Sri Lanka debt restructure: A critique from a third eye

Foreign exchange reserves in Sri Lanka decreased to $ 2,806 million in July from $ 4,060 million in June 2021. Source: Central Bank of Sri Lanka

The Government, being the sceptic, has strongly denied and dispelled the notion of Sri Lanka’s debt crisis, citing debt payments were up to date for the past two years

 

Monday, 25 October 2021

Abstract

After watching the webinar, sponsored jointly by FT and ICCSL and broadcasted over social media, repeatedly rewinding and fast-forwarding, has created an enthusiasm to write a review of the proceedings. 

It is evident that there is an immediate need to acknowledge, accept and assess the volume of the debt crisis, formulate a strategy to restructure debt to a sustainable level, and thereafter, to implement a long-term process to maintain debt with financial discipline across the government sectors, cutting down unnecessary, unaffordable expenditures, and ensure efficient utilisation of capacity thus preventing future crises of this nature. 

The Government, being the sceptic, has strongly denied and dispelled the notion of Sri Lanka’s debt crisis, citing debt payments were up to date for the past two years (2020, 2021), and assuring to honour future payments on a Year-on-Year (Y-o-Y) basis with a credible homegrown solution.

Preamble

The traditional ratio analysis hitherto available for predicting financial distress of any organisation could be easily applied to the Sri Lankan situation at the macroeconomic level, which proceeds from cause to effect and deductive reasoning. No one can argue that the situation is normal as there were clearly visible signs of the development of cracks in the economy. In addition to quantitative deductions, one has to see the qualitative factors, too. 

A good example was bringing in a new Governor to the Central Bank (CBSL), where his predecessor’s term ended prematurely. Although COVID-19 had an impact on the economy of the size of Sri Lanka, it is an aberrant form of justification to mislead and cover up the mismanagement of the economy. 

Keynote addresses

The first addressee, Prof. Devarajan, stressed that there is a visible and developing debt crisis enumerating from key indices of SL economy, e.g., [1] fiscal deficit, [2] debt crisis, etc.

The current taxable earning is 9% of the GDP, and it is the lowest among the developing countries. To address this, there is a need to increase the tax base, cutting down waste in terms of subsidies given — mostly targeted to benefit the rich — enhance tax administration and increase the tax rate to pre-election level. He further stressed that the Government needs the political will and a concerted effort to educate the public getting the consensus as opposed to technocrats making decisions and merely passing down the decisions to the public, which often leads to dismay. In order to protect the poorer, it was also suggested to provide cash transfers to compensate for the tax increase. 

The second point was debt restructure. At the current level, SL has foreign reserves adequate only for two months of imports and it is barely sufficient. Debt restructuring also requires careful considerations and analysis of the legal and economic aspects to regain the confidence and assurance of stakeholders. Therefore, it was suggested the Government seek assistance from third parties, determining the percentage of debt to be restructured, and bring the residual debt to a manageable level. 

Once the groundwork is completed, involve the IMF, World Bank and ADB to mediate and work out modalities that the Government is keen to proceed with. Engagement of these international organisations will be a strength in negotiating with the debtors and creditors for favourable terms of repayment going forward. These measures of restructuring will stimulate growth to a sustainable level. He also named a few countries that have sought assistance and resurrected their economies.

The second addressee, Governor Cabraal, at the opening remark, dispelled the idea that Sri Lanka is currently having a debt crisis, quoting the debt payments that were honoured in 2020 and 2021. As such this speculation with no tangible evidence to support this notion by various quarters is an exaggeration to discredit. This attitude of complacency and groupthink clearly shows the Government has no humility to listen to opposing views. Moreover, he has not made any reference of how the Government paid the debts and the source of funding. However, there is enough public evidence that short-term currency swaps with India and Bangladesh and selling two prime lands in Colombo were the avenues through which the repayments were made. The currency swap is a very expensive financial instrument as it requires adjustment to parity rate and premium at the settlement, which is over and above the standard interest rate. 

He reiterated that the stagnation of GDP growth from 2015-2021 has badly reflected on the debt to GDP ratio, as such to take steps to grow the economy is an urgent need. One has to understand the reason for no significant growth. The reason for insignificant growth could easily be correlated to the past destructive events which de-stabilised the economy, [a] the coup attempt in October 2018 by the then President to overthrow the Prime Minster and install Mahinda Rajapaksa, [b] the Easter bombings, killing over 270 devotees and [c] the COVID-19 pandemic which has gone out of control due to the mere lukewarm action of the Government and promoting mythical approaches as opposed to recommended scientific treatments. Explaining further, the Governor highlighted the importance of removing the vulnerability of International Sovereign Bonds (ISB) by retiring significant debt through the Government-to-Government (G2G) loan scheme. But the risks associated with G2G need to be assessed as no country or government will act as a benevolent party to save us without their national interest or motives. This has been clearly seen in the Sri Lanka context with China and India competing to acquire prime Sri Lankan assets.  

