Efforts by the Central Bank to keep the exchange rate around Rs. 185 per dollar have become futile in proving the phenomenon of “impossible trinity”, which says that it is impossible to fix both the exchange rate and the interest rate without capital outflows. Selling rate now exceeds Rs. 201 per dollar
- Sri Lanka’s external debt commitment exceeding $ 6.5 billion per year, 50% of export earnings
- Debt issue officially denied saying it’s a dramatized story
- But it’s a bitter reality
- the dynamics of SL’s bad debts; 50% of tax revenue spent on interest payments
- Before the debt crisis, things seemed calm, but bite quickly like the big bad wolf
- The country’s debt stock is growing rapidly
- Strong exposure to government. debt weakens the banking sector leading to capital flight
- Swaps are not a long-term solution to debt sustainability
- Import restrictions are helpful, but detrimental to export-led growth
- Depreciation of the rupee and rising interest rates inevitable
- Broad policies, instead of temporary measures, necessary for debt sustainability
Sri Lanka faces increasingly large foreign loan commitments exceeding $ 6 billion per year, absorbing 50% of export earnings. It also implies that almost all of the annual flow of workers’ remittances must be devoted to the settlement of external debt.
Following the degradation of the country’s sovereign debt ratings on several occasions, access to foreign capital markets has been severely restricted. Therefore, the government has now turned to bilateral swap agreements to overcome the immediate balance of payments difficulties.
In this context, the secretary to the president and former secretary of the treasury, Dr PB Jayasundera, reportedly said at a recent symposium organized by Biznomics that Sri Lanka’s debt is “the most dramatized story”, which is unwarranted. given the country’s unblemished repayment history. .
Sri Lanka’s reputation for debt repayment is undeniable, unlike some Latin American countries which have experienced several debt crises with massive defaults in recent decades.
But it must be recognized that successive governments have been able to maintain such a reputation for Sri Lanka not through any improvement in the country’s external finances, but by continually borrowing from abroad, thus risking debt sustainability.
Solving the country’s debt burden therefore remains a major challenge for the authorities, and the debt problem is not a fabricated story but a bitter reality.
Sri Lanka’s Bad Debt Dynamics
Sri Lanka is on the verge of a debt crisis, as Professor Ricardo Haussman, director of the Growth Lab, Harvard University Center for International Development, pointed out during a webinar on debt sustainability organized by the Adovocata Institute in October last year (see https: //www.youtube.com/watch?v=aOJMEhChCwU).
Hausmann, who himself has witnessed many debt crises in Latin America including three in his own country, says that before a debt crisis everything seems calm. But when that happens, the repercussions would be disastrous, as would the big bad wolf, who initially pretended to be harmless, swallowing the little girl and her grandmother in the fairy tale “Little Red Riding Hood,” he explains. -he.
While insisting on looking at the debt problem from a practical point of view since it is no longer a theoretical problem, Hausmann stresses that the debt burden should be assessed in terms of the ratio of payments to interest to tax revenue rather than the commonly used indicator of debt to GDP ratio.
For example, although Japan has a very high debt-to-GDP ratio of 240%, the Japanese government should not spend any of its tax revenues on interest payments because the interest rate on the debt is zero in this country. . In the case of Sri Lanka, on the other hand, the debt-to-GDP ratio is around 90%, but interest payments on tax revenue can reach 50%.
In addition, the ratio of tax revenue to GDP is over 40% in Japan, while the ratio in Sri Lanka is only 12%. Thus, the tax burden of the debt problem is much heavier in the case of Sri Lanka.
At some point, the borrowing country is no longer good value for its money, and as a result, lenders have started charging higher interest rates to cover the risks. This makes it more expensive to renew maturing debts, making debt service problems worse.
This is the kind of bad debt dynamic that Sri Lanka faces today, as evidenced by the substantial underwriting of international sovereign bonds and treasury bills in recent auctions calling for high rates of return by investors. foreign and domestic investors.
The stock of external debt is increasing
State banks have been mobilized to borrow abroad, and private sector banks should also do the same, according to Dr Jayasundera.
Such borrowing will further increase the debt burden as in the past, since repayments and interest payments on such loans must be secured using the country’s foreign exchange reserves in all cases, regardless of the type of loan. ‘borrower.
