8 August 2022 08:17 am Views - 750
By Nishel Fernando
Despite possible widespread economic consequences including threats to the stability of the financial sector, President Ranil Wickremesinghe fears that the government may have to consider potential restructuring of domestic debt in order to achieve debt sustainability under a debt sustainability analysis (DSA), which is to be presented to the International Monetary (Fund) IMF and the country’s foreign creditors.
“...the more important issue is have you taken a look at the local debt? Certainly, it will have far reaching consequences. Lazard, the financial advisors, are looking at both,” President Wickremesinghe said at an event organised by the Advocata Institute, last Friday.
Following his remarks on Friday, the secondary bond market experienced selling pressure in some maturities, resulting in 50-70 basis points increase in yields. Several leading economists including the former Central Bank Governor Dr. Indrajit Coomaraswamy advised against restructuring domestic debt from very early on.
Further, IMF officials have warned the governments on risks associated with domestic debt restructuring as it could pave the way for the country’s debt stress to spread to the banking sector, pension funds, households and other parts of the domestic economy.
Speaking to Mirror Business, First Capital Research (FCR) Head of Research Dimantha Mathew warned that full-scale potential domestic debt restructuring involving a haircut would be a massive blow to the country’s struggling economy, in particular the banking sector.
“In such a case, the capital adequacy of banks will go down, then the government will have to allocate funds from the budget for banks. Such additional burden on government coffers wouldn’t help to cut fiscal deficit. Therefore, local debt restructuring at the end would become meaningless,” he stressed.
Pension funds such as EPF and ETF, financial sector which includes banks and insurance firms, as well as corporates hold a majority of the Treasury bonds. In addition, banking sector holds 95 percent of US$-denominated SLDBs issued by the government.
Further, a potential domestic debt restructuring scenario would drive the current bond yields to 35-40 percent range increasing the funding costs for the government.
Mathew also highlighted restructuring of domestic debt may also cause the foreign debt portion in the country’s overall sovereign debt portfolio to remain unchanged at current unsustainable levels.
“As we are also in a BOP crisis, we have to question as to how restructuring of local debt would support in resolving the current forex crisis.
“Due to the depreciation of the rupee, the local debt to foreign debt ratio has come down to 50:50 from 65:35. If we are to restructure local debt, then this will continue to remain at 50:50, which is considerably high,” he said.
However, he noted that Lazard who is in the process of analyzing and evaluating multiple scenarios towards debt sustainability is unlikely to come up with such a recommendation which has a deep economic impact.
“Most likely scenario is that they (Lazard) won’t touch the local debt. Even if they do, as the President stated, it has to be carried out without hurting the economy further. In that case, the most likely scenario is that they may extend the maturity of bonds. We have to choose the most appropriate formula to achieve debt sustainability,” he elaborated.
Meanwhile, Central Bank Governor Dr. Nandalal Weerasinghe recently stressed the domestic debt has already gone through a restructuring process to some extent amid the sharp depreciation of the rupee and the high inflationary environment.