Debt justice for Sri Lanka

Charith Gunawardena meets with his local MP, Bambos Charalambous, at the UK Parliament to discuss the pressing challenges posed by Sri Lanka’s debt crisis 

• The need for legislative reform in the UK

In April 2022, Sri Lanka defaulted on its sovereign debt servicing, plunging the nation into one of the worst economic crises in its history. As the newly elected Government finalised an IMF-backed debt restructuring deal agreed by the previous Government, a sustainable path out of the crisis with key creditors, including international sovereign bondholders (ISBs) who hold nearly 30% of the country’s debt, seems unlikely.

This unjust debt restructuring process underscored deeper systemic issues in global finance, including the lack of a sovereign bankruptcy mechanism and the unchecked power of private creditors. Without binding legal frameworks to ensure equitable debt resolution, debtor nations like Sri Lanka remain vulnerable to reckless lending practices, odious debts, and delays in restructuring processes that further harm their economies and people.

The challenge of negotiating with ISBs

ISBs represent a significant portion of Sri Lanka’s debt burden and pose a unique challenge in the restructuring process. Unlike bilateral creditors or multilateral institutions such as the IMF and World Bank, ISBs are governed predominantly by New York or UK law, and there is no legal mechanism to compel private creditors to participate in debt restructuring negotiations. This absence of enforceable rules allows International Sovereign Bondholders to prioritise their financial interests, often to the detriment of the borrowing nation’s economic recovery and public welfare.

Compounding the issue is the “risk premium” that ISB investors receive—higher interest rates designed to compensate for the perceived risk of lending to countries like Sri Lanka. However, this premium has incentivised reckless lending practices, where creditors profit from high-risk loans without considering the long-term sustainability of the borrower’s debt. When a country defaults, these same creditors can delay restructuring negotiations or demand disproportionate repayments, exacerbating economic instability and social hardship.

The consequences of an imbalanced system

The lack of a sovereign bankruptcy mechanism creates a profound power imbalance between debtor nations and their creditors. For countries like Sri Lanka, this imbalance manifests in several ways:

• Prolonged negotiations: Without legal obligations to participate, private creditors can stall negotiations, delaying the resolution of debt crises. These delays exacerbate economic uncertainty, restrict access to international markets, and prolong the suffering of citizens.
• Odious debts: Reckless lending practices often result in debts that are unsustainable or unjust, burdening nations with obligations that prioritise creditor profits over the needs of their people.
• Limited resources for essential services: During restructuring, debtor nations must continue servicing their debts, diverting funds from critical areas such as healthcare, education, and climate resilience.
• Economic and social damage: The uncertainty and austerity associated with protracted debt crises can lead to widespread economic stagnation, social unrest, and loss of trust in government institutions.

Legislative solutions for debt justice

Recognising these challenges, lawmakers in the UK and New York—two jurisdictions that govern most ISB contracts—are working to address the systemic flaws in sovereign debt resolution. Proposed debt justice laws in these jurisdictions aim to create a fairer and more efficient framework for restructuring sovereign debt.

In November 2024, Bambos Charalambous, Labour MP for Southgate and Wood Green in London, proposed in the UK parliament to bring in a Bill to make provision for or in connection with the relief of debts of certain developing countries.

Key provisions of proposed legislation

Limit on litigation: Private lenders would be prohibited from suing debtor countries for amounts exceeding what they would receive under an agreed debt restructuring framework. This would prevent creditors from bypassing restructuring agreements in pursuit of higher repayments.

Mandatory participation: Courts could compel private creditors to participate in debt restructuring agreements once governments and multilateral institutions, such as the IMF, have endorsed them.

Repayment pauses: Borrowing countries would be granted a moratorium on debt repayments once they formally apply for restructuring, preventing further depletion of their reserves during negotiations.

Equity in restructuring: The laws would ensure that private creditors are bound by the same terms as other lenders, reducing the toxic power imbalance that currently exists.

Benefits of debt justice legislation

If enacted, these reforms could transform the sovereign debt landscape, providing significant benefits for debtor nations and their populations:

• Easier restructuring: By eliminating the ability of private creditors to hold out for better terms, the legislation would streamline restructuring processes and ensure greater compliance.
• Financial relief for essential services: Reducing repayment obligations would free up critical resources for healthcare, education, and climate adaptation, improving the quality of life for citizens.
• Faster resolution: Clear rules for creditor participation would reduce delays, allowing countries to return to stability and growth more quickly.
• Levelling the playing field: By addressing the power imbalance between debtor nations and their creditors, these laws would restore fairness and accountability to the restructuring process.

The path forward for Sri Lanka

Sri Lanka’s experience highlights the urgent need for systemic reforms in sovereign debt resolution. The country’s default has revealed the predatory nature of international lending practices and the inadequacy of current frameworks to ensure equitable outcomes. For Sri Lanka, the immediate priority is to secure a sustainable debt restructuring agreement that alleviates the burden on its economy and people. However, achieving this goal requires more than just negotiations with creditors—it demands a global commitment to reforming the rules that govern sovereign debt.

The role of international advocacy

Organisations such as Debt Justice UK, alongside campaigners and lawmakers in the UK and New York, are playing a critical role in pushing for these reforms. Their efforts are aimed at creating a legal framework that prioritises the welfare of debtor nations and their citizens over the profit motives of private creditors. As Sri Lanka navigates its debt restructuring process, these advocacy efforts offer hope for a more just and sustainable resolution—not only for Sri Lanka but for all countries grappling with unsustainable debt.

The writer, co-founder of the Institute of Political Economy and a former local councillor in London, met with his local MP, Bambos Charalambous, at the UK Parliament to discuss the pressing challenges posed by Sri Lanka’s debt crisis. During their meeting, Gunawardena highlighted the unsustainable nature of the current debt restructuring agreement and warned of the significant risk of further default when Sri Lanka’s IMF program concludes in 2028.

Charalambous acknowledged these concerns and drew parallels to past global debt relief efforts, stating, “2025 marks the 25th anniversary of the Jubilee 2000 campaign, which successfully secured over $ 100 billion in debt cancellation for 35 of the world’s poorest countries. We must build on that success and push for renewed international action on debt relief, ensuring that savings from debt cancellation are redirected towards vital investments in health and education for low-income nations.”

The way forward

Sri Lanka’s debt crisis underscores the urgent need for legislative reforms to address the inequities in sovereign debt resolution. Without mechanisms to enforce private creditor participation and ensure equitable restructuring, debtor nations remain trapped in a cycle of financial instability and social harm. The proposed debt justice laws in the UK and New York represent a critical step toward creating a fairer system—one that acknowledges the shared responsibility of lenders and borrowers and prioritises the well-being of people over profit. For Sri Lanka, these reforms offer a path to a more sustainable and just economic future, enabling the nation to rebuild with resilience and dignity.

(The writer is co-founder of the Institute of Political Economy (ipe-sl.org) and a former local councillor in London. [email protected].)