The Governor repeated his opening statement, where he continuously denied the debt crisis and reiterated the promotion of a homegrown solution, more feasible in the Sri Lanka context, thus keeping the Government fully in control of the scheme. The proposed four pillars to improve the fiscal and foreign debts are illustrated below.

a. Monetise under-utilised assets;

b. Retire ISBs with G2G loan scheme;

c. Increase export revenue; and

d. Open for tourism upon reaching 90% double vaccination. This is assumed to earn $ 4.5 billion on a Y-o-Y basis. This is a very conservative figure as the outflows have not been mentioned and factored into the equation to assess net revenue.

On 1 October, the Governor unveiled a roadmap for recovery, bringing stability to the financial system, economy and price. This involves strengthening the legal and statutory framework, to assure enforcement and its applications. Under these four pillars, it is expected to grow the economy, retire debt from the current $ 13 billion to $ 11.5 billion, thus bringing down the debt to GDP ratio to an acceptable level by end 2021. This target is quite optimistic as the modalities have not been clearly expressed, despite saying there is a cocktail of financial instruments at their disposal. Could this be another cocktail of seven paupers jointly prepared for a grandeur meal, putting fistfuls of grain to a boiling pot? We should wait and observe.

Panel discussions 

Following are the concerns that were raised.

a) Relax the importation restriction on essential goods that retarded productivity and negatively affected growth

b) Curb handsome subsidies, especially benefiting the rich, and safety nets for the poorer 

c) Focus on export-oriented industrialisation in contrast to domestic-oriented industries. Industrialisation should be reformed with the aspiration and expectation to the current labour market and skills

d) Reform export strategy without abruptly terminating active trade agreements (TA), antagonising the other party. E.g. in the case of the Singapore TA 

e) Increase remittances earned from exports. Currently only 20% of the earnings are brought to Sri Lanka

f) Learn from countries how they came out of such debt crises. Lebanon, Ghana and Argentina did so through IMF, World Bank-sponsored rescue packages

g) Monetise under-utilised assets

h) Analyse limitation of homegrown solutions against the well-structured IMF, World Bank packages

i) Risks of G2G loans, specially targeted at retiring ISBs debts. It was revealed that ISB is a big chunk of total debt, standing at 45% 

j) Attract foreign direct investments (FDIs)

 

Crux of the debt problem

The mounting debts, as a result of heavy borrowings under the guise of growth in GDP, incapability and inability to utilise the assets for generating revenue at the right time, are the factors that have created instability in fiscal and monetary systems, reverberating an acute and serious debt crisis. 

The Government’s failure to admit and address this early on with a credible plan and the ineffective short-term measures hitherto taken have further exacerbated the situation. Debts, both foreign and local, have risen to unhealthy levels as a percentage of GDP, growing deficits of primary and current accounts, erosion of reserves, losing exchange parity rates, increase in ISB value, lack of confidence of legal and statutory frameworks, mismanagement of the economy, and especially, the stubborn stand of few technocrats led to the shattering of the financial system and markets.

Vital statistics and comparisons 

To illustrate the damage inflicted on the Sri Lankan economy over the recent years, the following data has been extracted to compare the economy of Sri Lanka against Bangladesh (SAARC region). Any further comparisons on various indices can be found by visiting the following URL https://tradingeconomics.com/

The graph [1] shows the status in terms of foreign exchange reserves. The scale on the left indicates Sri Lanka and right, Bangladesh. Bangladesh has a steady growth but Sri Lanka goes down after 2019, suggesting free-fall with no control. Sri Lanka has never achieved a high level of reserves, with its highest being nearly $ 10 billion compared to $ 48 billion for Bangladesh. 

Solutions proposed as opposed to homegrown solutions

It is important to first admit the size of the debt crisis rather than slipping away from reality. The majority view was to have political will and a solid plan to provide a credible framework and seek engagement and mediation of IMF and World Bank in restructuring a good percentage of debt, which is sustainable in the current economic climate. 

Engagement of the international organisations provides confidence and assurance among the stakeholders, viz: creditors, debtors, including bi-lateral lenders, hedge fund investors, and private ISB holders. The debt restructure is a plan developed by the respective governments and driven by them, dispelling the notion that it was an IMF plan. However, international organisations will actively monitor the progress, thus ensuring success. In the current political climate, such schemes have been branded as detrimental, with room for interference and ill-effects to Sri Lanka’s sovereignty. The book authored and published by Minister Bandula Gunawardena, titled ‘Handcuff on Sri Lanka Economy by IMF’ further culminated fears among ordinary folks. 

This program(s), in association with IMF, World Bank and ADB, etc., is the most preferable way in moving forward as Sri Lanka is currently facing a multitude of issues, including regulatory issues, legal risks, credit downgrades, high cost of debt issue, and obstacles in attracting FDIs.

It is also the general consensus among the panellists that it is of utmost importance to restore fiscal stability and balance both primary and current accounts. The fiscal system was badly subjected to a downturn with handsome tax cuts introduced soon after the Presidential election that was proven unaffordable and reduced the income to 9%, which is below par with growing economies. 

