Too little reserves, too much volatility 

  • How can Sri Lanka sort out its external debt obligations?

By Yakuta Dawood 

Within three months Sri Lanka has to settle $ 1 billion in International Sovereign Bonds (ISBs) while also procuring fuel, gas, and other essential commodities. How the country is going to manage amidst all the volatility is the question at the moment. 

Speaking to us, Frontier Research (Pvt) Ltd. Sri Lanka Product Head (Macroeconomic and Thematic Research) Chayu Damsinghe stated that Sri Lanka should immediately follow an orderly default/restructure process in which the officials commence negotiation with creditors to figure out a way to repay the debt rather than denying the situation and ignoring the problem at hand by not taking any accurate action to resolve it. 

However, according to him, prior to commencing negotiations the officials should do what’s called a ‘consent solicitation’.

Explaining, he said that consent solicitation is where the officials involved would tell the creditors that they want to start debt negotiations and ask consent to proceed. Basically, it is a short negotiation for about a month, to start the actual debt negotiations. 

However, if it takes more time, it would mean that Sri Lanka would now have to pay the debt in the meantime, thereby creating two issues. First, the country would not have any reserves to pay its creditors and on the other hand, it would be unfair to the creditors as someone who is getting paid right now would get everything in comparison to the creditor who would get a bigger reduction on their payments in the future. 

“This is called the subordination problem, which is something creditors really don’t like. To avoid this, one option that Sri Lanka can take is to immediately announce publicly that the country will suspend debt payments and start a consent solicitation process. It is absolutely critical to immediately start negotiations because every single day that you delay, the outcome will get much worse,” Damsinghe explained. 

When asked if Sri Lanka would be able to settle the $ 1 billion ISB in July, Damsinghe highlighted: “Realistically, it will be very unlikely to make all these payments unless we have new money of about $ 2-3 billion coming into the country.”

He stated that together with the debt negotiations, the Government should start talks with the International Monetary Fund (IMF), which will not be able to give us any money until Sri Lanka is in a better position with regard to debt sustainability. 

“Through this process, it doesn’t mean things will come back to normal very soon very quickly as things are going to be tough with further currency depreciation, interest rate hike, prices will continue to keep rising until it stabilises. We are past the point where we can reverse any of this, but what we can do is stop it from getting worse,” Damsinghe added. 


Politics or economics?


Speaking to The Sunday Morning Business, University of Colombo Faculty of Arts Department of Economics Senior Lecturer Grade II and Attorney-at-Law Dr. Shanuka Senarath stated the present economic crisis may worsen severely within the coming weeks as the country and its Government were in jeopardy due to the political instability and the escalating public unrest.

Explaining what might happen right now, he said that the country would not be gaining a considerable rate of tourist arrivals in the next few months while foreign remittances would also start to decline significantly as people would now send the bare minimum for their families residing in the country given the exchange rate depreciation. 

“We are in a true dilemma at the moment as the situation is beyond economics now. Thus, right now the foremost task is political stabilisation in the country since nobody will be willing to fund a country where there is instability, including the IMF. We have gone too deep into the crisis and this sort of fragile political atmosphere will definitely be even worse with no financial/foreign aid,” Dr. Senerath affirmed. 

According to his expertise, the best thing is to sort out the political issue and then work with the IMF to come up with a debt restructuring plan. 

However, he said Sri Lanka was late for debt restructuring. Explaining, Dr. Senerath said that countries go for debt restructuring before bankruptcy in which they would have some income and payment ability to guarantee the debtors by saying “we will pay but in a different way”.

“We are in a position where we are already bankrupt; we cannot pay any debt and thus we can’t go for debt restructuring. This mechanism should not be taken for granted and this is what the Government is doing by thinking that it can do debt restructuring at any point. But no, after a certain point, you cannot go for debt restructuring since the country has no income and is already in default,” he emphasised. 

He said that everything right now was heading towards a deep recession which was why it was extremely essential to sort out the political situation in the country by going for a Presidential or Parliamentary Election soon and then commence talks with the IMF for assistance. 


Paying the piper


Further, he noted that Sri Lanka would not be able to settle the $ 1 billion ISB as it was very unlikely for any nation to give Sri Lanka any sort of credit facility to meet the debt obligation unless a country like India gives a sympathy donation to repay. 

“Unless India gives out another billion, we will be in default by July and since we will be considered as default, we lwil not have any access to foreign exchange after that,” he added.

Meanwhile, Ceylon Chamber of Commerce Senior Economist Shiran Fernando told The Sunday Morning Business that it was important for Sri Lanka to focus on prioritising engagement with the IMF and the selection of legal and financial advisors to assist the country with the debt restructuring. 

“We hope with the recent appointment of the new Governor, these actions will be fast-tracked so that there can be a pause in debt repayments while the country engages with the IMF on a reform programme. The pause will help relocate dollars to finance the importation of fuel, medicines, and other essentials. With this progress, Sri Lanka will have to secure bridge financing from multilateral and bilateral sources,” Fernando stated. 

Meanwhile, a Senior Economics Professor who wished to remain anonymous told The Sunday Morning Business that the present situation in the country required urgent action and solution as the most important challenge at the moment was to access credit lines that would enable the country to finance essential imports. 

“Thanks to our terrible policies and leaders, we don’t have cash in hand to finance anything. In the circumstances, I don’t think any of the creditors expect that the country can pay its debts immediately (where debt obligations stipulate immediate or near future payments) and in full. My feeling is that they will be quite happy to come to some agreement to reschedule payments so long as they can get an agreement for payment of interest and some fraction of the principal later. This will require difficult but not impossible negotiations because no creditor will want to be treated worse than others,” the Professor said. 


Who will carry the burden?


The Professor highlighted that the standard IMF package would inevitably pass on most of the burden of resolving the crisis to wage earners – statements about safety nets for the poorest mean that they will be provided with a basic subsistence income. 

According to his expertise, there is no way that the pre-crisis average standard of living can be maintained in the policy settings that the IMF has already outlined.

Explaining why, he noted that the IMF staff report has assessed that the country requires a depreciation of the real exchange rate of some 17% sustained over several years.

“In an economy where export and import-competing prices are heavily labour intensive, this is close to requiring a similar cut in real wages or earnings of a similar magnitude. Therefore, I don’t think people will accept such cuts to resolve a crisis for which they don’t feel responsible. Hence, any attempt to prioritise debt repayments over providing essential goods will produce another social and political explosion.”

When contacted, Ministry of Finance and Central Bank officials refused to divulge any information or speak on what steps would be taken to resolve the crisis.