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In the case of bilateral credit, the overall debt level has not come down but only the payment terms have been eased
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Aseni and Sarath Mahatthaya have been continuing their interactive conversation on Sri Lanka’s debt and the process involving the debt restructuring to facilitate the country to get into debt sustainability, a requirement under the ongoing Extended Fund Facility or EFF from IMF.
Previously, the conversation focused on the borrowing of the central government from the domestic market and the foreign sources, the country foreign debt which constitutes, in addition to central government foreign debt, foreign borrowing of the central bank, commercial banks, public corporations, and the private sector entities. The country was pushed back to debt unsustainability by all these types of borrowing. Of them, the unsustainable foreign debt of the central government was manifested on 12 April 2022 when the Ministry of Finance announced that it would suspend the debt servicing-payment of interest and repayment of the principal-on account of the borrowing from individual countries, known as bilateral borrowing, and from commercial sources, which was mainly made up of borrowing by issuing international sovereign bonds or ISBs.
The Ministry of Finance promised to add the arrears of interest and principal to the original loan at the same interest rate until the debt restructuring is complete. It was noted that the data on country borrowing had been understated by the central bank by recording the ISBs at the going market prices which could not be done by a borrower unless the foreign lenders had agreed. In the case of the domestic debt optimisation or DDO, it was revealed that the government had wrongly compared the taxes paid by superannuation funds with that paid by commercial banks hiding that the former paid taxes on the gross income, while the latter paid the same on net income. As a result, the burden of DDO was placed unfairly on superannuation funds and the central bank.
It also was revealed that during the colonial times, there was prudent management of foreign borrowing by requiring the borrowing entities to build sinking funds to assure the repayment of the loans. This was continued even in the early years of independence, but in 1983, it was abolished believing in that loans could be serviced by making a further borrowing. That practice has caused both the domestic and foreign borrowing to increase beyond the requirement of the country to finance the saving-investment gap. When Sri Lanka could not borrow anymore from foreign sources, its debt became unsustainable.
They continue their discussion of the restructuring of the bilateral debt.
Aseni: About the agreement reached with the Official Creditor Committee, known as OCC made up of Paris Club proper members and India, President Ranil Wickremesinghe made an address to the nation and clarified to the Parliament. He gave only the broad picture and did not give the finer details. What do you think of this position?
Sarath: You are correct. The President gave only a broad picture and not the finer details. It would have been more informative and useful to the public had those details been disclosed.
There were two types of external debt that needed to be restructured in terms of the suspension of the servicing of selected debt by the country in April 2022. They were borrowing from the individual countries, known as bilateral credit, and from commercial sources, mainly by issuing international sovereign bonds or ISBs and from China Development Bank on commercial terms. At end 2022, that amounted to $ 24.1 billion made up of $ 9.8 billion by way of bilateral loans and $ 14.3 billion from commercial sources. Due to the debt suspension, arrears had accumulated amounting to $ 777 million payable to bilateral creditors and $ 1,633 million to commercial creditors. Hence, the total restructurable debt, as estimated by IMF, had amounted to $ 27.1 billion.
Out of this, only debt amounting to $ 10 billion had been restructured by the creditors agreeing to postpone the repayment of the principal beginning from 2028 and ending in 2042. Hence, from 2024 to 2027, Sri Lanka should pay interest to those creditors at about 2% annually as announced by the President. Hence, the annual interest payments will be about $ 200 million which is an outflow from the country. Since there is a moratorium over the principal, there is a relief for the country during 2024 to 2027 by way of a cessation of the previously contracted outflow of foreign exchange.
According to the Debt Bulletin issued by the Ministry of Finance for March 2024, the annual saving on this count is estimated at $ 1,084 million and the total for 2022 to 2027 will be about $ 6,501 million. This is a substantial relief to the Treasury as well as to the external sector of Sri Lanka. But this will be added to the principal and Sri Lanka should repay the full debt amounting to about $ 10.6 billion over a prolonged period from 2028 to 2042. Hence, in the case of bilateral credit, the overall debt level has not come down but only the payment terms have been eased.
Therefore, what Sri Lanka has got is a relief on the annual cashflow till 2027 by way of a debt moratorium. But for Sri Lanka to get full relief, it is necessary for the country to get a fair amount of the principal loans as the debt forgiven by the creditors. This is known as a haircut. Considering the gap in the foreign exchange receipts and payments during 2022-27, IMF had anticipated a debt forgiveness of about $ 14 billion which amounted to about 51% of the total debt to be restructured. Hence, Sri Lanka should get a haircut of about 51% if it is to resolve its foreign debt problem permanently.
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Aseni: About a haircut to be received by Sri Lanka, it had been maintained by President Wickremesinghe that the Paris Club normally does not offer such concessions to borrower countries. Is there any truth in that position?
Sarath: This position is not accurate since there had been instances in the past in which the Paris Club had provided such concessions to the borrowing countries which are in difficulty to service their external debt. This all depends on the specific state of the borrowing country concerned. If the Paris Club feels that offering a haircut will help the borrower to get out of indebtedness fast, it would offer a haircut to such borrower. There are three instances in which the Paris Club had provided a haircut to borrowing countries in difficulty in this way.
The first instance relates to Latin American countries which had defaulted the servicing of the foreign loans in early 1980s. Considering their difficulty, in 1988, the Paris Club decided to offer a partial debt forgiveness of a third of the outstanding borrowing, which is a haircut under what is known as Toronto Terms. Twenty countries benefitted from this arrangement.
