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Can SL come out of its debt trap?

07 Mar 2021

Sri Lanka’s mounting external debt never failed to be an engrossing topic of discussion, be it amongst local economists or international economic analysts. Woes of mounting external debt have been exacerbated by the ongoing pandemic which compelled the island nation to switch swiftly into a prolonged nationwide lockdown and to impose stringent restrictions on imports last year.  Giving the opening remarks at a webinar held recently, Central Bank of Sri Lanka (CBSL) Governor Deshamanya Prof. W.D. Lakshman stated that Sri Lanka has to pay as principal interest on external debt a total sum of $ 3,709 million in 2021 in comparison to a total of $ 4,321 million in the year 2020.  Explaining the difference, Lakshman stated: “Of this sum of $ 3,709 million, already, $ 1,103 million had been repaid in January-February 2021 and during the rest of the year, we have to pay a total of $ 3,227 million on external debt service.” As of December 2019, Sri Lanka’s foreign reserves were at $ 7.6 billion and by December 2020, the reserves dropped to $ 5.6 billion.  “Obviously these numbers have gone down. Similar debt service payments are due during up to 2025 as well. The debit obtained in the past continues to mature. There is a decline in the debt service payments below $ 4,000 million from 2026 onwards,” Lakshman said.  For us to understand how we entered the debt trap, let us go through the recent rollercoaster ride of the borrowings taken by the Government and CBSL.    Borrowings and repayments     Before 2005, Sri Lanka borrowed money from multilateral agencies initially on concessional loan terms. However, since then, foreign debt has slowly but surely increased. According to Lakshman, Sri Lanka's promotion to middle-income status has made it less eligible for concessional funding and therefore, it has moved increasingly into commercial borrowing.  This decision was taken in order to finance its investments as well as to meet its consumer imports and debt servicing obligations. Subsequently, foreign commercial borrowing had increased gradually over the past decade. “The country has issued $ 17.55 billion worth of international sovereign bonds (ISBs); issuances of ISBs were made between 2007 to 2009, of which we have already settled $ 3.5 billion by end-2019. Annual interest payments on ISBs alone had increased to about $ 1 billion,” Lakshman explained.  In order to overcome this situation with a new policy framework, the Government has decided that reliance on foreign borrowings, particularly commercial borrowings, should be phased out gradually to reduce the burden of debt service. “The Government believes that the country's development projects should be domestically oriented both in terms of the implementing parties involved and the lending institutions wherever possible,” Lakshman noted.  However, despite the challenges faced and predictions by many parties who project doomsday scenarios, the country has continued with its unblemished record of services both internally and externally of around $ 3.7 billion to repay external debt in 2021. Commenting on this, Lakshman said: “We have paid considerable chunks so far already in the first two months of this year. One of the large chunks of the debt service schedule 2021 is the ISB repayment of $ 1 billion coming in July 2021.”  The necessity of adopting such policies is important in the current condition of the global financial markets after the Covid-19 pandemic, as the prospects of external financing has been adversely affected by this risk aversion and volatility discovered in global financial markets.    In regards to where repayments of loans are concerned, one of the main objectives of Sri Lanka is to pay off foreign debt as much as possible this year. According to Lakshman, the CBSL has been making purchases in the foreign market amounting to about $ 10 million per day on average. “Ours is an alternative approach to address this issue. The medium-term objective is the reduction of the foreign-to-domestic ratio in total public debt from the current 43: 57 to 33:67. This could have been done by the second half of the 2010s, but instead, the foreign debt volume was allowed to increase from $ 24.6 billion in 2015 to $ 34.47 billion in 2020.”  In this context, Lakshman stressed that now is the time to bring down the foreign-to-domestic ratio of total public debt in order to gradually take the country out of the debt trap. However, this would require some austerity in terms of mostly cutting down on essential consumer imports and of course improving efficiency in the systematic effort pertaining to all forms of foreign currency inflows.  “We are confident that not only this ISB payment, but all other external as well as domestic debt obligations would be met punctually,” Lakshman emphasised.    How will SL repay?   The Government right now is focusing on the export industries, namely rubber, coconut, garments, gem and jewellery, and IT/BPO (information technology/business process outsourcing) in order to increase the foreign reserves. The Government has taken measures to appoint ministers and state ministers for each export industry to look into the shortfalls of those respective export industries.  Commenting in this regard, Lakshman noted that the CBSL is closely involved in the process with each task force’s activities being co-ordinated by a CBSL official. “A progress review and follow up in each identified export sector will be in accordance with an overall export development programme under the National Task Force for strengthening foreign exchange. However, specific attention wil also be focused on selected sub sectors of exports with quarterly and annual targets given to each such trust sector.”  Despite the second wave of Covid-19, most of the export industries have had a strong order book demand which has resulted in around $ 1 billion per month, even after months of disruption due to the pandemic. Accordingly, the CBSL is also in collaboration with commercial banks working to ensure exporters bring export proceeds into the country within a stipulated time so that a percentage of this could be purchased by the CBSL to strengthen reserves.  