reform. The IMF assesses that despite Bangladesh being at ”a low risk of external and overall debt distress,” economic and financial risks are skewed to the downside due to balance of payments financing difficulties and the country’s declining foreign exchange reserves. In January, the IMF approved a 42-month Extended Credit Facility (ECF), along with two loans worth $3.3 billion and $1.4 billion. $476 million of the first loan has already been released, which will help secure additional financial support from other official lenders (such as the World Bank) that often condition their lending on a sustainable macroeconomic outlook. But while inflation is also expected to remain elevated in the country, the IMF forecasts strong and moderately accelerating economic growth in the coming years, as well as a stable external debt-to-GDP ratio and manageable current account deficits, which will support the accumulation of foreign-exchange reserves.

Following a temporary slowdown to 5.5% in the fiscal year 2023, the IMF forecasts Bangladesh’s real GDP growth to rebound to 6.5% in 2024 and 7% in 2025. Like nearby India, Bangladesh has seen rapid economic growth over the past few years thanks to favorable demographics, policy reform and significant ”catch-up” potential due to the country’s low per capita income.

According to the IMF, inflation in Bangladesh will fall gradually from an estimated high of 8.9% at the end of 2023 to less than 7% by the end of 2024, and to less than 6% in subsequent years due to IMF-mandated fiscal and monetary adjustments.

International credit rating agencies rate Bangladesh’s sovereign debt at around ”BB-” or equivalent, which suggests medium-to-borderline-high default risk.

The outlook for Sri Lanka’s economic outlook is also set to improve, provided the government follows through on the structural reform and macroeconomic policy adjustments laid out in the IMF agreement it reached following last year’s default. In March, the IMF approved a $3 billion loan for Sri Lanka after the country’s official creditors, including China, agreed to provide financing assurances. The IMF just recently released the first $330 million tranche of that bailout, which will help catalyze further financial support from other multilateral and bilateral lenders. Sri Lanka will aim to conclude the restructuring of its debt with both official and private-sector creditors this year. The government has also pledged to engage in good-faith negotiations with its private creditors, as well as implement IMF-supervised macroeconomic and structural reforms, though many of those reforms will likely prove politically challenging. If Colombo follows through on its commitments, the Sri Lankan government will retain access to external funding, alleviating a major constraint on economic growth. The IMF program foresees Sri Lanka returning to modest economic growth in 2024, with inflation declining substantially to politically manageable levels after reaching almost 60% last year. However, the political opposition to continued reform will increase over time, unless a rapid economic recovery strengthens the governments’ political position vis-a-vis the vested interests. The IMF cited this concern in its economic outlook, noting that given ”Sri Lanka’s weak track record of reform implementation, the program runs significant risks of slippages regarding fiscal consolidation, revenue mobilization and reserves buildup.” If the country again fails to implement significant reforms, it would lead to souring market sentiment, lower economic growth and a renewed increase in financial instability.

In March, the IMF approved a 48-month extended arrangement for Sri Lanka under its Extended Fund Facility (EFF) worth $3 billion.
According to the IMF, Sri Lanka’s real GDP will reach 1.5% next year, after two consecutive years of economic contraction of -8.7% (preliminary) in 2022 and -3.0% (estimate) in 2023.

Inflation in Sri Lanka is forecast to fall to 15% by the end of this year and 7% by the end of 2024.

The international credit rating agencies have a default or quasi-default rating assigned to Sri Lanka’s sovereign debt.

In the Maldives, a sharp, post-pandemic recovery of tourism, transportation and trade has led the IMF to forecast solid economic growth in 2023 and 2024, as well as falling inflation. The island nation’s fiscal deficit was extremely high in 2021 and 2022, and, according to the IMF, will remain very high this year and next year before declining precipitously between 2025 and 2027. A large fiscal deficit and a very large government debt burden represent significant financial risks in the Maldives. Large fiscal deficits may increase government debt to the point where investors will be unwilling to finance it, which would then lead to a government debt crisis. Although the country’s banking sector is assessed to be sound, such a crisis could quickly cause banking sector instability due to the sovereign-bank nexus (or interconnectedness). At around 10% of GDP, the Maldives’ fiscal deficit is projected to remain very high in both 2023 and 2024. Such a large deficit is not unusual for small island countries, nor is it necessarily unsustainable if it’s financed by solid inflows of foreign direct investment. The continuation of such investment inflows, however, will depend on whether the government is able to prevent a further increase in public debt. Government debt amounted to a whopping 120% of the country’s GDP in 2022, which the IMF forecasts will decline to 100% of GDP by 2027. While this projected decline is encouraging, government debt levels are still expected to stay very high, creating significant financial vulnerabilities that will leave the Maldives economy exposed to external shocks. Within this context, the IMF believes it will be very difficult, though not impossible, for the country to avoid a debt restructuring in the next few years, assessing the Maldives to be at ”high risk of external debt distress and a high overall risk of debt distress.”

According to the IMF, the Maldives’ real GDP growth will slow from 11% last year to 6.6% this year and 5.7% next year. In 2021, the economy grew by 40%.

Inflation will decline from a projected 5% this year to 2% by 2025, as food and energy costs, along with supply-chain-related price shocks, abate.

International credit rating agencies have assigned low ratings to the Maldives government’s sovereign debt, with Fitch giving it a ”B-” rating and Moody’s giving it an even lower ”Caa” rating. This suggests a very elevated risk of a sovereign default in the coming years.

Although the outlooks for Bangladesh, Sri Lanka and the Maldives differ in terms of financial risks and economic growth, they will all face similar challenges in implementing far-reaching structural reforms and macroeconomic adjustments. All three governments will need to implement a fiscal adjustment and run a tight fiscal policy thereafter to maintain market confidence and retain access to external financing at a reasonable cost. Tax increases, expenditure cuts and a reduction of energy subsidies will prove highly contentious politically and could result in new episodes of social unrest. The required adjustment is less dramatic in Bangladesh than in Sri Lanka, which has just defaulted. While this adds urgency in the case of Sri Lanka, it may also make it more politically difficult for leaders in Colombo to pass more wide-ranging reforms. Both Bangladesh and Sri Lanka will also need to implement sweeping structural reforms under their respective IMF agreements, which will antagonize vested interests (in this case, interest groups that stand to lose economically and financially from the proposed reforms) and mobilize them to oppose the reform policy of the government (e.g. privatization). The Maldives has not signed up for IMF-led structural reforms. But compared with neighboring Sri Lanka and Bangladesh, the small island nation also faces the most imminent fiscal and financial challenges due its high debt levels and large fiscal deficits. Much will depend on how much political capital the three governments can mobilize to push through wide-ranging structural and macroeconomic reform.