Response to former CB Governor Central Bank says debt standstill was correct and only available decision

8 November 2022 10:10 am Views - 209

• Sri Lanka’s dwindling foreign exchange reserves were used up for continued debt service, leaving little or no foreign exchange resources for essential imports for the economy
• This led to the manifestation of long queues for fuel, cooking gas and other essential items, alongside power outages of up to 13 hours a day

In response to former Central Bank Governor Ajith Nivard Cabraal’s assertion that there was no need for debt default, the Central Bank said yesterday that the announcement of the debt standstill on April 12, 2022 was the right decision and only available option to prevent a hard default and subsequent far worst outcome than country is experiencing now. 

Issuing a detailed response to Mr. Cabraal’s statement, the Central Bank said for months prior to the announcement of the debt standstill, there had  been attempts by the Government to secure foreign funding from several sources and made requests from some external creditors for external debt moratoria. 
None of such requests for debt moratoria were materialized as sovereign debt had already been assessed as unsustainable by the International Monetary Fund. Further, there was an extremely high degree of uncertainty of the expected foreign exchange inflows to the Government with already downgraded sovereign ratings by international rating agencies, such as CCC- by S&P Global Ratings. 

• The article under reference claims that the Government had expected a large forex inflow in the period ahead to boost foreign reserves. It needs to be noted that most of these inflows had been anticipated for several months since mid-2021, but with no indication of realization within the required timelines, in spite of several costly visits to various Middle Eastern countries to solicit funds. Further, some of these inflows had already been utilized and planned for rolling over with no new inflows of foreign exchange, while some facilities were not usable due to conditionalities. Therefore, it was abundantly clear that none of such expected flows were likely to be materialized before the payments due in April 2022.  The Central Bank of Sri Lanka (CBSL) and the Government had already explored all available options, including liquidating foreign currency investments and gold holdings by the CBSL, while the Government had exhausted proceeds received for certain foreign funded projects in servicing foreign currency debt obligations and financing essential imports. 
• Against this backdrop, the Government of Sri Lanka announced the “Interim Policy Regarding the Servicing of Sri Lanka’s External Public Debt”. This announcement came following lengthy consultations with the highest political authorities, including the then President and the then Minister of Finance; and the senior officials, including the Secretary to the Treasury and Governor of the Central Bank and the Monetary Board. This announcement was ratified, and the decision of debt standstill was made by the Cabinet of Ministers on  April 16, 2022. This was a decision that had to be made to prevent a ‘hard default’ from occurring as the level of usable official reserves was inadequate to meet the debt servicing which was due on April 18, 2022.    
• At the time of making this announcement, the country’s foreign exchange reserves had fallen to a critically low level. Although Sri Lanka had, and still has, the willingness to pay, the liquid foreign exchange reserve position available was insufficient to meet the immediate debt service obligations. Although gross official reserves, including proceeds of the People’s Bank of China swap facility, stood at USD 1,889 million on 11th April 2022, liquid and usable reserves were as low as USD 24 million.
• At the same time, there was a government debt service obligation of USD 182 million on 18th April 2022. The near-term commitments that had already been made by the CBSL with respect to the importation of fuel, coal, and other essential items amounted to more than USD 500 million. 
• In addition, foreign currency debt service payments of the Government during the remainder of the year 2022 were estimated at about USD 4,330 million, excluding the liabilities arising from Asian Clearing Union (ACU) related payments and foreign currency liabilities of the CBSL. As such, it was abundantly clear that the available foreign exchange was insufficient to meet the liabilities maturing even within a few days from 12th April 2022.
• In addition to the above debt service payments of the Government during 2022, the commitments given to state-owned banks by the Central Bank to import essential imports amounted to USD 633 mn as at 12 April 2022, while the total obligations of the Central Bank amounted to USD 2,317.6 mn as at 12 April 2022. Therefore, total short-term foreign currency obligation of CBSL has been increased to an unprecedented level of US dollars 6,647 million compared with available liquid CBSL foreign exchange reserves of around US dollars 20 million.  
