Sri Lanka’s debt sustainability and its current challenges

• Daily FT-ICCSL webinar sheds key insights from global and local experts

The Daily FT and ICCSL in association with CA Sri Lanka, the MBA Alumni Association of the University of Colombo and Ceylon Innovent, organised a high-profile webinar titled ‘Sri Lanka’s Debt Sustainability – The Current Challenges’ on 25 September. 

The keynotes were delivered by Central Bank Governor Ajith Nivard Cabraal and a former Chief Economist of the World Bank and currently Professor at Georgetown University USA, Prof. Shanta Devarajan. 

The webinar included a panel discussion featuring former PM Ranil Wickremesinghe, former Governor of the Reserve Bank of India Dr. Duvvuri Subbarao, former Senior Deputy Governor of the Central Bank of Sri Lanka Dr. Nandalal Weerasinghe, United Nations Economics and Social Commission for Asia and the Pacific Section Chief Financing for Development Dr. Alberto Isgut, former Deputy Governor of the Reserve Bank of India Dr. R. Subramaniam Gandhi, University of Rotterdam Netherlands Senior Lecturer in Economics Dr. Howard Nicholas, Institute of Policy Studies of Sri Lanka Director Dr. Dushni Weerakoon, a former Director of Research of the ADB Institute in Japan Dr. Ganeshan Wignaraja and Lanka Rating Agency CEO Adrian Perera. The webinar was moderated by Daily FT Editor Nisthar Cassim and ICCSL Chairman Dinesh Weerakkody.

 Excessive debt

It is a given that Sri Lanka has accrued a very large debt, and opinion has been expressed that this is an excessive amount to have to pay for an economy the size of Sri Lanka. In turn, the concern that has been often heard is that there is a looming default crisis. 60% of the total debt is local and 40% is foreign. The local component is set to rise further given that the pandemic is far from over. So, despite the substantial macroeconomic stimulus, Sri Lanka according to economists is unlikely to soon revert to pre-pandemic levels till mid-2023, let alone recoup 2020-2021 economic losses.

 Concerted program

Prof. Devarajan in his opening remarks advised that a concerted program be initiated without delay, with fiscal consolidation, which is notably a political issue. However, he advocated building consensus around the country, keeping the public fully informed about the nature of the debt and the need to restructure. The decision-making process, he said, should not be restricted to the province of technocrats disassociated with the public. He opined that it would be of benefit to work in collaboration with the IMF. In that option he considered it prudent that any debt-restructure be planned from within the country, and that the ‘positive’ engagement with the IMF will be in the spirit of partnership. There is a need to counter the present apprehension by sending the correct signals to the international community to enhance confidence in Sri Lanka- in that sense too, it will be incumbent on Sri Lanka to decide how much of the debt must be restructured, and such decisions will not be left for the IMF to determine.

 Pay-back time for the rich

In response to a question, about whether this is a ‘bitter pill’ that the country will be forced to swallow, Prof. Devarajan replied that ‘it is pay-back time’ for the rich. That component of society has benefited so far from the pattern of subsidies that have existed in Lanka’s fiscal history, which have been ‘skewed in favour of the non-poor’. For them it could be a ‘bitter pill’ but one swallowed in the interest of the debt burden being lifted from the poorer community, and the whole of Sri Lanka. 

Admittedly, the country is not in debt default at the moment, but such ‘bitter pills’ will, in the end, lead to overarching benefits. In response to another question, Prof. Shantha indicated that support with SDR from the IMF is not a display of largesse, rather, this was part of an ‘entitlement’ that Sri Lanka can enjoy, being a member of the system. However, debt restructuring requires a sustainable macro framework, and that is what the World Bank and IMF will need to be assured of. That has to be done with or without the IMF in line.

