Sri Lanka’s attempt to become a developed country has taken different turns at various times. For a long time, we tried to become a developed nation through the Diyasen Kumaraya initiative. Then, we focused on the Trincomalee Port. At one point, we aimed for self-sufficiency to achieve development.
We also waited for the 30-year-long war to end to pursue this goal. Later, there was a thought that we needed a benevolent dictator in order to become a developed country. Now, we are entering a new phase, aiming to achieve development through debt restructuring.
After more than two years of suspending debt servicing, the Government has reached some level of agreement with commercial creditors on a new repayment schedule. In debt relief, the first thing we need to realise is that reforms focused on growth are what can truly take us out of this crisis. While we need adequate debt relief and better bargaining, thinking that we can leap to the next stage solely through debt restructuring is not sensible.
According to published reports, our past due interest alone has been about $ 1.8 billion for the last two years. We have agreed to an 11% haircut on the interest, bringing it down to $ 1.6 billion. We are issuing new bonds to pay the accumulated interest at a rate somewhat equivalent to US Treasury interest rates.
The rest of the commercial debt restructuring is mainly based on International Monetary Fund (IMF) projections. If our economy aligns somewhat with IMF projections, we will receive about 28% debt relief from the principal and a Weighted Average Coupon (WAC) rate of 6.3%. The IMF projects our economy to reach about $ 88.6 billion between 2025 and 2026.
If we perform better than the IMF projections, indicating increased debt repayment capacity, our haircut proportion will decrease and our interest rates will increase accordingly. If our Gross Domestic Product (GDP) increases to $ 100 billion, our haircut will decrease to 15%, and the coupon rate will rise to 8.2%. Conversely, if we underperform relative to IMF projections and our GDP shrinks to about $ 84 billion, we will receive 41% debt relief and the WAC rate will remain at 6.3%.
Simply put, the restructuring strategy is to provide more debt relief if the country is not doing well and requires more repayment if we increase our capacity for debt repayment.
Regarding total debt servicing after restructuring – which, as of today, is about $ 14 billion worth of debt – if we perform according to IMF projections, our total debt servicing will be about $ 15.9 billion from 2024-2038. Comparing the current $ 14 billion of debt to the $ 15.9 billion total payouts until 2038 may be misleading, as the $ 14 billion today is more valuable than $ 15.9 billion in 2038 due to the time value of money.
Thus, one should not be misled into thinking our total debt has increased after restructuring. However, if our economy performs well, reaching $ 100 billion, bondholders will gain about $ 3.6 billion cumulatively from 2024-2038. Our total debt servicing until 2038 will be about $ 15.9 billion if we follow IMF projections, and if the economy grows to $ 100 billion, our total debt servicing will be $ 19.6 billion.
On the flip side, if our economy fails to grow according to IMF projections and underperforms to a level of $ 84 billion, our total debt servicing until 2038 will be $ 13.7 billion.
This structure indicates that our commercial creditors believe we will perform better than IMF projections, bearing the cost of our failure if we do not. Conversely, if we succeed, they will gain better profits than the baseline case.
For Sri Lanka, a new variable has been added to activate the Macro-Linked Bond (MLB) scenarios: a cumulative growth of 11.1% from 2024-2027. Only if our economy reaches this cumulative growth will our MLBs be activated. This safeguard for Sri Lanka indicates again that private creditors expect economic recovery.
In debt restructuring, deeper debt relief is always better. However, we need to recognise that countries like Argentina became multiple defaulters despite receiving significant debt relief. The real game here is economic reforms that accelerate growth.
As highlighted, our State-Owned Enterprises’ (SOEs) losses contribute to our debt problem. We have absorbed debt of $ 3 billion of the Ceylon Petroleum Corporation (CPC) and the Ceylon Electricity Board (CEB) into our balance sheet, equivalent to all we are to receive from the IMF. Without restructuring SOEs, debt restructuring will be meaningless.
Additionally, growth-enhancing reforms must kick in. Without economic growth, our debt repayment capacity will not increase and we will revert to our previous state. Growth and reforms are the only solutions, and there is no alternative.