Sri Lanka has voted – but the new left-wing president, Anura Kumara Dissanayake, has limited room for political maneuver. He took office promising to renegotiate the loan program with the IMF and the ongoing debt restructuring negotiations. However, just two weeks after taking office, he backed down and accepted a debt deal that heavily favors the creditors.
In Part I of the blog series, I discussed the importance of renegotiation and the social and political consequences of Dissanayake’s turnaround. In Part II, I now look at how the ongoing lawsuit between the Hamilton Reserve Bank and Sri Lanka provides insight into the complex mechanisms through which pressure was exerted on the new president.
Prehistory: Crises, Litigation and Austerity Measures
Despite multiple crises and high debt service burdens, Sri Lanka tried for a long time to pay its creditors on time and avoided debt restructuring negotiations. This changed in spring 2022, when the oil- and wheat-importing island state was once again heavily impacted by skyrocketing global prices. In April 2022, the country had no other option but to stop repayments and enter into debt restructuring negotiations.
Public creditors – including the German government – and the majority of private creditors agreed to negotiate a debt restructuring with Sri Lanka. As usual, the adoption of an IMF loan program was made a condition by the public creditors. As part of this program, Sri Lanka was obliged to meet tough austerity conditions, while debt cancellation was completely insufficient.
However, one of the private creditors, the Hamilton Reserve Bank, refused to negotiate from the outset: In June 2022, the investment bank which is based in the tax haven of St. Kitts and Nevis filed a lawsuit at the New York court demanding full and immediate repayment of its claims.
April 2022 – July 2024: Close Cooperation Between Interim Government and International Actors
The interim government under Mont Pèlerin Society member Wickremesinghe swiftly moved forward with debt restructuring, pushing through reforms and legislative changes in parliament at record speed – all in line with the international creditors and their economic policy ideology. The Hamilton Bank’s lawsuit was therefore initially dismissed by Western states, as it risked to jeopardize the smooth progress of the debt restructuring process. The bank initially acted too boldly to fully exploit the political pressure potential inherent in such lawsuits.
Both the US government and the Paris Club Secretariat supported Sri Lanka by filing amicus curiae statements in court when the country requested a suspension of the lawsuit in July 2023 and February 2024. They argued that a judgement in favor of the bank would jeopardize the restructuring process. The US government also emphasized that a successful debt restructuring process as part of the IMF program was in its geopolitical interest. Most recently, the process was paused until August 1, 2024 by order of the court, following that argumentation.
When the suspension ended on August 1, the restructuring with the private creditors had not yet been completed. Therefore, Sri Lanka applied for a new suspension at the end of July 2024.
While the Paris Club immediately submitted a statement in February 2024 and the US government responded two weeks later, this time it took around three weeks for the Paris Club to submit a statement. For the first time, the US government did not submit a statement in support of Sri Lanka. This could be related to the fact that the change of government in the presidential elections in September was already clearly visible at that time. The left-wing candidate Dissanayake, who advocated a renegotiation of the IMF program, was clearly ahead in the polls.
August 2024: Final Act of the interim government: Making Political Change More Difficult
In August 2024, the private creditors of the bondholders’ committee, which according to their own statements “includes some of the world’s largest financial institutions”, also approached the court for the first time. In their intervention of August 28, which explicitly referred to Sri Lanka’s request for a further pause, the private creditors stated:
„Given the uncertainties relating to the upcoming presidential elections in Sri Lanka (scheduled for September 21, 2024), … the Steering Committee is concerned that delay could threaten the significant progress that has been made by Sri Lanka… The Steering Committee does not take a position on the relief sought by Sri Lanka in the Stay Motion, but the Steering Committee believes it is critical that the bond restructuring contemplated by the Joint Working Framework is launched by the middle of September 2024.”
(own emphasis)
Even if the specific aim of the intervention in relation with the Hamilton case remains unclear, it becomes obvious that the investors used all possible channels to force the completion of the restructuring before the change of government.
On September 19, 2024, two days before the presidential election, the Sri Lankan interim government reacted publicly and announced that it had reached a provisional agreement with the committee of bondholders. This was not yet a legally binding restructuring. However, by publicly announcing the provisional deal, the government of the interim president attempted to make renegotiation more difficult after the presidential election.
September 2024: A “Marxist Outsider” Wins the Election
On September 21, Dissanayake was elected with a clear majority. Shortly after the election, the IMF and the public creditors announced that they accepted the provisional agreement with the bondholders’ committee – even though private creditors would grant an estimated 21 percent less relief than public actors. This actually contradicts the principle of comparable treatment that public creditors demand in debt restructurings so that publicly granted relief does not finance private profits. The approval was a decisive step in bringing the debt rescheduling negotiations with the bondholders to a conclusion as they had been initiated before the election. This made it more difficult to restart the negotiations, as Dissanayake was still aiming to do at the time.