CBSL road map

Governor CBSL was firm in his view that since the situation does not exist where the country faces a default crisis, home grown solutions can and should be worked out without any involvement of the IMF. He saw no sense in restructuring, but indicated that vulnerability will have to be addressed, and said that a roadmap offering the details of the strategy will be unveiled on 1 October. He promised it would be a ‘cocktail of instruments’ that would offer solutions. He hinted that one of the measures to be adopted will be with monetising under-utilised assets. 

He provided evidence for confidence that the economy will grow with a return to normality, especially with the hope that tourism will again contribute greatly toward dollar inflows. He mentioned that priority projects will be considered, such as road construction and water supply projects. These measures will lead to new streams of income and export growth as well. Each stakeholder in the local economy, he suggested, will need to contribute to the economy and in this way mitigate the challenge being faced in the immediate time ahead. He also averred that Sri Lanka is not in recession. He opined that the economy will burgeon as there is tendency for economies to grow even faster than before, after meeting with an economic crisis. 

 Selling State assets

Former Prime Minister Ranil Wickremesinghe stressed that Sri Lanka must use the current situation to forge ahead with structural and public sector reforms although he remains wary of ‘homegrown solutions’ alone. He also said, “Government shouldn’t sell State assets to ease off the shortage of foreign exchange to have breakfast but reinvest those proceeds back into the economy. Going to the IMF is the best solution,” in contradistinction with the opinion of the Governor. The main issue is the paucity in foreign reserves. When many countries in the global community have built up their foreign exchange reserves, this country has had a serious decline. 

The need for Sri Lanka to successfully manage geopolitics, opening up to attract more foreign investments from all over instead of a select few and enhancing exports, were also emphasised by Wickremesinghe. The former PM also expressed concern that tourism is now in deep trouble and recovery will take time, before it can effectively contribute to the balance of payment factor. Among other things that needed urgent attention was re-skilling to be able to attract foreign investment, and the shortcomings in the whole education structure in preparing a work-ready population adapted to the new developments in technology, was stressed. 

The Fourth Industrial revolution is a reality that the country needs to come to grips with. Wickremesinghe also expressed confidence in Lanka’s ability to build on the primary surplus to be able to get over the debt issue, and suggested that there has to be some help from outside such as the IMF to bring the matter to fruition. It has been successfully done before.

 Export-oriented industries

Dr. Howard Nicholas saw warning signs, and feared that Lanka was appearing to be going the way of Zimbabwe and Argentina; he said that too much store was laid by ‘hope’ and insufficient on concrete measures to deal with the crisis. He underscored looking at interest payments as a percentage of foreign exchange reserves. He also observed that the budget deficit is not the problem but just a manifestation of the underlying problem. His focus was on aggressive development and fostering of export-oriented industries. Vietnam was quoted as an example of an economy that has pursued this course. 

In this matter of reliance on wishful thinking, Dr. Dushni Weerakoon concurred. She observed that the country is currently in a weak fiscal position – and has been, even at the start of the pandemic. There exists a ‘lack of clarity’ as to a way forward, she said, and relying ‘on chances’ of recovery was insufficient reason for confidence in meeting the challenge of debt sustainability. She also shared the apprehension of Cabraal with regard to debt restructuring, because it becomes more problematic in the future when agencies need to be approached. FDIs are needed, and again the curbs that exist with regard to imports and other areas, also tend to dent such non-debt inflows. 

Unfortunately, while there is a chunk of the debt accruing on the side of sovereign-bond holders, debt restructure is a far more complex issue. There is no provision in place with entities like the G20 to assist middle income countries with debt restructure. There is no mechanism to bring all prospective lenders together in taking on Sri Lanka’s situation, the bi-lateral and multilateral lenders and hedge fund investors. So, the IMF might be an option.

Need for cheaper debt

Dr. Subbarao emphasised the need for building confidence in the international sphere since the debt is sizable. Interest rates/payments will go up, and the domestic economy is just not generating enough. Borrowing foreign funds is not a viable solution. Such an avenue opens up an economy to the vagaries of a global economy and might not allow the benefit of such borrowings to flow to the private sector because it is the Government that is borrowing. He urged caution. Action, though, is needed to mitigate the serious problem and to avert a crisis. 