Secondly, the Government is expecting a gradual increase in tourist earnings in 2021 which would strengthen the current account improvements further. “A progress made in vaccination against Covid-19 would stand as a favourable factor in this proposed expansion of tourist earnings,” Lakshman noted.  Thirdly, as workers’ remittances have had a sharp rise since June 2020 with around a 22% increase in December 2020 and 16% increase in January 2021, the Government introduced a new policy of giving an additional Rs. 2 per dollar at the time of workers’ remittances being paid. Accordingly, the CBSL will absorb 10% of these inflows from licensed commercial banks (LCBs) to strengthen its reserves. Since 9 February 2021, the CBSL has purchased over $ 20 million from these inflows.  Furthermore, the Government, with the help of some restrictions on imports of non-essential goods, has planned to alter the trade deficit. Due to these import restrictions, it has been observed that the trade deficit would come down by around $ 2 billion. “The current account is expected to strengthen further with policy measures of import substitution and export promotion, hence the restrictions on non-essential imports and on products that can be domestically produced are continued,” Lakshman explained.  The current account deficit and Balance of Payment (BOP) in 2020 is estimated to have come down to $ 1-1.2 billion compared to around $ 1.8 billion in 2019. The Government also hopes to continue to strengthen its current account throughout the year.  According to Lakshman, the target of achieving a surplus on current accounts could be considered realistic with the policies being adopted, however this was last achieved more than 40 years ago in 1977.    Finally, the export of port and airport-related activities will also contribute strongly to foreign exchange earnings of Sri Lanka with the expected increase in the global transportation following the gradual subsiding of the pandemic. These were few measures which have already been implemented in order to release Sri Lanka from its debt trap. However, we all know that this alone is not sufficient to cater to something so serious, hence the Government plans to increase inflows to the current account, as it will be complemented with expected inflows of FDIs (foreign direct investments) and other foreign investments on the BOP.   Inflows   The fast-tracking of the legislation process of the Colombo Port Development and also the development of the Hambantota Industrial Zone might result in a healthy flow of FDI by mid-2021 onwards.  Apart from these two developments, there are several other options presented by the Government in collaboration with CBSL in order to increase foreign inflows into the country. One of them is expecting a turn-around in the sentiments of foreign investors pertaining to the Colombo Stock Exchange (CSE), and also domestic investors. According to Lakshman, the majority of companies are exceptionally well under the current policy conditions with high prospects for the future. “CBSL engagement sectors mentioned in collaboration agencies will be complemented and supported by the traditional policy actions carried out with an overall growth orientation with the usual care about avoiding inflation.”  For this scenario, both the Government and the CBSL have co-ordinated together to ensure that adequate foreign financing is available to meet the debt service payments if needed, in which necessary action will be taken to strengthen gross reserves through actively pursuing to secure financial inflows in order to support non-debt-creating foreign exchange. Next is the active negotiations which are ongoing with a number of bilateral and multilateral lending institutions along with overseas central banks and governments of foreign countries, which would materialise within a matter of a few weeks. However, no further information was revealed by Lakshman on this matter.   Official measures taken    The Government of Sri Lanka has expressed the need to develop a medium to long-term alternative policy approach to manage the country's economy on a sustainable path. Hence, in the coming years, it is said that export growth will be given high priority, with positive developments, out of these policy changes. The Government has also created a conducive environment for investment through tax reforms as well as legislative reforms, thereby making Sri Lanka a destination of promise for investment domestically and internationally. For this measure, the CBSL has complemented these efforts by maintaining a low-interest and high-liquidity environment while ensuring low-inflation conditions in the country. According to Lakshman, the Government and CBSL will continue to pursue a co-ordinated growth-oriented approach in steering the economy through these challenging times. “To support these initiatives, the financial markets will become proactive in maximising funding sources for growth-oriented endeavours for the public as well as the private sectors. Hence, the implementation of these structural reforms along with the picking up of government revenues and rationalisation of government expenditures would ensure sustainability and successful management of public debt in the period ahead.”  Giving the concluding remark at the webinar, Lakshman said that the Government has honoured all its liability and in spite of the continued adverse speculation by many of an impending doomsday, “the CBSL wishes to reiterate that Sri Lanka will engage with all investments and development partners and implement the envisaged measures to ensure continuous service of the country's external debt service obligations to build up reserves through no-debt-creating inflows”. The Governor of the CBSL promised all foreign stakeholders that all of Sri Lanka remains committed to meet its debt obligations as it has done impeccably in the past, and assured that it has the ability to do so in the future. Responding to “critics” of Sri Lanka’s debt situation, Lakshman said the following: “Try to gain policy-relevant insights from reading history and not simply through application of models developed on macroeconomic theory built up on unrealistic assumptions.”


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