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Inflation puts poor countries at risk of default

By Wong Kon How

Inflation puts poor countries at risk of default. Sri Lanka is about to default on its debts and the next things to watch out for any spill-over effects.

COVID-19 has raised debt distress, particularly in low-income countries and emerging market economies. Sharply higher global food and energy prices due to the war and covid are hitting developing countries hard.

Higher inflation, slower growth and tightening financial conditions leading to rising interest rates. This could lead to widening spreads for countries with weaker fundamentals, making it more costly for them to borrow.

When a country defaults on its interest payments, creditors might lose money.

The International Monetary Fund describes default in simple terms as a broken promise or breach of contract. When a government borrows money from foreign and domestic creditors, it is contractually obliged to pay the interest on those loans. If a payment is missed, this is described as a default.

Defaults happen when governments are not able to or don’t want to meet some or all of their debt payments to creditors.

What might happen after a default? There is a 30-day grace period until the end of next month to pay the interest payment owed. The country will officially be in default if no payment is made by then. These economies account for about 40 percent of global GDP. On the eve of the Russia-Ukraine war on 24 February 2022, many of them were already on shaky ground. Following up on a decade of rising debt, the COVID-19 crisis expanded total indebtedness to a 50-year high.

Gross domestic product (GDP) based on purchasing-power-parity (PPP) per capita. Sri Lanka is ranked 97th as a poor country. The concern is how about the rest of these nations?

One of the ways to monitor for any contagion effect is to study their currency, when it starts to weaken, meaning investors are cashing out on them and high inflation will set in. Sometimes it can come like a thief without anyone expecting it.

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