The devil is in the details

By Jemuel Chandrakumaran

Between the periods of 2009 and 2014, the then left-leaning Government engaged in the mass commercial undertaking of rebuilding this war-stricken island to unleash its economic potential, tripling total government debt and doubling external debt. 

Noble though it may seem, there is no doubt in everyone’s mind that monies spent on these endeavours were mismanaged. The country was presented with the world’s emptiest international airport coupled with a highway that should have been paved with gold for the price that was paid, which have caused debt servicing costs for 2016 to shoot up over $ 4.5 billion. 

With over $65 billion in debt, and $8 billion owed to China alone, the country’s debt to GDP ratio currently stands around 75%, while nearly 95% of State revenue is rerouted to debt repayment. Moreover, new revelations show that the previous Government used SOEs to obtain loans on its behalf that are currently pegged at a minimum $9.5 billion. Though much of this pile can be attributed to the uncontested buffet of building, the current coalition Government has also failed to reinstate investor confidence, further growing domestic and external debt by 12% and 25%.

But what is the real cause of this debacle? Policy. With depleting forex reserves, a depreciating LKR and a growing BOP deficit (which is approximately 100% of exports), Sri Lanka has been bleeding money since accepting the floating of its currency back in 2012. Though the nominal value of these loans have not inflated, their real value in LKR has hyper inflated. 

Unable to negotiate for better terms (with BB- and B+ credit ratings), some of these loans have higher interest rates that further burden the debt service bill. With a continuing budget deficit, the state has opted to pay off debt using new debt (such as the $1.5 billion IMF bailout), which cannot be sustained in the long run. 

Why haven’t these capital and operational expenditures paid off? 

nFirst, the actual costs of these investments are inflated (i.e. not all money spent went into producing these structures) and hence do not reciprocate expected returns. 

nSecond, expenditure was rerouted to the ex-President’s hometown, and not properly expedited in decentralising the business district and propagating further economic growth. 

nThird, though Sri Lanka is not an entitlement nation, Sri Lankans are entitled to several free services and subsidised amenities, which have made them more dependent on them, with the CPI continuing to rise while marginal income remain gridlocked. 

nFourth, with competitive advantage in the agricultural sector moving further north of the sub-continent, we still subsidise fertilisers and other base products to aid farmers, while the opportunity costs for these injections remain high. 

nFifth, continued expansions of State oversight has blown Government to greater lengths, increasing employee remuneration within the State sector and the number of loss making SOEs.

What can be done? 

nNegotiate debt-to-equity swaps with existing lenders (such as the deal done with the Chinese with regards to the Hambantota Port).

nCease long-term domestic borrowing at higher rates (averaging at 10%+) and either entice rate cuts to inflate the LKR against the USD, which would derail borrowing rates in the market, or use the depreciation to obtain an advantage in the foreign markets by facilitating scaled manufacturing in the major export goods (which is impractical as private investment cannot be solicited while Treasury bonds offer an attractive payoff). 

nPrivatise or liquidate a stake in loss-making SOEs. Even though the intent of these entities should be applauded, the best way to reduce price is to introduce competition (as in the telecommunication industry).

nEntice business investments (through tax breaks especially in the tourism sector) in the regional suburbs, which would involve private development and the decentralisation of the financial district. This would in turn deflate the city’s estate indexes and increase the disposable income of city dwellers for private consumption.

nIntroduce and encourage commodity trading, which is the main drainer of operational revenue next to debt servicing, where the Government fixes the market prices of fuel, bearing the profits and losses of international oil price shifts.

nIntroduce a system by which students who obtain a State-sponsored national school education, repay their debt through public service. (N.B. statistics show that a significant proportion of students from the Colombo National Schooling System tend to migrate to foreign countries after their secondary schooling tenure.)

nRevamp the taxation system which has operated in its flawed precipice since the dawn of the republic. The philosophy behind this system is that direct taxes reimburse the government, while indirect taxes redistribute income. But in Sri Lanka, 80% of State revenue is sourced through indirect taxes, thereby negating the fundamental use for which it was intended for. 

Is it too late?

In 2001, Sri Lanka had a debt-to-GDP ratio of 101%. With the election of the UNP Government in 2001 and the subsequent Cease Fire Agreement with the LTTE, the nation was able to rejuvenate economic progress through a measured approach of lower interest rates and the mass production of export goods. But even with a 75% leverage, the current crisis and the subsequent measures to quench it have dug us further into a debt trap. Due to this, the immediate application of the above could push the country further into the brink of bankruptcy, unless better terms are arrived at with the current lending players. 

Also, as 20% of the Lankan population are just above the Poverty Index, free market policies could push them back under the line. But if we continue to privatise profits and socialise losses, the prospect of waking up to the news that sovereign could not honour its debt is inevitable. Thus this remains to be a question between morality and practicality.

(The writer is a FX trader and a poker enthusiast.)