Sovereign debt, which is usually in the form of securities, is issued by a nation's government to borrow money and may also be referred to as government debt, public debt, and national debt. This borrowing is done for a variety of reasons, from financing public investments to boosting employment.

The level of sovereign debt and its interest rates will also reflect the saving preferences of a country's businesses and residents, as well as the demand from foreign investors. Countries with stable economies and political systems are typically viewed as having better credit risks, allowing them to borrow on more favourable terms.

When investing in sovereign debt, bondholders monitor a sovereign entity's political stability and financial environment to determine the risk of sovereign default. Although sovereign countries are not subject to bankruptcy laws, as is the case with companies and individuals, cases of sovereign default are common and are preceded by an economic crisis.

Sri Lanka was so great until it wasn't

Sri Lanka was destined to be the Singapore of South Asia. The macro-economic strength of the country was rated as investment-grade by global ratings agencies and many central banks invested in Sri Lankan sovereign bonds to diversify their reserves.

A few years ago, Sri Lanka seemed to be on the right track. Tourism was booming, with mega-infrastructure projects making headlines worldwide. Today the country is insolvent, and prices are skyrocketing.

The island nation has leapt into a deep economic crisis. With more than $50 billion in external debt and a shortage of foreign exchange reserves, the country is currently struggling to pay for essential imports. This has led to sharp increases in the price of essential commodities like rice, fuel, and milk.

Sri Lanka's foreign debt obligations for this year exceeded $7 billion. But the country's forex reserves as of March 2022 are just $1.6 billion.

Recently, the country announced a default on all its foreign debts. Now Sri Lanka is hoping for a bailout from the International Monetary Fund (IMF) to save it from the worsening crisis.

The main source of the crisis came from the mismanagement of its macro-economy as the country leveraged high-interest bilateral loans without making a thorough need assessment and returns from investment analysis.

Should we compare Bangladesh to Sri Lanka?

One could say Bangladesh is also rising and is considered to be just as great (if not even greater) than what Sri Lanka was promising to be in the very recent past. So, it begs the question of whether Bangladesh should also be worried.

Recently, there have been warnings made towards Bangladesh of the current crisis in Sri Lanka. However, one should keep in mind that the nature of Sri Lanka's economy is different from that of Bangladesh.

There is no shortage of food production in Bangladesh and its main food is not import-dependent. The amount of export earnings and remittances is increasing day by day.

Bangladesh's reserves are over $40 billion and Sri Lanka's was less than $2 billion. Bangladesh's foreign debt per capita is not as high as Sri Lanka's. The per capita debt of Bangladesh is $292 and Sri Lanka is $1,650.

Considering the economic situation, it would not be accurate to compare Bangladesh with Sri Lanka. The society and economy of the two countries are quite dissimilar.

Sri Lanka, which was on the verge of emerging as an upper-middle-income country a decade ago, is now on the verge of bankruptcy. However, it should be recognised that Bangladesh is facing many challenges on the development path. It is addressing these issues through proper policy and planning and will continue to do so in the future.

Managing sovereign debt, a preemptive approach

Proactive debt management, in countries at high risk of debt distress, can lessen the probability of defaulting and open up resources to support economic recovery.

Generally, one of the options for debt management is debt reprofiling, which is modifications of the aggregate schedule of future country repayments through refinancing, debt substitution or renegotiations. The other option is debt restructuring, which is modifications of the financial structure of liabilities to reduce the net present value.

A reprofiling operation could be helpful if a country has multiple loans that come payable in the same year or other kinds of buildup in exposure, such as in the currency structure of obligations. New debt could be issued with a longer or more uniform maturity profile.

Debt reprofiling can also help address currency risk, which often adds to debt sustainability concerns. In such situations, instead of changing the maturity of existing debt, the debt reprofiling operation would retire existing debt designated in one currency and issue new debt in another currency.

Nations facing rising default hazards also have the choice of initiating preventive negotiations with their creditors to reach a debt rearrangement. This option requires transparency in the terms and title of the debt.

Evidence indicates that preemptive restructurings are fixed faster than post-default restructuring, lead to shorter exclusion periods from global capital markets, and are associated with a smaller output loss. In such situations, it is important to minimise the chances that a particular creditor holds out to gain benefit from the process.

What if it's too late? 

Once a nation is in debt crisis, the choices available for tackling the issues become more limited. A primary instrument at this phase is debt restructuring, combined with a fiscal and economic reform plan. Optimising the use of this tool requires quick recognition of the depth of the problem, coordination with and among creditors, and an agreement by all parties that restructuring is the first step toward debt sustainability and not the final one.

International financial institutions such as the IMF and the World Bank often play an important role in the debt restructuring process in emerging economies. These organisations conduct the debt sustainability analyses required to understand the problem in a complete manner and frequently provide financing to make the deal feasible.

An immediate and deep restructuring agreement could allow for a faster and sustained recovery. However, based on historical experience, the resolution of sovereign debt distress is often delayed for years. Even if countries enter negotiations with creditors, they often require multiple rounds of debt restructuring to emerge from debt distress.

The author is an economic analyst