• The banking system, particularly the state banks, saw funding lines drying up and interbank foreign exchange transactions had almost come to a halt. Particularly, the Sri Lankan banking system, for the first time in history, had already experienced defaults on account of maturing Letters of Credit in and domestic swap facilities in March 2022, reflecting the prevailed persistent foreign exchange shortage in the country. 
• Meanwhile, the Central Bank had freely floated the Sri Lanka rupee, despite the Monetary Board decision to allow for a measured adjustment of the Sri Lanka rupee, not more than Rs.230 per US dollar, on 7th March 2022. This reflected the inability of the CBSL to mobilize foreign exchange needed to meet the maturing foreign currency obligations, and even to intervene in the domestic foreign exchange market to stabilize the exchange rate.   
• Meanwhile, the Government had already attempted to seek debt relief from various bilateral and multilateral sources from the onset of COVID-19 but with no success. For instance, the Government has requested India for a debt moratorium in June 2020, while the Government requested the global lenders in June 2020 to temporarily halt debt recovery in order to safeguard the economic conditions of the COVID-19 affected communities. Further, the CBSL itself has requested the International Monetary Fund (IMF) in October 2021 to lead a process of ‘debt standstill’ for 2022 to be granted by multilateral lenders to emerging market economies who lost access to capital markets. 
• All such previous attempts for possible debt restructuring have turned out to be futile. As such, it is evident that the decision to restructure Sri Lanka’s external debt was significantly delayed, despite the loss of access to international capital markets, including that of non-conventional financing from markets, such as Japan amidst a series of rating downgrades from early 2020. 
• As a result of this delay, Sri Lanka’s dwindling foreign exchange reserves were used up for continued debt service, leaving little or no foreign exchange resources for essential imports for the economy. This led to the manifestation of long queues for fuel, cooking gas and other essential items, alongside power outages of up to 13 hours a day, thereby resulting in an unprecedented socio-political unrest. 
• These unprecedented events reflected the gravity of the economic crisis that had been developing for several months prior to the announcement of the debt standstill on 12th April 2022. In fact, the announcement of the debt standstill, along with the decision to engage with the IMF announced by the President on the 16th March 2022, were the first steps in the recovery of the economy from the dire situation. 
• By announcing the debt standstill, Sri Lanka underwent a “Selective Default” as opposed to missing the coupon and bilateral debt repayments on 18th April 2022 without any preemptive action or communication, and thereby avoiding an even more adverse market outcome. The debt standstill and interim debt repayment policy have enabled Sri Lanka to set aside the foreign exchange resources to pay for critical imports, such as fuel, while also providing time and space for the sovereign to engage with its creditors in good faith with a view to restructuring the country’s debt. 
• Considering the scale and immediate nature of the liability maturities, most prudent and appropriate decision was to restructure Sri Lanka’s debt well before foreign exchange reserves dropped to near-zero levels. 
• This would have provided some reserve cushion during the debt restructuring process and avoided the acute shortage of essential commodities, thereby the resultant economic crisis, social unrest and political instability. 
• Had the announcement on debt standstill not been made on 12th April 2022, it would have resulted in a hard or disorderly default on its creditors. If that happened, the country could have faced cataclysmic consequences, which in turn, would have resulted in a myriad of adverse ad irreversible consequences, where Sri Lanka would have prolonged the manifestation of lack of foreign currency, acute essential import shortages and price rises of unimaginable scale, with no path to economic stabilization and recovery. Thus, the debt standstill was announced against the backdrop of the failed ‘home grown’ solution, which was also orchestrated in the ‘Six-Month Road Map’ of the CBSL that became futile, while the economy was heading towards a disastrous trajectory.      
• It needs to be reiterated that the decision to announce debt standstill as an interim measure was made transparently, and with the envisaged support of an external anchor in the form of engaging with the IMF for an Extended Fund Facility (EFF) arrangement. Subsequently, there had been several developments, such as successful completion of several missions by IMF staff reaching a staff-level agreement for an EFF arrangement in the near term, securing the services of internationally recognized firms to implement the debt restructuring process, the stabilization of socio-political conditions, and the gradual adjustment of the economy towards the desired path through policy measures from the monetary and fiscal fronts. 
• With these in place, the economy is expected to move forward on a recovery path, aided by the economic adjustment programme with the IMF, while managing external debt at sustainable levels in the period ahead.