Since 2013, commercial banks and blue chip companies have been allowed to borrow specific amounts of foreign currency on global financial markets. Eventually, state banks (Bank of Ceylon, NSB, NDB and DFCC) became indirect sources of government borrowing.
The total external debt outstanding of the government, central bank, financial institutions and other entities currently stands at nearly $ 55 billion, which is equivalent to 65% of GDP. Five years ago, it stood at $ 44 billion, or 57% of GDP. This reflects the continued accumulation of external debt over the years without showing any sign of debt reduction.
Foreign investors leaving SL bonds
The government is due to settle an international sovereign bond of $ 1,000 million in July and Sri Lanka’s development bonds of $ 1,325 million in August of this year.
The debt problem has worsened due to the difficulties the government encountered in attracting foreign investors to its dollar-denominated bonds in recent auctions. This limits the rollover of maturing foreign bonds.
Reflecting investor concerns over Sri Lanka’s creditworthiness, the last two Sri Lanka Development Bond (SLDB) auctions were largely underwritten.
At the auction held in November last year for $ 200 million, the Central Bank was only able to raise $ 24.82 million, which is up to 67 percent of the sub -subscription. The January auction, which had a bid of $ 200 million, raised only $ 43.6 million reflecting a 78% subscription.
There is a noticeable increase in recent SLDB yields, again reflecting the worrying concerns of foreign investors over the country’s debt service capacity.
Public borrowing weakens banks
As the countries of Latin America show, debt crises are expected to spread to the banking sector, exposing high exposure to government borrowing.
Against the background of the limitations on borrowing in foreign capital markets as explained above, the government has turned to domestic bank borrowing.
Bank lending to government and public enterprises has grown at a rapid rate, as I explained in a previous column (http://www.ft.lk/columns/Bank-credit-to-private-sector-picking -up-at-slow-pace-of-response-to-monetary easing / 4-712502).
Given the significant exposure of Sri Lankan commercial banks to government securities, the rating agency Fitch believes that the operating environment for banks has weakened considerably.
The weakening of the banking sector causes capital flight, which in turn leads to a depreciation of the exchange rate and a further increase in debt service costs.
Swaps are temporary solutions
Much publicity has been made with some pride over the past two days on the bilateral currency exchange agreement between the Central Bank of Sri Lanka (CBSL) and the People’s Bank of China. Under this agreement, CBSL is entitled to a swap facility in the amount of CNY 10 billion (approximately $ 1.5 billion). The agreement is valid for a period of three years.
The swap facility must be received in Chinese currency and hence it helps Sri Lanka to make payments for imports from China in the same currency without using dollars. Imports from China amounted to nearly $ 4 billion a year, and so, the swap is enough to finance about one-third of Chinese products, and the balance of two-thirds will have to be paid in dollars. Therefore, the swap does not help much to improve the reserve position of the country.
Sri Lanka’s debt became so severe that the government reportedly sought a swap deal with Bangladesh.
Policy options to tackle the fragility of external financing
Against the backdrop of large debt repayments and rising crude oil import prices this year, the balance of payments is expected to be under severe strain although the export sector shows signs of recovery from the COVID pandemic -19.
Meanwhile, the CBSL imposed several regulations requiring exporters to convert part of the earnings into foreign exchange, and some of those rules had to be withdrawn due to their adverse effects on the export sector affected by the pandemic.
The import restrictions, currently in force, help to overcome the immediate balance of payments problems. But the continuation of such controls will have negative effects on the export sector and economic growth, as I explained in a previous column according to the thesis of “economic growth constrained by the balance of payments”.
Efforts by the CBSL to keep the exchange rate around Rs. 185 per dollar has become futile proving the phenomenon of “impossible trinity”, which says that it is impossible to fix both the exchange rate and the interest rate without capital outflows. The sale rate now exceeds Rs. 201 per dollar.
While interim measures such as import restrictions and mandatory conversion of remittances backed by swap agreements can ease balance of payments strains in the short term, far-reaching economic reforms are essential to achieve this. to debt sustainability.
The authorities have the primary responsibility for accepting the gravity of the debt problem and addressing it with corrective measures, rather than denying the impending debt crisis.
(Professor Sirimevan Colombage is Emeritus Professor of Economics at the Open University of Sri Lanka and Senior Visiting Fellow of the Advocata Institute. He is the former Director of Statistics at the Central Bank of Sri Lanka and can be contacted via sscol @ or.ac.lk)