There has to be an adjustment to deal with the problem, there is no sense in waiting for the return to normality and inflows. In response to a query about currency swaps – Dr. Subbarao indicated that funds received from India and Bangladesh cannot be used to swell currency reserves, rather, such funds are in the short term and can only be allocated for the specific stated purpose for which those funds were transferred.

With reference to exports, Dr. Wignaraja was of the opinion that export growth is a must but the return so far has been slim, garments and tea and rubber have seen a waning in impetus. He suggested that services be an area to examine more. A place to do business – is how Lanka needs to be marketed to attract more investment and industrial opportunity. He touched briefly on the prospects with the Port City, and insisted that a transparent regulatory regime must be in place; one which will provide confidence to bring not tens of millions of dollars but hundreds of millions. 

Doubt has been already created in the international market, and that has to be overcome. He also thought that excessive reliance of China will not be the most prudent course, and indicated that there is more to gain from linkage with India. Are there alternative sources of financing? Dr. Alberto Isgut indicated that there might be such alternatives. Green bonds were mentioned, where specific industries and products come within the frame, such as would be of benefit to the environment. Invoking the Paris climate agreement, he said, was a possibility. 

Dr. Nandalal Weerasinghe drew on his long tenure with the CBSL and recalled the instances in previous years where the foreign reserves were in a good state sufficient to be able to seek short term and long-term financing via ISBs (international sovereign bond issuances) and even IMF inputs, but the present day offers a far more serious challenge. He indicated that there is a positive side in what was mentioned by Cabraal, and that is the monetising of under-utilised assets, a euphemism for privatisation. He thought that could be hopeful in this time where the debt-stress is far greater than before. 

Yet, the Government will have to come up with a credible plan to make certain that there will be ‘takers’ for those assets that do have encumbrances. Dr. Nandalal also touched briefly on what he thought was a folly- namely the investment of borrowings and the receipts from the exports not into expansion of those very exports, but those funds being deployed toward supporting domestic consumption. This he sees as counter-productive and distinct from the Vietnam experience, where export earnings were plowed back to export-oriented exports, which he considered to be sound fiscal policy.

 Curtail non-essential imports

Dr. Gandhi weighed in by observing what took place in India when that economy faced similar debt issues in the year 1991. Reforms were needed and they had to have the acceptance and recognition not only along the political platforms, but all intelligentsia and corporate/industrial heads needed to be on the ‘same page’ to succeed in the implementation of the policy of reform. Any reforms will need a hierarchy of consistent reforms of the external sector. Borrowings had to be carefully managed with even commercial borrowing not being for the short term but for the medium and long term to ensure stability. 

For Lanka the program has to be with a focus on the external sector. That too will have to demonstrate a permanent shift in how current accounts are managed, not just for a year or two. Bilateral borrowings will bring greater stability to the economy than short term commercial borrowings, because the re-payments will be made over a long period where the projects will themselves be generating the funds for the repayment. Dr. Gandhi also took note of the possibility of ‘capital flight’ and suggested that the Governor was wisely inviting exporters not to park their foreign money in overseas banks. Rather they should remit their earnings to Lanka and that itself will swell reserves.

Another point worthy of being underscored is that the rupee is overvalued and would be of little use to export industries. Adrian Perera of the Lanka Rating Agency noted that export earnings have also been declining, and excessive imports have had a disastrous impact on BOP. Therefore, there is no room for non-essential imports for some time. For firms to borrow, the rates at this time are at the optimum and such borrowing should be invested in business growth. The private sector then needs to be geared to take a role in growth albeit with a new economic model. Many of the earlier dependence on garments and IT will adjust and change, and the new model will have to be crafted so as to attract the new entrepreneurs of today and tomorrow.