While Sri Lanka experienced an eventful period over the past two weeks on the debt restructuring front with the finalising of agreements with official creditors and holders of International Sovereign Bonds (ISBs), attention was fixed on numbers when the first quarter debt report revealed that Government debt had increased to $ 100 billion from $ 80 billion in 2022.
Accordingly, the domestic debt stock, which was at $ 34 billion by the end of June 2022 had risen to $ 57.2 billion.
The total Central Government external debt as of end-April 2024 amounted to $ 36.9 billion, although the total debt service payments from 1 January to 30 April amounted to $ 248.7 million, of which $ 137.6 million was in lieu of principal repayments and the balance of $ 111.1 million for the payment of interest.
Accordingly, the principal amount of $ 6,020 million and interest of $ 2,586 million have accumulated as unpaid debt service by end-April 2024.
Through Domestic Debt Optimisation (DDO), domestic debt stock was reduced by $ 5.3 billion by the end of September 2023, bringing the total debt stock to $ 91.1 billion.
President Ranil Wickremesinghe in May said that the Government expected to reduce annual external debt servicing from $ 6 billion to $ 3 billion through debt restructuring. Given this context, questions arise whether Sri Lanka, which was unable to handle a debt of $ 80 billion, can survive a debt of $ 100 billion, with more accumulating.
IMF seeks high-risk Govt. domestic financing needs
In its staff report following the completion of the second review, the International Monetary Fund (IMF) said that the Government’s domestic financing needs risk remained high in 2024, as it would continue to rely on market borrowing and superannuation funds.
Further, it said that the net domestic financing being projected at 5.8% of GDP in 2024 due to a large fiscal deficit and limited external financing was also a contributing factor.
A key risk is the ability to access continued domestic financing at reasonable interest rates. Most gross domestic issuances in 2024 (mostly Treasury bills and shorter-end Treasury bonds) are expected to be absorbed by banks and pension funds, within their respective absorptive capacity following the DDO.
With monetary financing prohibited, the IMF notes that the Government will continue to rely on domestic borrowing from banks and superannuation funds – the main institutional investors in Sri Lanka.
Prez refutes claims of increased borrowings
Speaking in Parliament on Tuesday (2), President Wickremesinghe said that certain political groups had been spreading misinformation regarding the country’s foreign debt on social media, claiming that under his presidency, the total foreign debt which had been at $ 71 billion had now increased to $ 100 billion.
Rejecting this as a false statement, the President said that Sri Lanka’s total foreign debt stood at $ 37 billion and not $ 71 billion as claimed.
Moreover, he said that certain groups had suggested that the Government had borrowed up to $ 100 billion in the last two years, adding: “However, it’s widely known that no country has provided us with loans since we declared the default. Legally, no country has the authority to lend to us under these circumstances.”
According to the 2024 mid-year fiscal position, the total gross borrowing limit approved by Parliament for the year amounted to Rs. 7,350 billion, including provisions made for the execution of external debt restructuring and the financing of bank recapitalisation during the year.
The utilisation of Government borrowings for the period from 1 January to 30 April was recorded as Rs. 796.5 billion. Total borrowing utilisation consisted of domestic and foreign project/programme borrowings amounting to Rs. 734.2 billion and Rs 62.3 billion, respectively, to finance debt service payments and development projects during the period.
From the total borrowings, approximately 92.2% consisted of domestic borrowings in the first four months of 2024. Treasury bills and bonds were the Government’s main sources of domestic borrowings.
Accordingly, around 98.5% of the total domestic borrowings were raised by way of Treasury bonds, which were recorded at the value of borrowing made during the year, while 1.5% represent Treasury bills in the first four months of 2024, since these borrowings were recorded at net value after setting off the cash outflow on maturing Treasury bills.
Foreign loans missing in Govt. statements
In the same report, the Auditor General notes that a difference of $ 227,823 or Rs. 82,724,927 as at 31 December 2022 and 1 January 2023 was observed relating to Loan Agreement No.2017045.
Further, it was found that although a difference of $ 227,823 was observed between loan repayments, no difference was observed in its local currency value. Moreover, it was observed that an unusual foreign exchange rate of Rs. 524.6050 per US Dollar had been used to convert the repaid amount of $ 332,704 into local currency as per the financial statements of the Government.
Issuing a clarification on the matter, the Ministry of Finance said that in the payment of $ 332,704, an exchange rate of Rs. 524.6050 had not been used to determine the rupee value of the debt service amount. The loan referred to above is in US Dollars. However, as per the respective agreement, the related loan instalment is to be paid in Sri Lankan Rupees.
Accordingly, in 2022, the instalment amount paid in relation to the above loan amount had been paid in Sri Lankan Rupees and the value of the rupees paid had been converted to US Dollars in the data system maintained for that purpose.
“However, due to a data entry error, an incorrect foreign exchange rate was recorded in the database. As a result, the corresponding US Dollar value was also recorded as an incorrect value in the database. Therefore, whilst there was a data recording error, this did not affect the actual transaction value. This exchange rate data entry error has already been corrected in the financial statements in 2023,” the Treasury said.
Furthermore, in relation to the above loan, the Finance Ministry said that the loan instalments were paid in Sri Lankan Rupees, so there was no need to purchase US Dollars by paying Sri Lankan Rupees for this purpose, and, accordingly, a very high exchange rate had not been used to buy US Dollars, as erroneously reported in some media articles.