Export-oriented industrialisation has been a focus to balance the current account deficit. Questions were raised as to what changes are needed to align with aspiration and expectation — especially for the young members of the workforce — the necessity of modernisation with the proliferation of technology for growth, sustainability and scalability, viz: artificial intelligence and robotics, etc., and the need to explore service sector business ventures. It is also important to not abandon the agriculture and farming sectors but make them efficient with mechanisation, so that they may be self-sufficient. So many lessons have been learnt over the past two years as countries battled with COVID-19. It is critical to have food security and dependency with other countries. 

The way the Government handled TAs was also subjected to criticism, hence it was suggested that the export strategy be reviewed with emphasis on bi-lateral and multi-lateral dealings. Strengthening such deals will reinforce the export-oriented industries and growth. 

Summary and endnotes 

It is an undeniable fact that Sri Lanka is facing an acute debt crisis. All the indications and facts that have been put forward by the panel members clearly display the cracks formed in the economy and the various proposed solutions and pathways to overcome the crisis. The Governor’s ambitious proposals that spread across four areas are impracticable as they need initial groundwork to mitigate risks and articulate plans to regain confidence among local and international stakeholders. 

Export strategies must be reviewed to strengthen relationships and regain confidence with export partners, thus paving the way for sustainable growth in export-oriented industries. 

Flogging of assets under the guise of monetisation to foreign ownership requires a stable legal and statutory framework and enforcement. Graph [4] shows a dramatic downfall of capacity utilisation of assets in a period of one year by 20%. 

In terms of opening borders and reigniting tourism with the 90% of double dose vaccination, we have to live with COVID in years to come, so strict health guidelines need to be adhered to. I can recall one was saying even the well-disciplined country Singapore had issues controlling the spread of COVID-19. Hence, one can draw his/her own conclusion about the behaviour of Sri Lankans in terms of honouring the rules and guidelines. 

The Governor suggested retiring a substantial amount of ISB debts through the G2G loan scheme. This implied the inclination to borrow from China, considered as the benevolent country, at higher interest rate as in the past. We need to keep in mind that with the drop in the Sri Lanka sovereign credit ratio, many countries will not support this scheme. 

Replying to a question, the Governor indicated to negotiate and encourage exporters to bring total/substantial foreign earnings to Sri Lanka. This can only be achieved provided easy convertibility and parity adjustments when they require foreign exchange. Furthermore, without assessing the local and foreign content of the respective products being exported, it is hard to determine the percentages of forex to be brought back to Sri Lanka.

Conclusion

Weighing the pros and cons of both homegrown and IMF-sponsored debt restructure schemes, it is very clear that the latter provides a structured, progressive and transparent debt restructure plan compared to the local scheme explained by the CBSL Governor. 

Considering the track record of this Government over the past two years, promises have never been delivered, only ad hoc approaches. The approach should be progressive and the benefits must be seen in the short to long term. The successive Sri Lankan Governments were very good at making initiatives and plans that they broadcast over public media as an achievement. 

The success stories have hardly been heard and communicated. Before launching any scheme, the problems need to be identified and analysed, and then plan, implement, monitor, and adjust if needed and follow the cycle until the outcomes and benefits are realised. If the monitoring and assurance are in the hands of the same group of technocrats, success will hardly be achieved. This is the prime reason Sri Lanka needs a third party to monitor and adjust when warranted. As Dr. Devarajan said, it is not a weakness to approach IMF, with Sri Lanka being a member since IMFs inception, and it will be a strength to win the minds and regain confidence of the stakeholders of Sri Lanka to be engaged with currently and in the future. 

In terms of Modern Monetary Theory (MMT), printing money is an option to settle government Rupee debts. This again increases the money circulation and creates inflation if the supply and demand are out of balance. A country like USA or Japan will not have the same effect as Sri Lanka as their currencies can be used for international transactions. The two graphs, [1] and [2], show the rate of inflation and CPI in comparison with Bangladesh, which clearly illustrates the damage due to high money circulation. 

The success of the carved-out independent Port City investment zone is yet to be assessed as it is supposed to be managed and audited within, and there is no accountability to the Parliament. 

Finally, it is a regret to note that CBSL, being an independent body, what responsibility the Governor carries to outline the fiscal policies rather than explaining monetary policy settings (interest rate, inflation, stability of currency unemployment etc.) that has been given by the virtue of being the head of CBSL. Is this CBSL becoming a ‘Presidential Bank’ (PBSL) that has been recently reported in the electronic media?

 

The Inflation rates and CPI of both countries. The increase in inflation in Sri Lanka is contributed to high circulation of money, attributed ad hoc printing of Rupees

 

Capacity utilisation is a measure of the intensity with which a national economy (or sector, or firm) makes use of its resources. This graph shows an abrupt fall from 81% in 2019 to 2020, which is self-explanatory: the urgent need to monetise assets usage

(The writer is a Chartered Engineer and Fellow of IET UK.)