- Assessing conditions for Sri Lanka’s RFI has taken longer than for other countries: IMF
- Ready to discuss all options with the authorities to ensure debt sustainability: IMF
- Government yet to present a concrete plan to face debt crisis
- Sri Lanka’s 10-year sovereign bonds sold in 2016 are trading above 17.5%
- Sri Lanka failed to attract investors despite offered to cap forex risk
- Sri Lanka has not sought debt moratorium directly from China, Japan
The new Government is in the process of implementing its first full year Budget for 2021 announced on Tuesday. It will be one of the toughest budgets in the country’s history given that Sri Lanka is facing an unknown devil in the form of coronavirus (COVID-19) pandemic and a challenging budget deficit and external debt.
The bottom line is if Sri Lanka cannot increase its foreign exchange revenue at least by an additional $ 4 billion either through exports, remittances and tourism or borrowings, the country is likely to face a sovereign default.
Many in the Government have followed an ostrich approach in not accepting the reality and recognising the truth on the challenging foreign debt repayments. But Sri Lanka facing a possible sovereign debt default is not completely ruled out given Sri Lanka’s precarious finances.
Prime Minister Mahinda Rajapaksa, who is also Sri Lanka’s Finance Minister, last week told Parliament that dire predictions about sovereign default had not happened.
“We were able to stabilise the exchange rate, which was steadily depreciating then at around the 185 rupees (per US dollar) and to service the foreign debt of 4,200 million dollars averting the country being classified into a debt default status,” he told Parliament while participating in the 2020 Budget debate.
Many economists who are backing the current Government’s economic policies do not want to talk about how to face the debt crisis in the future. But the reality is Sri Lanka is inching toward a hard landing on the debt crisis. The 2021 will be the start of the series of hardest years ahead in terms of economic management.
Looming sovereign default?
Sri Lanka has never defaulted any foreign loans so far and successive governments have bragged about this. They also have repeatedly promised to maintain the Government’s untarnished track record in the future as well. But the current reality threatens the $ 84 billion economy’s non-defaulting track record.
Let me explain in simple words. Sri Lanka has to pay a total foreign debt which includes both principal and interest payments of around $ 4.5 billion annually for the next five years through 2025.
The country has been rolling over many of maturing International Sovereign Bonds (ISBs) and Sri Lanka Development Bonds (SLDB) except in one occasion before this Government came to power. Sri Lanka had to use its foreign exchange reserves in January 2019 as it could not borrow an ISB due to the coup attempt by former President Maithripala Sirisena. The current Government also repaid $ 1 billion of matured sovereign bonds last month from the foreign currency reserves.
Rolling over through borrowing at a lower cost is not bad for the economy and in fact it could help sustain Sri Lanka’s debts. However, Sri Lanka will not be able to borrow at a lower cost from the international markets after the rating downgrades by all three global rating agencies early this year.
If the country still wants to borrow, then it will have to borrow at an exorbitantly higher rate compared to its emerging market peers due to higher risk premium and the country cannot afford to borrow at the level.
The last week’s SLDB auction reflected Sri Lanka’s extreme difficulty in borrowing. The Central Bank’s effort to raise $75 million in four short term papers was heavily undersubscribed and the bank was able to attract bids for 33.4% of the total requited amount it wanted to raise. The Central Bank had no option but to accept 99.2% of the total bids at fixed rates ranging from 6.69% to 6.82% in this auction.
However, on Monday, the Central Bank in a statement said there was a renewed interest/investor appetite for SLDBs and it was able to raise further $62 million without mentioning the weighted average fixed rates. Analysts said the Central Bank used a method that existed before the infamous bond scam in 2015 to sell the bonds similar to private placement.
Sri Lanka’s 10-year sovereign bond sold in July 2016 priced at 6.825% was trading around 17.5% this week and that gives an indication of the borrowing cost Sri Lanka will have to pay if it seeks funds from international capital market.
Sri Lanka has also failed to attract foreign investors into Government bonds in rupees even after State Minister Ajith Nivard Cabraal in September offered to cap forex risks to reduce the country’s dependence of international sovereign bonds.
Since the announcement, foreigners have in fact withdrawn a net $22 million worth investments in Treasury bonds and bills.
In this backdrop, Sri Lanka’s options to seek borrowing from international capital market could set a higher benchmark rates for Sri Lanka’s five-year and 10-year sovereign bonds.
For its smooth sailing of the economy, Sri Lanka needs to borrow at least around $6 billion in 2021 including to bridge its current account deficit, with all its tight import controls. The import controls are expected to compensate the loss of country’s foreign revenue from tourism and remittances in the face of COVID-19 pandemic.
Out of this $6 billion, analysts say Sri Lanka should be able to manage to borrow around 2.5 billion from currency swaps from China and India as well as from Panda bonds from China. If the diplomatic relations with Japan is still good after abruptly cancelling the Light Rail Transit (LRT) project, Sri Lanka can borrow some money from Samurai bonds.
The next option is going for syndicated loans, especially with some Middle Eastern markets. That will help, but the borrowing cost will be still high.
