The Dong-A Ilbo visited Sri Lanka one month after the country’s declaration of moratorium to find the entire nation is in state of panic as its foreign currency reserves have dried up. The direct cause of its sovereign default is Russia’s invasion of Ukraine. As oil and food prices soared due to the war, the government, companies and households were hardly able to withstand. However, Sri Lanka already had excessive national debts due to populist state policies while its tourism industry, its flagship sector, took hit by the Covid-19 pandemic. As the double whammies of high inflation and slow growth have dealt an additional blow to the economy whose fundamentals had already collapsed, the government ended up declaring sovereign default.
We cannot take Sri Lanka’s default lightly because emerging economies including South Korea cannot be considered completely immune to a similar crisis. If a country fails to improve its economic fundamentals in tune with evolving economic situation amid snowballing national debt, this could spark a national crisis.
More than anything, the financial crisis is dangerous because it can spread rapidly through the flow of money even if countries are remote each other and industries are not interconnected. The Asian financial crisis in 1997 was sparked by Mexico’s national default, which was caused by flight of capital due to the U.S.’ steep hikes of interest rates. Then, the crisis spread to Thailand and the Philippines before putting South Korea in danger. The world needs a security system that can help prevent ‘the spread of a crisis’ starting from Washington’s interest rate hikes to strengthening of the dollar, and to flight of capital from emerging markets.
The Korean government has claimed that Korea has strong economic fundamentals, but the reality is not completely optimistic. While the government is confused over its priority between inflation and growth policy, companies’ facility investment has been declining for three consecutive months. The private sector’s ability to create jobs remain sluggish due to regulations, whereas the nation’s labor productivity is ranked 51st among 63 countries around the world due to rigid labor-management relations. If the U.S. rapidly sucks in money from around the world following the start of tapering, countries with weak economic fundamentals will be inevitably impacted. Korea cannot afford to turn a blind eye to possible ‘domino defaults of countries” originating from Sri Lanka.