COLOMBO: Sri Lanka’s impending default on US$12.6bil of overseas bonds is flashing a warning sign to investors in other developing nations that surging inflation is set to take a painful toll.

The South Asian nation was set to blow through the grace period on US$78mil of payments yesterday, marking its first sovereign debt default since it gained independence from Britain in 1948.

Its bonds already trade deep in distressed territory, with holders bracing for losses approaching 60 US cents on the dollar. The government said last month it would halt payments on foreign debt.

Sri Lanka’s situation is unique in the way all debt crises are - the particulars here involve an unpopular government run by an all-powerful family, the unresolved aftermath of a 30-year civil war and violent street protests. But the island’s saga is starting to be seen as a bellwether for emerging markets where shortages exacerbated by inflation, including record-high food costs globally, have the potential to roil national economies.

“The Sri Lanka default is an ominous sign for emerging markets,” said Guido Chamorro, the co-head of emerging-market hard-currency debt at Pictet Asset Management, which holds Sri Lankan bonds. “We expect the good times to stop. Slowing growth and more difficult funding conditions will increase default risk particularly for frontier countries.”

Sri Lanka, an US$81bil economy located off India’s southern coast, has been mired in turmoil for weeks amid annual inflation running at 30%, a plummeting currency and an economic crisis that has left the country short of the hard currency it needs to import food and fuel.

Anger over the situation - brought about by years of excessive borrowing to fund bloated state companies and generous social benefits - has boiled over into violent protests.

Widespread arson and clashes were reported from several parts of the country while homes and properties of several government lawmakers were set on fire. At least nine people, including one member of parliament, were killed in the violence.

Sri Lanka is currently without a finance minister, which could complicate efforts to get through the crisis as the government struggles to restore security and get a bailout from the International Monetary Fund. At the same time, it needs to negotiate a restructuring with creditors, including BlackRock Inc and Ashmore Group.

The nation’s dollar bonds are among the worst performers in the world this year, with only Ukraine, Belarus and El Salvador’s bitcoin-busted notes faring worse. The government yeterday failed to transfer about US$78mil in coupons to holders of debt maturing in 2023 and 2028, leading S&P Global Ratings to declare a selective default.

Fitch Ratings and Moody’s Investors Service have yet to declare official defaults, despite issuing their own warnings.

 - Bloomberg