Another option is to privatise or lease State assets to foreign countries similar to Hambantota Port being given to Chinese firm. But doing that would be egg on the ruling Sri Lanka Podujana Peramuna (SLPP) party’s face and against the mandate given by the people. Many hard-core SLPP members marketed te Hambantota Port deal as an infringement of Sri Lanka’s sovereignty. Unless the ruling party comes up with some sugar-coated strategies, selling or leasing State assets will be seen as an unpatriotic move.
Bragging about the past record on not defaulting any international loans may only help if Sri Lanka has a prudent and sound plan to address its debts. At the moment, such plan is obviously not in place.
In the event of Sri Lanka failing to raise the required amount of foreign loans to pays its debt servicing, it has the option of debt moratorium.
A debt moratorium is a delay in the payment of debts or obligations. It may take the form of a complete cessation of debt repayments, or a partial cessation. However, Sri Lanka cannot decide the debt moratorium on its own. Its past deeds with its lenders and diplomatic relations with the rest of the world will matter a lot if Sri Lanka needs a debt moratorium.
President Gotabaya Rajapaksa in March through the Director General of the World Health Organization requested all the international donor agencies, both multilateral and bilateral lending agencies, to provide a debt moratorium or debt deferment facility to all COVID-19-hit vulnerable developing nations
Prime Minister Mahinda Rajapaksa has directly requested a debt moratorium from India. Strangely, Sri Lanka is yet to request a debt moratorium from China, Sri Lanka’s largest lender at the moment, and Japan, the country’s long-term lender.
“The President, Prime Minister and I have been saying there must be a universal moratorium; not an individual moratorium for Sri Lanka,” Ajith Nivard Cabraal, State Minister of Money and Capital Markets and State Enterprise Reforms, says.
“No requests for moratoriums have been made from China and Japan. A possible moratorium had only been discussed only with India.” In the event Sri Lanka is forced to request a debt moratorium, which cannot be ruled out in the current context, the island nation will have to agree to certain conditions of financial discipline.
Sri Lanka could get the best out of a debt moratorium when all its lenders agree to defer the repayment of loans and interest payments. The negotiations will take a long time and be very tough.
“Sri Lanka will have to compromise its fiscal and monetary sovereignty if it goes for a debt moratorium,” the Opposition’s economist turned legislator Harsha de Silva said.
“We will have to determine what we are comfortable with,” he said.
Sri Lanka will have to go through a hard time in managing its debt and it is likely go to the extent of compromising its sovereignty which could be in the form of lands or fiscal/monetary policies.
The longer term solution is sustainable debt management with encouraging more exports through trade agreements and foreign investments. That could only happen when Sri Lanka genuinely deals with its international partners with consistent foreign and prudent economic policies. Unfortunately, Sri Lanka has been unable to deal with nations like Japan and Singapore which have the least political agenda in their dealings. And Sri Lanka’s last option is likely to be the International Monetary Fund (IMF).
Discussions with IMF
When the Sri Lankan economy has faced crises, the country has turned to the global lender regardless of which party has been in power. However, governments led by centre-left ruling parties have been shy of dealing with the IMF throughout post-independence history.
The IMF has assisted Sri Lanka soon after the end of the 26-year war in 2009 and when the country first started to realise the extent of debt crisis in 2016. The IMF gave money in much-needed US Dollars to boost the country’s foreign currency reserves on both occasions.
There is a delay on the seventh review of the $ 1.5 billion existing IMF Extended Fund Facility (EFF) arrangement with Sri Lanka due to the COVID-19 pandemic, postponed General Election, and the Government’s failure to present a National Budget for 2020, which was only presented last week.
Government authorities started discussions with the IMF for a Rapid Financing Instrument (RFI), a facility made available by the global lender for the countries to face the pandemic. However, Sri Lanka failed to secure the facility.
“In April, we received a request from the Sri Lankan authorities for emergency financial support under the Rapid Financing Instrument (RFI),” the global sender said in an emailed response when asked about the discussion between it and Sri Lanka.
“Assessing relevant conditions for the RFI has taken longer than for other countries, due to Sri Lanka’s daunting economic challenges, high public debt, and Parliamentary Elections in August.”
The IMF said it had yet to reach understanding on how to fulfil key requirements for the RFI, “which include policies to continue ensuring debt sustainability”.
“The authorities have a range of options to ensure debt sustainability and the IMF stands ready to discuss all options with the authorities.”
With the Budget presentation this week, the discussions with the IMF are likely to start based on the Budget document, a top Government official said.
Sri Lanka’s economic growth is expected to see its worst performance since 2001 when the country saw a 1.5% contraction after the terrorist attack on the only international airport hit the economy.
Though the Central Bank has said the contraction would be 1.7%, independent economic analysts estimate the contraction to be between 7%-10% depending on the recovery in the last quarter.
The State-run Department of Census and Statistics has delayed the April-June quarter growth data, citing more data needed for compilation.
The negative growth would be a bad news for a new Government which had many ambitious plans to revive the economy. The pandemic has aggravated the situation.
Job losses, fall in exports, loss of foreign revenue from tourism and remittances, and lack of purchasing power of the general public are likely to make the situation worse than what it is now.
And above all else, now the uncertainty of the second COVID-19 wave threatens a further slowdown of the economy.
All these conditions could result in Sri Lanka’s foreign borrowing ability falling to its weakest level in its history.