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

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Atlantic Council GeoEconomics Director Josh Lipsky joins Yahoo Finance Live to discuss what led to recent protests and the economic collapse in Sri Lanka as well as what it means for other countries and global markets.

Video Transcript

[MUSIC PLAYING]

AKIKO FUJITA: Well, some extraordinary scenes coming out of the presidential palace in Sri Lanka over the weekend, as crowds stormed the compound to protest the country's worst economic crisis since 1948. President Gotabaya Rajapaksa is set to resign this Wednesday with heavy spending, rising inflation, and lavish tax breaks all forcing his government to default on its sovereign debt. Our next guest says rising debt levels may be a sign of things to come for other countries.

Joining us now is Josh Lipsky, Atlantic Council's Geoeconomics Center director. Josh, I got to tell you. I was watching that video over and over. It is an incredible thing to see just crowds storm into the presidential palace. But let's talk about how we got here, because Sri Lanka has been dealing with corruption, I mean, other issues for some time. But there's some very familiar threads in here that I think other economies are going through right now.

JOSH LIPSKY: That's right. Thanks, Akiko. The images are absolutely extraordinary. And you can't help look at them and think, is this unique to Sri Lanka? And I think the answer is no. If you look at the factors driving this, pandemic shutdown tourism affects a lot of countries. Bad fiscal management and corruption-- that's repeated, unfortunately, in many countries. High debt burdens and overextended loans to China and many other creditors, we know that's a story across the world. So, yes, there are some idiosyncratic factors here. There was a fertilizer ban, and that lowered the food end cost.

But there's a lot of issues here if you think of the trend lines that you know are going to be repeated other places. And we're already seeing that bubbling up. So it has to be cause for concern, both for the Sri Lankan people, but more globally for EMs.

AKIKO FUJITA: So for our viewers who haven't necessarily been following all this play out, I mean, what are some of these other countries that could follow?

JOSH LIPSKY: Well, you have to look at El Salvador, Ghana, Tunisia, Egypt, even Pakistan, as a range of different kinds of EMs in different parts of the world that are potentially at risk of default here. And that doesn't mean it will happen, but we have an extraordinary amount of money of distressed assets trading a higher amount than we've had in years. And so that triggers a lot of alarm bells. The IMF is saying this is not a moment for complacency. They need more firepower.

And in the background of all of this is Russia's invasion of Ukraine because it's sending energy and food prices soaring at absolutely the worst time. So you have higher interest rates from the US and ECB and other major central banks' perspective, higher food costs coming in, no tourism revenue in a lot of these EMs. And it's a toxic mixture for these countries. And I think there will be other defaults following on Sri Lanka in the months ahead, unfortunately.

BRIAN CHEUNG: Hey, Josh, Brian Cheung here. And to that point, the IMF chief this morning saying there's a growing risk of a debt crisis. But I guess, I'm asking, what is the overall picture here? Are we looking at something like a global, I guess, pull-down that could result from one of these countries going bust? I'm thinking of '94 in Mexico, '97, the Southeast Asian countries. Is that what's at risk now?

JOSH LIPSKY: So I don't think we're at that sort of domino effect situation where we're looking at '94 or the Asian financial crisis, or certainly not the 1980s in the Latin America crisis. I don't think we're there yet. There's not as many countries at risk of default as there were in that period of time. The IMF is more well resourced than it was then. And interest rates in the US and other central banks aren't going to go as high as they went in the 1980s.

So those immediate risk factors are not there. But I would just say and we should all learn from the past two years, there is a law of unintended consequences here. It doesn't seem like we're in some major systemic global shock from default, even if we get 5, 6, 7, 8. It seems like that can be handled and managed, but you don't know the ripple effects. So we all have to be on alert. And I think that's why the IMF chief said we can't be complacent. We have to handle more than one crisis at a time.

And 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 the political unrest. These things are connected. And so we can't just disassociate. The economic and political repercussions are deeply intertwined.

BRIAN CHEUNG: Yeah, and I guess, maybe to drill down, I mean, the financial side of everything, right? We know that these financial crises in the examples we just kind of talked about were very much triggered by a strong US dollar, rising interest rates. And it is a very different story in 2022 than it was in the '90s, given where the Fed funds rate is. But I mean, how relevant are those stories, because they are happening now-- stronger dollar, raising interest rates-- to what's happening in these emerging market countries?

JOSH LIPSKY: Well, they're very relevant The fact that you're having the stronger dollar, higher interest rates, this is triggering capital outflows. So this is just another piece of the puzzle. You have the high food prices, the high energy prices, the strong dollar, high interest rate in the US, 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.

And I think that's an important difference from previous crises. In the past, you could go to the IMF. You could go to the Paris Club. You could renegotiate these loans. China has not shown the same kind of willingness as other creditors to renegotiate. And you can bet this is going to be front and center of the G20 finance ministers' agenda as they gather in Bali this weekend.

AKIKO FUJITA: Yeah, Josh, let's pick up on that point on China. I mean, Sri Lanka one of those countries, right, where Belt and Road was a huge push for China. I mean, this feels like a very familiar story that we're starting to see play out. Many had warned about a debt trap for some time. How do you think this sours the sentiment towards China, especially in some of these emerging economies who had looked to China as a potential, a real growth driver?

JOSH LIPSKY: Well, they have to look at the Sri Lanka example and other examples in the region and be very concerned about being too far indebted into China. On the other hand, as we all know, the immediate fiscal needs and the immediate needs to serve the population and be re-elected can sometimes trump those longer term debt concerns. So I don't expect China's lending or country's willingness to accept China's lending to stop.

But it's going to be a very interesting G20 meeting because these other economies, the 18, 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. It's not good for anyone to have a wave of EM debt defaults. You have to renegotiate with these countries. It's not good for you as a creditor, and it's not good for the global economy. We'll see if they make traction on that over the weekend.