HAVING been asked some questions about why countries might choose to default on their debts, I am writing this week about what is happening in Sri Lanka, after a short comment about the recent Russian default.

Economic sanctions have been designed to restrict Russia’s access to credit markets very severely, by preventing other banks from accepting payments from Russian banks in most currencies.

Denied the capacity to make interest payments in US dollars, as required by some of its lenders, the country is now technically in default.

Russia has emphasised that it is able and willing to make payments, but has been denied the ability to do so. This is not an example of voluntary default.

Sri Lanka’s situation is different. The government has failed to make debt repayments since April. Its central bank has run out of foreign currency reserves and so the country simply cannot make interest payments in dollars. Unlike Russia, Sri Lanka has incurred debts which it cannot service, given the catastrophic failure of its government to manage the economy.

The economy is desperately weak, and this is not a recent problem.

Sri Lanka has relied on support from the International Monetary Fund (IMF) for nearly 60 years.

The fund’s remit is to support countries through short-run difficulties but Sri Lanka has gone back to it time after time.

IMF support almost always come with substantial conditions, usually aimed at reducing the government deficits, by increasing taxation, and cutting spending. The last support package, in 2016, came with those typical conditions.

Investment and savings fell, government tax revenues also dropped and the external debt burden continued to rise. The IMF would claim that it wants countries to accept some short-term pain so that they can return to the path of economic virtue. Its critics accuse it of continuing to apply what Denis Healey called “sado-monetarism”.

Healey famously had to go to the IMF for support during a financial crisis, but never needed to draw on the line of credit which it provided.

Democratic institutions in the UK were sufficiently robust that the country accepted the necessary pain. Indeed, in electing Margaret Thatcher three times, many people enthusiastically embraced it. The leadership of the Conservative Party – promising tax cuts and a shrivelled state as it panders to the party’s wider membership – still offers little else.

Back to Sri Lanka. In April 2019, the bombing of a Catholic Church on Easter Sunday shut down most of the tourist industry, which has traditionally accounted for about 10% of the economy. That shock was followed by Covid.

In 2021, the government decided to make a rapid shift to organic agriculture. Badly managed, with a complete ban on imports of fertiliser, this led to a large increase in food imports and a large fall in export earnings from rubber and tea. Running a large trade deficit, the country became steadily worse off.

To buy time, and support, then president Gotabaya Rajapaksa’s government made large tax cuts. These further reduced the government’s revenues, forcing it to drain the country’s foreign reserves, rather than export earnings, to make external debt payments I was asked specifically whether countries default on their debts voluntarily. The problem in Sri Lanka is ultimately political. The ruling elite has been largely insulated from the costs of default.

The protesters swimming in the president’s pool this week may have marvelled at the lavishness of the official residence. Rajapaksa, who resigned this week, and his brother have fled into a very comfortable exile.

THE Panama Papers and other leaks demonstrate just how easy it is for political leaders to enrich themselves. Losing the presidency may not be what Rajapaksa wished for, but one way of understanding this crisis is that Sri Lanka’s leadership balanced the risk of eventual default against opportunities to continue enriching themselves.

Perhaps the ultimate reason for choosing to have fully democratic institutions is to prevent this degree of seeming political corruption, in which leaders may not actually choose to drive the country into default, but seem almost indifferent when it happens.

From the Russian example, we see that default on debt simply means not making payments in full, and on time. Loan contracts tend to be specified so that any breach of those conditions mean that the loan is technically in default.

Stop making payments on a personal loan and the lender can seek immediate repayment of the full amount outstanding. Anyone unable to repay a loan risks court action, and a substantial reduction in their credit score, limiting access to credit in future.

The same discipline applies to countries. Once a country has defaulted on a loan, investment banks will be much less willing to provide funding. Other countries’ governments may continue to provide loans on generous terms as development assistance.

They will often rely on confirmation that the country is in good standing with the IMF and the World Bank, though. For Sri Lanka, at present, without an agreement with the IMF, access to the funding needed to rebuild the economy is unlikely. The country is between a rock and a hard place.

The path to national economic virtue does not have any shortcuts. It relies on probity, on competence, and on the gradual development of trust in government.

After independence, earning that reputation should be a priority for Scotland’s Government, as it takes becomes responsible for supporting the development of the country’s productive capacity.