On October 1, the Hamilton Reserve Bank approached the court again and warned against granting the request for a further pause of debt repayments:
„For context, since Sri Lanka’s 2022 default, President Ranil Wickremesinghe’s administration had presided over restructuring negotiations with creditors and the IMF. But on September 21, 2024 … a Marxist political outsider, Anura Kumara Dissanayake, defeated President Wickremesinghe in a run-off election… Thus, while Sri Lanka has repeatedly speculated that this litigation could ‘pose severe risks to the success’ of its restructuring, after it agreed to the restructuring and an IMF program, Sri Lanka’s new leadership itself appears to present the most significant risk to these objectives… no further stay is warranted.”
(own emphasis)
Hamilton thus took up the argument previously put forward by the Sri Lankan interim government, the USA and the Paris Club and adopted by the court not for the rejection but for the granting of the previous moratoria: that the legal dispute jeopardized the debt restructuring, based on the current IMF program, and that the moratoria were necessary in order not to interrupt this – otherwise well-running – process.
October 2024: The President Caves In
On October 4, the Sri Lankan authorities then assured the court that they were still committed to the IMF program and the agreement with the bondholders’ committee and were not seeking any renegotiations:
„Hamilton Reserve Bank (HRB) speculates that Sri Lanka’s restructuring efforts have been undermined by the recent Presidential elections… HRB is misinformed… Sri Lanka remains committed to the restructuring process… the Sri Lankan authorities have confirmed their endorsement of the International Monetary Fund (“IMF”)-supported program debt targets and the September 19, 2024 agreement in principle with representatives of Sri Lanka’s international and local holders of international sovereign bonds”
(own emphasis)
The newly elected president thus buried one of his most important plans after less than two weeks.
How To Understand The President’s Reversal?
The president’s turnaround cannot only be understood in the context of the lawsuit. Shortly after the presidential elections, there have been also meetings between IMF employees and the new president. What was discussed there and in other bilateral meetings is likely to have had a significant influence on the president’s rapid change of course. Although it is not known publicly how the talks went, it is clear that the IMF and presumably also the Western and Eastern creditor states did not signal any willingness to engage in constructive re-negotiations.
In this context, the lawsuit is of interest as it shows that the support in court from Western countries was closely linked to Sri Lanka’s compliance with the IMF’s measures. If the new president had stuck to his plan and renegotiated with the IMF and the creditors or conducted the negiotiations in a more conflictual manner, Sri Lanka would probably have lacked this support in court. In addition, other private creditors might have taken legal action.
The lawsuit also threatened to send out an unpleasant signal immediately. At the time Dissanayake took office, the decision on whether to grant a further moratorium had yet to be made – which could also be linked to the fact that the US government did not submit a supporting statement this time and other states only did so with delay. A rejection by the court would not only have entailed further negative repercussions from a corresponding court dispute, but would presumably also have been a perfect opportunity for the media to portray the “Marxist” Dissanayake as incompetent in terms of economic policy and diplomacy.
What Happens Next With The Lawsuit?
The court agreed to Sri Lanka’s application on November 15, i.e. well after the president’s change of course, and paused the process until November 30, by which time the bond exchange will in all likelihood not have been finalized. It can therefore be assumed that Sri Lanka will submit another application for a moratorium at the end of November, but that the bond exchange will probably already have been carried out before the court decides on the application for a new pause.
However, it is not yet clear whether the Hamilton Reserve Bank will participate in the bond exchange. The deal is fundamentally advantageous for creditors: they do not incur any real losses and continue to achieve comparatively high returns. This is particularly true for Hamilton Bank, which bought up its bonds on the secondary market at greatly reduced prices between August 2021 and June 2022, when Sri Lanka was already deep in crisis. It is therefore quite possible that the bank will agree to the deal and drop its lawsuit. On the other hand, it took a high risk from the outset and may have already invested considerable legal costs.
However, it is uncertain whether a bond exchange is possible without the voluntary participation of the Hamilton Bank. In order to overrule the bank, a majority of 75 percent is required. According to its own information, the bank holds principal claims amounting to 250.19 million US dollars and thus exactly the necessary blocking minority of the 1 billion bond. If this information is correct and the Hamilton Bank does not voluntarily agree to a restructuring, it still has the right to enforce the full amount of its claim in court. If the bank is successful in court, the question remains as to whether the Sri Lankan government will follow the ruling – and what impact this would have on the agreement with the other creditors. An advantageous payment to individual creditors could render restructuring agreements with other creditors null and void. If, on the other hand, the government refuses to pay, the bank could attempt to seize Sri Lankan assets abroad, which would however be a risky and costly process for the bank.
Conclusion: The Right To Debt Cancellation
Once again, this process reveals the weaknesses of the current structure of the international debt architecture: in any other debt transaction, there are clear guidelines as to when claims can no longer be enforced in full and the creditor’s right to repayment must be restricted – for example, if this conflicts with the debtor’s right to a live in dignity. This does not apply to government debt, and any relief is seen as a concession by the creditor. Binding regulations are therefore needed: An established and institutionally enforceable right to cancel unsustainable and illegitimate debts as well as laws that oblige private creditors to participate in these cancellations.
This publication was co-funded by the European Union. Its contents are the sole responsibility of erlassjahr.de and do not necessarily reflect the views of the European Union.