“Therefore, it is hereby confirmed that there has been no financial crime or any other such offence as reported by some media,” the statement said.
Ability to handle more debt with economic growth
Speaking to The Sunday Morning, Advocata Institute Chief Executive Officer (CEO) Dhananath Fernando said that if the economy of a country was expanding, then the country had the ability to handle more debt sustainability.
He said that there were two reasons for Sri Lanka’s overall debt stock to increase to $ 100 billion when the country did not have access to external credit.
“When taking the rupee debt and converting it to US Dollar debt by dividing by the exchange rate, the US Dollar debt increases as the rupee has appreciated in the past few months. When the denominator value decreases when the numerator increases, then the resulting value will keep on increasing. This applies to US Dollar debt when the rupee depreciates, as the rupee value of the debt increases when the rupee depreciates.”
The total Government debt stock which stood at $ 79.8 billion at end-June 2022 when the US Dollar was at Rs. 359 increased to $ 100.1 billion by the end of March 2024, with the US Dollar at Rs. 300.
“Even though a country stops taking in new debt, it does not mean that the debt stock will stop growing as unpaid interest will be added to it. This is the second reason for the growth in Sri Lanka’s overall debt stock.”
He noted that even in the debt statement released by the Treasury, the accrued interest for the ISBs for the past two years, which were not paid, were added to the debt stock. Further, he said that the debt stock would change constantly depending on the exchange rate taken to calculate the debt. “Due to the unpaid interest accumulation, even though we have stopped taking new debt and servicing external debt, the debt stock continues to increase,” he said.
He added that the authorities and the bondholders had failed to reach an agreement at the April discussions on what was to be done with the unpaid interest, with the authorities wanting the unpaid interest – amounting to about $ 1.6 billion – to be cut off.
He added that when compared to 2022, in 2023 the overall debt stock had reduced to about 118% of GDP from 128% a year earlier and that it should reduce to 95% by 2032. “But this is a big amount, and it should at least come down to 60% of the GDP,” Fernando added.
Bondholder deal
According to the deal agreed upon this past week, bondholders have proposed a 28% principal haircut on existing bonds on the outstanding amount of $ 12.5 billion, in addition to a 11% principal haircut on accrued interest outstanding of $ 1.9 billion while coupon reductions have also been implemented, on a step-up basis, with the effective coupon reduction at c. 25% (weighted average).
Moreover, a maturity extension of five years has been provided for existing bonds, with repayments starting from March 2029 and concluding in 2038 and total payments of $ 724 million to be made by end of 2024, including a consent fee of $ 225 million to be paid upfront upon finalisation of the debt restructuring agreement, a maturity payment of $ 291 million, and coupon payments of $ 208 million.
Repayments will begin from September 2024, with principal instalments due in March of each year and coupon payments made biannually.
SL GDP will overperform, triggering lower haircut
According to the investment firm Capital Alliance Ltd. (CAL), despite the Government’s proposal to include only three Macro-Linked Bonds (MLBs) within the agreement (of the existing bonds), the bondholders’ stance had been unchanged, with eight bonds continuing to be macro-linked.
However, the test criteria for activation of adjustments on the MLBs have been updated, where under the baseline scenario, US Dollar based nominal GDP is projected to average at $ 88.6 billion (vs. $ 84.2 billion in the April proposal) during the 2025-2027 period, reflecting the IMF’s updated forecasts.
Based on CAL’s projection for nominal GDP to grow by a minimum of 6% in 2024E, with an assumed average exchange rate of Rs. 310/US Dollar (currently Rs. 307/US Dollar), nominal GDP is projected to increase to $ 94.4 billion by the end of 2024.
“Extending this to the period under assessment, assuming nominal GDP growth of 8% thereafter (3% GDP growth, 5% inflation) and currency depreciation of 5% annually, average nominal GDP is projected to average at $ 100.3 billion; standing at the highest GDP threshold under the current proposal. This would effectively reduce the principal haircut to 15% (vs. 28% under the baseline scenario),” CAL said.
Furthermore, it said that a control variable had been introduced on cumulative real GDP growth of 11.1% in the period from 2024-2027, which implies that if GDP grows by a Compound Annual Growth Rate (CAGR) of 2.67% between 2024-2027, upside adjustments would be triggered, enabling a lower principal haircut and higher coupon rates.
Given CAL’s expectation of real GDP growth of between 3.5-4% in 2024 alone, this indicates a high likelihood of adjustments being triggered.
CAL also expects that listed commercial banks that have undertaken adequate impairment provisioning on foreign-denominated instruments are not expected to see further impairments on the ISB front (minimum 55% NPV loss provided for by all LCBs) as of Q1 2024.
In addition to MLBs, CAL states that plain vanilla bonds may see adjustments based on agreements between the Government and bondholders to include governance-linked terms, which is likely to include quantitative target (tax revenue as a percentage of GDP) and qualitative target.
Moreover, CAL expects reserve accumulation to slow down owing to $ 724 million debt related payments by September 2024. In addition to the consent fee of $ 225 million required to be paid upfront upon finalisation of the debt agreement, the Government is further required to make debt service payments of $ 499 million in September.
Given the resumption of debt payments, CAL anticipates reserve accumulation by the CBSL to slow down in the coming months. Additionally, CAL anticipates these foreign exchange outflows to result in depreciation pressure on the currency.