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Sri Lanka’s economic collapse ringing ‘alarm bells’ for emerging markets: Expert

Sri Lanka's political and economic crisis is only getting worse. The country’s acting president – Prime Minister Ranil Wickremesinghe – declared a state of emergency on Tuesday after President Gotabaya Rajapaksa fled to the Maldives, sparking protests in the nation’s capital of Colombo.

Atlantic Council GeoEconomics Director Josh Lipsky joined Yahoo Finance to talk about the country's economic collapse and its implications for emerging markets (EMs).

“We have an extraordinary amount of money of distressed assets trading a higher amount than we’ve had in years,” Lipsky told Yahoo Finance Live. “And so that triggers a lot of alarm bells.”

Lipsky cites global macroeconomic headwinds – such as tourism shutdowns, corruption, and high debt burdens – for Sri Lanka’s economic crisis. The Central Bank of Sri Lanka recorded an annual average inflation rate of 18.4% in June 2022, with food inflation surging 80.1% year-over-year (YoY).

But Sri Lanka is not the only country in trouble. “You have to look at El Salvador, Ghana, Tunisia, Egypt, and even Pakistan, as a range of different kinds of EMs in different parts of the world that are potentially at risk of default here,” Lipsky said.

Lipsky advises handling one crisis at a time.

“We know the lesson of recent history is that one crisis leads to another. We think of the global financial crisis, then the Eurozone crisis. Then look at the Arab Spring and political unrest. These things are connected, and so we can’t just disassociate. The economic and political repercussions are deeply intertwined,” Lipsky explained.

The global economy has taken a hit in 2022 following Russia’s invasion of Ukraine, putting a strain on oil and commodity prices. The OECD June 2022 Economic Outlook forecasts a sharp decline in global GDP growth of 3%.

“You have the high food prices, the high energy prices, the strong dollar, high interest rates in the U.S., the high debt burdens, highest debt burdens in EMs we've ever seen at this point. And in the back of it all, you have a creditor, China, that is not willing to renegotiate,” Lipsky added.

China is the world’s largest creditor and has lent more than $1.5 trillion to 150 countries, according to the Harvard Business Review. These loans are given to primarily low- and middle-income countries – the World Bank’s 2022 International Debt Statistics report documents more than half of net financial flows are accounted for by China. However, the Covid-19 pandemic has made it difficult for these countries to meet their debt obligations.

The Stimson Center finds that countries are looking to the Paris Club – a group of Western creditors who help EMs with restructuring and financing – for debt relief. The issue is that China is not a member of the Paris Club, and the institution does not want to forego payment obligations to China.

Lipsky has his eye on the upcoming G20 Leaders’ Summit in Indonesia and anticipates countries confronting China on its lending practices.

“I’m putting Russia to the side at this meeting, but the other 18 are going to turn to China and say, 'You have to play ball,” Lipsky said. “It’s not good for anyone to have a wave of EM debt defaults. You have to renegotiate with these countries.”

Yaseen Shah is a writer at Yahoo Finance. Follow him on Twitter @yaseennshah22

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