The cost of financial stability

Sri Lanka will publish its debt restructuring strategy in May, according to State Finance Minister Ranjith Siyambalapitya, who also stated that the Government aims to lower taxes and reduce debt to GDP in the following years. Siymabalapitiya stated that the administration intends to progressively lower recently raised taxes over the following five years after revenue objectives have been attained through additional tax base growth. 

According to the minister, the debt burden currently stands at 128% of GDP. The Government intends to reduce this to 95% during the next five years. The Central Bank has earlier stated that a debt restructuring scheme will be announced in April. When asked about the delay, the state minister stated that a strategy is being developed and will be presented within the month.

Sri Lankan domestic debt restructuring refers to the process of reforming the country’s debt obligations owing to domestic creditors such as banks, financial organisations, and individuals. It is the Government’s approach to addressing the country’s economic crisis and stabilising its financial status. One advantage of explicit debt restructuring is the possibility of gradually shifting expenses to sections of the economy that are better suited to absorb them. 

This strategy avoids unduly burdening the wage-dependent working people and contributes to the reduction of poverty caused by high inflation and unstructured debt management. This can be carried out in a number of ways and each has its own benefits and risks.

Debt rescheduling is the process of extending the maturities of existing debt commitments. This gives the debtor (in this example, the Sri Lankan Government) additional time to repay the loan, alleviating immediate financial difficulties. Rescheduling might imply extending the repayment period or postponing interest payments. A coupon haircut is a decrease in the interest rate on existing debt. 

This can be accomplished by negotiating with creditors to decrease the coupon payments, thus decreasing the debtor’s financial load. It tries to improve debt sustainability by lowering interest costs. Another alternative is converting current debt commitments into alternative financial instruments is what debt conversion entails. 

The Government, for example, may offer creditors the option of exchanging their debt for equity or other forms of securities. Debt conversion can assist restructure the debt structure and perhaps give the debtor additional sources of finance.

According to a top IMF official, Sri Lanka may be set on the path to prosperity if it achieves debt sustainability, but the island nation must also face the problem of restructuring domestic debt without jeopardising financial stability. The recent IMF-backed increase in progressive personal income tax in Sri Lanka met with opposition from a minority of the working population that earns more than most Sri Lankans but is well-organised and supported by the country’s leftist and left-leaning parties. 

Inflation is the worst type of tax on the poor, and the poor and vulnerable are the ones who suffer the most. As a result, you want to keep inflation under control. And thus, once again, monetary policy, with fiscal policy backing, must drive inflation down to acceptable levels. Meanwhile, Foreign Minister Ali Sabry told Channel News Asia on Wednesday that the Government is optimistic (“fingers crossed”) that the South Asian country, which is still recovering from its worst currency crisis in decades, will finish its debt restructuring program before the IMF reviews it in September.

To make an educated decision, the Sri Lankan Government will almost certainly need to assess the possible impact of each restructuring option on its financial stability, economic development prospects, and long-term debt sustainability. Furthermore, engaging in constructive dialogue and negotiations with creditors would be critical, while keeping the broader impact on the domestic economy and financial system stability in mind.