Can Sri Lanka avoid borrowing from international bondholders in the coming years?

If we do not borrow externally in 2028, we will either default in 2028 or have to cut down our imports drastically

Sri Lanka’s emergence from default status is positive news. This means we can gradually start borrowing once again from ISB bondholders when most external debt payments come due in 2028. Many Sri Lankans may inquire why we should borrow from bondholders again and if this is detrimental. Allow me to explain as simply as possible. It would be ideal if we never had to borrow from international capital markets. However, Sri Lanka does not have a choice at present.

Sri Lanka’s overall gross financing needs (domestic and foreign debt) in 2022 was 34% of GDP which was around $ 27 billion. But in this article I will focus on the external debt only. In 2022, the foreign currency gross financing needs of the Sri Lankan Government were over 9% of GDP. Gross financing needs are interest payments plus principal payments due for a year. This was close to $ 8 billion in 2022. Sri Lanka has been rolling over debt; that is, borrowing to repay the maturing debt and, in many cases, the interest as well. Until 2028, Sri Lanka should be able to manage, as most foreign currency debt repayments are not due. However, after 2028, we have to pay back maturing debt and interest payments. Sri Lanka cannot do this without external borrowing further.

If we stop borrowing

Even now, with import restrictions on vehicles, we still run a trade deficit, and we are barely managing our current account largely thanks to tourism income and remittances. Therefore, if we stop borrowing, where will we get the $ 8 billion (2022 figure) in foreign currency to pay for external gross financing needs? If we do not borrow externally in 2028, we will either default in 2028 or have to cut down our imports drastically. Reducing imports by close to half will collapse the economy as around 80% of Sri Lanka’s imports are capital and intermediate goods and only around 20% of our imports are consumer goods. Inability to import capital and intermediate goods will affect our exports and bring down the exports. 

Are there any other ways, other than borrowing from bondholders in 2028? As Sri Lanka is a middle-income country, aid from other nations is more difficult to obtain. World Bank and ADB lending is also lower due to this; at the same time, as multilateral debt is exempt from restructuring, Sri Lanka continues to service debt to the World Bank and the Asian Development Bank while we continue to borrow from these two multilateral institutions. No other nation is going to lend around $ 8 billion a year for consecutive years. India was very generous to Sri Lanka in 2022 and provide assistance worth $ 4 billion but expecting around $ 8 billion a year even from our friendly neighbour, India for a few consecutive years is not possible

Therefore, the only option is returning to the international capital markets and borrowing from international bondholders. However, is this sustainable? Answer is no, it is not. For example, the United States of America can continue to borrow using its treasury bills and bonds because the US treasury is considered the safest place to lend and the US debt is in its own currency, the US Dollar which is also the reserve currency of the world. So the borrowing costs of the United States are very low. But Sri Lanka cannot always continue borrowing from bondholders, as Sri Lanka’s borrowing costs are very high. Sri Lanka will eventually default again. What is the long term solution?

The best option

An export-oriented economy and a push to attract foreign direct investments. Focusing on boosting our tradable sectors, in which Sri Lanka has a comparative advantage, would be the best option. Liberalising trade and joining regional and bilateral FTAs will help Sri Lanka attract opportunities to supply global value chains. 70% of global trade is supplying global supply chains of multinational companies. Additionally, Sri Lanka must focus on attracting FDI by improving ease of doing business, having consistent policies and reducing corruption. Sri Lanka has a lower savings rate, so Sri Lanka needs foreign investments to expand many productive sectors in Sri Lanka. Sri Lanka also needs to work on the SOE reforms and privatise SOEs with commercial interest so it can free up fiscal space for the Sri Lankan government to spend on education, health and infrastructure which will propel the Sri Lankan economy further. If we can expand our exports and attract investments and keep fiscal discipline, we can eventually, by the 2030s, drastically reduce borrowing from bondholders and maybe even eliminate it totally in the long term.

It is not realistic for Sri Lanka to grow its exports before 2028 to stop borrowing from capital markets, as three years is too short a time, but if Sri Lanka can have a focused strategy and keep transforming into an export-oriented economy and implementing the structural reforms, Sri Lanka can gradually reduce international capital market borrowings by the 2030s.

For now, the Government needs to focus on its export strategy. It is also important that we have good fiscal discipline so that we move up on our credit ratings; so, when we restart borrowing from international capital markets, our borrowing costs will be much reduced. This can reduce Sri Lanka’s interest payment costs which is one of the highest in the world.

Nevertheless, Sri Lanka coming out of selective default is positive news. The Government should focus on expanding exports, attracting investments, maintaining fiscal and monetary discipline, and implementing the much-needed structural reforms.

(The writer is an Economist and a member of the Expert Network of the World Economic Forum. He is a Consultant at the Asian Development Bank and he is a regular columnist for the International Monetary Fund’s public finance forum. The opinions expressed in this article are strictly the writer’s personal views.)