Sri Lanka has an IMF deal, now it courts China and India

• Sri Lanka's provisional IMF deal hinges on certain measures.
• China, India and Japan as creditors a rare mix.
• Questions over whether country will need to bail out banks.

Sri Lanka's International Monetary Fund bailout plan could be a turning point in its worst economic crisis, but far-from-stable politicsanda need to get debt relief from competing powersChina,IndiaandJapan means some of the hardest work is still to come.

President Ranil Wickremesinghe knows a lot of circles will need to be squared for theIMF's $2.9 billion lifeline to become a reality.

Spending cuts, tax hikes,anddebt write-downs are a common formula for bankrupt countries, but crisis veterans say there are some uniquely difficult elements here.

An impoverished population that forced former President Gotabaya Rajapaksa to flee in July still needs to accept Wickremesinghe, seen by many as of the same political ilkanda man who faces a bristling opposition.

The country's borrowings are so complex that estimates of the total range anywhere from $85 billion to well over $100 billion. To get it to a sustainable level Beijing, New Delhi, Tokyo, multilateralsandglobal asset managers must all swallow losses.

"This one of the biggest messes I've ever seen," said Renaissance Capital's chief economist Charles Robertson whohaswatched emerging market crises unfold for decades.

"The government destroyed its revenue base with unsustainable tax cuts, it tried to hold the currency when tourism revenues collapsed,andnowithasno reserves in the bankanda population facing widespread poverty."

Estimates from the United Nations say the crisishasleft more than a quarter ofSriLanka's 22 million population struggling to secure adequate, nutritious food.

TheIMF's 4-year rescues plan provisionally agreed last week demands serious fiscal repair workandmore autonomy for the central bank, which was ordered to frantically print money under Rajapaksa.

To hit theIMF's target of lifting its primary budget surplus to 2.4% by 2025,SriLankawould get its economy growing by around 6%, something not achieved for about five years. This year it is expected to contract at least 8%.

Courting Asia's heavyweights

Just as challenging, theIMFwants Colombo to secure "financing assurances" - Fund speak for debt reliefandnew loans—from regional heavyweightsChina, JapanandIndiawho have long jostled for influence.

The World Bank estimates Beijing's lending, whichhasfunded costly projects from ports to stadium, adds up to $7 billion, or 12% ofSriLanka's $63 billion external debt. Japanhasprovided another $3.5 billion whileIndiahasgiven around $1 billion.

Without the "assurances" from those countries, the Fund's money cannot flow,IMFMission Chief Peter Breuer stressed.

"Finding creative ways to have a collaborative platform to advance these debt restructuring discussions is very useful," Breuer told Reuters. "How debt relief is distributed amongst creditors...that is something we don't insert ourselves into."

Uncommon framework?

The crisishasculminated inSriLanka's starkest crisis first debt default since independence from Britain in 1948. The rupee almost halved in value since the central bank abandoned its peg in March, basic goods have become scarceandinflation isnowrunning at 64%.

Economists say the restructuring could have been far simpler if the country had been part of the G20 "Common Framework" plan - a programme set up at the height of COVID-19 to help debt-crippled countries. At the time,SriLankawas classified as a middle-income countryanddid not qualify.

Chinaautomatically provides debt relief alongside "Paris Club" countriesandprivate sector creditors under that arrangement. Colombo's absence from the setup means an alternative is needed.

Step up Japan - which isnowpushing forChina,Indiaandothers to join talks. Beijing, which did not respond to a request for comment,hasnot yet signalled if it will, although there are hopes its lead role in Zambia's restructuring may encourage it to do so.Indiahasnot commented so far.

Pessimists worry though that ifChinadoesn't take a writedown others won't either, including global asset managers who hold nearly $20 billion ofSriLanka's international bonds.

"Chinais the largest creditor country. Without its participation, any scheme won't succeed," a Japanese government official who requested anonymity said.

Doom loop

Another problem is what to do about the country's $50.5 billion of "local" debt mostly dominated in rupeeandlargely held as capital by commercial banksandlocal pension funds.

Sanjeewa Fernando, Head of Research at CT CLSA Securities said it won't be a straightforward decision, especially with elections looming in 2024.

"From a realistic point of view, banks are preparing for a 40% haircut (onSriLanka's international bondsand'development' bonds which are also dominated in dollars) as a base case scenario," he said.

Even that might not be enough though, given theIMFwants the debt-to-GDP ratio slashed to under 100% from 140% currently.

That would put domestic debt in play but David Beers, a Senior Fellow at the London-based Center for Financial Stability whohascompiled a global database of sovereign defaults said there are always tradeoffs.

"If the domestic debt is predominately held by domestic banksandyou get haircuts, then that eats into their capital," he said, adding that they might then require bailouts which add to the government's costs again.