Future SL borrowings must have experts oversight

IMF Senior Mission Chief for Sri Lanka Peter Breuer for Sri Lanka in a statement said recently the IMF Executive Board approved a 48-month extended arrangement under the extended Fund facility of 2.286 billion SDR, Special Drawing Rights, and that corresponds to about $ 3 billion to support Sri Lanka's economic policies and reforms. 

He went on to say, Sri Lanka, as you know, has been facing a severe crisis as a result of past policy missteps and economic shocks. One of the biggest policy missteps was the haphazard borrowings. To add to our list of debt restructuring challenges a court in the US denied a motion by the Government of Sri Lanka to dismiss a lawsuit brought by Hamilton Reserve Bank following the default by the GOSL on a sum of more than $ 257 million of bonds and interest that Hamilton had invested in. 

Lending to Sri Lanka between 2007 and 2022 was often marked by an absence of due diligence, opaque conditions and aggressive lobbying with politicians and bureaucrats. Interest rates charged which were in the range of 6.3% were “exorbitant” given that the effective LIBOR (London Inter-Bank Offered Rate) was much lower (just 2% in 2009 and even lower in 2018) and could be construed as predatory lending. This is when commercial banks were borrowing at much less.

Generally, Predatory lending is lending with “severe conditions” and can be some or all of the following.  

• Aggressive sales/lobbying tactics by lenders
• Very high- interest rates, 
• Overcharging for administrative costs, to mask introducer commissions, third-party facilitation fees and many such opaque elements 
• Non-disclosure of risk factors and associated risk premiums by the lender and the absence of Integrity Due Diligence on the borrower. 
• Failure to carry out due diligence with regard to the technical feasibility and/or financial viability of a particular project,
• High collateral requirements, spurious events of default, stringent penalties in the event of default, or a combination of the foregoing.

Critically, Sri Lanka’s capacity to repay was also not factored in. Herein lies our problem. These borrowings must be investigated to prevent a future catastrophe. The findings must be discussed at the highest levels of Government to prevent repetition. Accountability is easy to pin with such disastrous results more than evident now. 

Criticism 

The high-pitched soundbites, particularly in the western press and that too in relation to the debt owed to China masks the true nature of the rest of the debt, both Foreign and Local. Of the former, the multilateral debt is not labelled as predatory as it does not meet the definition above. Governance structures are also very high. 

The bilateral debt restructuring has largely come onboard with haircuts and moratoriums, particularly the Paris Club and India. China is in the political dimension at present and will hopefully be negotiated to a satisfactory conclusion to all parties concerned, given their willingness according to the newspapers. 

Commercial Borrowings

The commercial foreign debt, aka ISBs, have signalled their willingness to come on-board with haircuts and moratoriums. Most holders for the time being have acquired them in the secondary markets at deep discounts and have room for negotiating such concessions.

Sri Lanka’s Domestic debt also has almost all the characteristics of “predatory” lending to the GOSL over the years, principal among which are:

• Aggressive lobbying tactics, via private placement of Treasuries in the 2007 to 2015 period
• High-interest rates vis-à-vis policy rates and the backdrop of policy rate volatility by fiat
• Lender risk factors being downplayed or ignored by the borrowers like the twin macroeconomic deficits, the managed exchange rates, burgeoning state expenditure and shrinking fiscal revenues, money printing and expanding M2, sovereign rating downgrades and many more. 
• Sovereign guarantees taken to mask the failure to carry out due diligence with regard to the technical feasibility and/or financial viability of a particular project related lending

Here again, GOSL's capacity to repay nor service the debt was notably not factored in. 

Sustainable Future 

Experts say Sri Lanka has been the target or victim if you may, of predatory lending over the years, both foreign and domestic and sauce for the goose is sauce for the gander. Our domestic public debt too must therefore be subject to significant restructuring, haircuts and interest discounts. Here too, most holders for the time being have either acquired them in the secondary markets at deep discounts and have room for negotiating such concessions and/or have recognised significant capital gains and even realised such gains. 

The earlier the holders for the time being abandon holding out, the less pain for them and the smoother the overall debt restructuring, unlocking Sri Lanka’s trajectory to the next level of recovery and normalcy.

Moreover, given that in today’s extraordinary conditions of a sovereign debt default and sovereign rating downgrades most or all of the lender risks of predatory lending have either crystallised or will soon. The banking regulator should proactively stop the distribution of such unrealised gains and manage these elevated expectations for the greater good of the nation.

The banks and holders of treasuries for the time being will most likely cry foul and lean on the lobbyists to negate this and we can expect an increase in the protestations, threats and whining of their apologists among the ranks of their tax and financial advisors and their shareholder lobbies. 

Some licensed deposit-holding financial institutions have, in the recent past in relation to this measure, audaciously even hinted at enforced haircuts on the FDs they hold, in the expectation that this uncorroborated notion that it will derail the entire debt restructuring and the consequent recovery to a semblance of normalcy. The nation’s savers are not to blame for the recklessness of the financial institutions in their mission to increase shareholder distributions.

Here again, the regulatory authorities should not countenance such moves on savers, let alone approve them (as only they can) and manage all expectations firmly, for the greater good of the nation. Offering a few sellable options to our lenders may go a long way in closing the debt restructure. 

References

https://www.outlookindia.com/business/lessons-from-sri-lanka-over-borrowing-a-trap-you-must-avoid-in-personal-finance-news-208466/amp

https://www.orfonline.org/expert-speak/sri-lankan-crisis-the-perils-of-inherited-fallacies-and-economic-mismanagement/