The second loan forgiveness took place in 1991 under London terms. In this instance, the haircut of a third was increased to a half. Twenty-three countries benefitted from this.
The third occasion took place in 1994 under Naples Terms for the Highly Indebted Poor Countries or HIPCs. In their case, the haircut was a two third of the outstanding borrowing.
Therefore, there is no hard and fast rule that a creditor will not agree to a haircut of the principal loan. It all depends on the prevailing circumstances mostly ruled by the status of the borrower (his inability to pay in full) and the willingness of the creditor (to protect at least a part of the amount lent). Since China does not provide such a haircut to its borrowers as a policy, it can be surmised that there had not been such a relief provided to Sri Lanka by China on its lending to the country which had amounted to $ 4.5 billion, with arrears, as at end of 2022. Paris Club lenders plus India had insisted right throughout that there should be comparability principle applied to the debt restructuring. Therefore, the non-availability of a haircut by this group may be due to the need for making the entire restructuring comparable across the two types of creditors, namely, the Paris Club plus and China. It shows the hard bargaining which the Sri Lankan negotiators had to do with the Official Creditor Committee of the Paris Club members.
If Sri Lanka is to be relieved of external debt indebtedness, as IMF had estimated in December 2023, Sri Lanka needed to have a debt relief of $ 14.1 billion after getting a moratorium of $ 2.8 billion. Of the total debt liability of $ 27 billion, this debt relief of $ 14.1 billion amounted to about 51% which should be the written off component of the total debt. These estimates have been revised upward by IMF in May 2024 to $ 17.1 billion made up of a debt relief of $ 10.5 billion and a moratorium of $ 6.6 billion. When we the interest in arrears is added to the outstanding debt from the restructurable sources, the total debt still stands at $ 27.5 billion. These three numbers are staggering and show that, in the absence of a haircut, the debt liability should be postponed to the future.
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Aseni: The Treasury Secretary Mahinda Siriwardana is reported to have announced recently that debt is being negotiated not on a haircut of the principal but on the relief that is provided to the country through a lower net present value of a discounted future foreign exchange outflows. His contention was that if the calculated net present value is lower than the projected nominal outflows, it is tantamount to a haircut. This is a new point presented by Sri Lankan authorities to justify the absence of a haircut in the present agreement with OCC and China’s EXIM Bank. What do you think of this position?
Sarath: I also saw his presentation. But in my view, he is both right and wrong in his position.
When a borrower makes a borrowing, it is usual to calculate whether there is a ‘grant element’ in the loan by using this procedure. The detailed procedure is as follows.
If there is no repayment of the principal amount which a country or a person has received, the entirety of the receipt is a grant. At the other end, if there is a repayment and the interest rate paid is the market interest rate, then, the grant element is zero. Therefore, the grant element lies between zero and 100% depending on the level of interest paid. The borrower can prepare a projected cash outflow that consists of the principal and the interest paid. The present value of this cash outflow is calculated by discounting it by a suitable discount rate. That discount rate is the market interest rate at which the borrower can raise that loan. This present value is then deducted from the amount which is borrowed to ascertain the net present value. If this net present value is positive, and when it is expressed as a percent of the original loan, that amount is called the grant element. If it is at least equal to 25%, then it is used as a rule of thumb to decide on the adequacy of the grant element. It is this rule of thumb which is used by the Central Bank when it advises the suitability of the loan to the Ministry of Finance. Since the interest rate charged by bilateral lenders is usually lower than the market interest rates, those loans have a grant element.
Therefore, it all depends on the discount rate used. For loans at market interest rates the net present value is zero and therefore, there is not any grant element. If the discount rate used for calculating the net present value is higher than the nominal interest rate, the discounted net present value is lower than the total value of the loan. The difference is considered a grant received by the borrower. In this context, the Treasury Secretary is right. He is wrong because the lower net present value does not give a relief to the country which is already in a debt trap. That country should get a relief on nominal terms and not on hypothetical calculations of which outcome is basically determined by the choice of the discount rate used. Such discount rates are arbitrary and by using a higher discount rate, it is possible to show a high grant element for the country.
It would have been better had the Treasury Secretary disclosed the discount rate used, why that discount rate was chosen, and the amount of the grant element involved in the debt restructuring concerned. This information is still in a black box. I hope he will reveal this to the public promptly.
Aseni: Thanks, Grandpa for your elaboration.
Parts I, II, and III of this series can be found at https://www.ft.lk/columns/A-child-s-guide-to-debt-and-restructuring-Country-driven-to-economic-collapse-has-not-many-options-Part-I/4-763940,
https://www.ft.lk/columns/Child-s-guide-to-debt-and-debt-restructuring-Part-III/4-764544
(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)
What Sri Lanka has got is a relief on the annual cashflow till 2027 by way of a debt moratorium. But for Sri Lanka to get full relief, it is necessary for the country to get a fair amount of the principal loans as the debt forgiven by the creditors. This is known as a haircut. Considering the gap in the foreign exchange receipts and payments during 2022-27, IMF had anticipated a debt forgiveness of about $ 14 billion which amounted to about 51% of the total debt to be restructured. Hence, Sri Lanka should get a haircut of about 51% if it is to resolve its foreign debt problem permanently