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1. Controversy of public debt vs external debt
The thresholds indicated in the UN-ESCAP framework that classify countries in to less indebted, moderately indebted and highly indebted categories relates to external debt, which includes both private and public debt. In the first press release, the CBSL had mentioned that the “six external debt indicators” have improved; implying that it has used external debt (both private and public debt) for computations. In a markedly different stance, the second press release of the CBSL that provides a clarification on the first refers to “external debt of the Government” instead of the words ‘external debt’. In fact, it has used external debt of the ‘Government’ for computations although it has used the word ‘external debt’ in its first press release.
It is reiterated that the UN-ESCAP thresholds should be used to compare ratios that use ‘external debt’ for computations; NOT ‘external Government debt’ alone. It may not be appropriate to use ratios computed based on external Government debt to compare with the thresholds of UN-ESCAP framework – like what the CBSL has done. Interestingly, the CBSL finds fault with Mr. Wijewardena’s computations that use external debt in line with UN-ESCAP framework. It would have been sensible for the CBSL not to confuse with external debt and external Government debt.
2. Remittances: Is it a source of exports and non-factor service income?
The second press release of the CBSL implies that it had used remittances as part of exports and non-factor service income. And it argues that certain commentaries in media reports “seem to have deliberately kept out workers’ remittances”.
There is a global debate on whether to include remittances as part of exports and non-factor service income with arguments for both sides. However, even if remittances are included, it comes as a modified ratio supplementing the original ratio that is computed without remittances. In this context it would have been a good practice from the part of the CBSL had it disclosed the fact that it included remittances and modified the formula accordingly. The CBSL press release did not include the computed original ratio nor did it mention that remittances had been included as a source of exports and non-factor services income.
The CBSL press release quotes ‘Staff Guidance Note on the Application of the Joint Bank-Fund Debt Sustainability Framework for Low-Income Countries 2010’ to strengthen the inclusion of remittances. It quotes from the note “From a debt sustainability perspective, remittances share similar characteristics with other variables that affect capacity to repay (exports and GDP)”. However, the CBSL seems to have omitted or is not aware that this Guidance Note was upgraded in 2013. Let me share the link to the new Guidance Note with the learned CBSL staff: http://www.imf.org/external/np/pp/eng/2013/110513.pdf.
The new Staff Guidance Note clearly distinguishes between an external Debt Sustainability Analysis (DSA) (based on external private and public debt) and a public Debt Sustainability Analysis (based on Government debt). Let me quote; “The external DSA covers total external debt in the economy, owed by both the public sector and the private sector. The public DSA (sometimes referred to as the fiscal DSA) covers total debt of the public sector, both external and domestic. Public external debt, which is common to both DSAs, includes both external debt owed by the public sector and external debt guaranteed by the public sector”.
The new Note provides guidance as to when remittances should be used. Accordingly, if a country so wishes to include remittances, it needs to establish remittances as ‘large’. The word ‘large’ is defined as if remittances are “both greater than 10 percent of GDP and greater than 20% of exports of goods and services”. In the Sri Lankan case, the first criterion is not satisfied although the second one is satisfied with a significant margin. Thus, based on the new Staff Guidance Note (2013), Sri Lanka cannot use remittances as part of exports and non-factor service income, although the CBSL has used it without disclosing such fact.
3. Revised thresholds when remittances are considered
When remittances become eligible to be included, the Guidance Note requires the country to use a more difficult threshold. Let me quote the Note again: “The remittance-adjusted thresholds for the PV of debt to GDP are 10 percent lower than the corresponding thresholds without remittances, while the remittance-adjusted thresholds for the PV of debt to exports and debt service to exports are 20% lower”. For example, when adjusted for remittances, the present value of debt to GDP threshold moves down from 30% to 27%, a 10% reduction. This means, a country that includes remittances will be recognised as vulnerable when the ratio goes above 27% whereas it would have been identified as vulnerable only if the ratio goes above 30% when calculated with remittances.
Therefore, it is clear that inclusion of remittances is not an easy way out to show a rosy debt picture. The thresholds need to be adjusted with such inclusion. It would have been good had the CBSL made these adjustments prior to contesting Wijewardena’s computations. A re-computation of the ratios would reveal to the CBSL that Wijewardena’s numbers are close to reality.
4. Historical perspective
According to four of the three indicators in the EU-ESCAP framework, Sri Lanka seems to be moving towards a high debt burdened country (Chart set 1). (The present author does not compute the last two indicators of the framework in the absence of a comprehensive, publicly available debt schedule. He requests the Public Debt Department to publish a debt schedule so that the discussion could be further broadened. Also, remittances adjustment was not made as remittances do not become eligible for inclusion in the Sri Lankan context according to the Staff Guidance Note for IMF and World Bank.)
In the chart set, the green line indicates the less indebted threshold and the red line reflects the highly indebted threshold. Except for interest payment related indicator, others show a gradual rise towards the high debt threshold or remain above threshold. The growth rate is relatively high during the past few years. These trends are clearly not healthy signs for debt sustainability.
5. Prospects for debt improvement is slim
Sri Lanka is moving away from concessional financing. The country is fast loosing access to multilateral low interest funds as it graduates to a middle income country. Also, the policy makers seem to give preference to bi-lateral and financial market funding because most of them come without attached conditionality. As a result, the country’s debt mix is changing and becoming expensive. Non-concessional and commercial component of the Government foreign debt has risen from 4% in 2005 to 50% in 2013, representing an annualised growth rate of 58% during this period. The country’s external debt service burden has doubled from 3% of GDP in 2005 to 6% of GDP in 2013. The Government total debt servicing exceeds its total tax revenue.
Due to the shift towards high-cost sources and aggressive borrowings of Government, the debt servicing is set to become a significant burden on the economy in the years to come. In order to avoid a debt driven crisis, it is important for the Government to be vigilant at least from now. Steps should be taken to a) curtail/rationalise new borrowings; b) attempt to tap low cost funding sources if they come with reasonable conditions; c) ensure new borrowings are invested in projects capable of generating high returns; d) ensure matching of cash-flows (outflows and inflows) in projects on an individual basis; e) increase the revenue through improved tax administration .
The policy makers need to carefully assess the viability of projects and advise the Government on investments. They need to be humble enough to entertain constructive discussions on important policy matters that could provide important insights; instead of bulldozing, labelling or questioning the capacity of people who create the dialogue. They should scan the environment for new developments and improve their decision making processes rather than advising other ‘analysts to expand their understanding’. Importantly, they should understand there could be people as capable as they are – if not better – outside the premises of the policy makers.
When men are most sure and arrogant they are commonly most mistaken, giving views to passion without that proper deliberation which alone can secure them from the grossest absurdities – David Hume.
(The author invites a constructive dialogue on the issue and can be reached on [email protected].)
