CB continues to maintain that rupee debt doesn’t have to be restructured

• Says about-face was driven by need to come to a swift deal with foreign creditors

The Central Bank continues to maintain its stance that domestic debt does not need to be restructured in order to achieve debt sustainability as the local debt has already undergone restructuring in response to high inflation and significant currency depreciation experienced last year.

According to Central Bank Governor Dr. Nandalal Weerasinghe, although the original position was against domestic debt restructuring, some form of restructuring had to be accepted during the debt negotiation process. 

This was necessary to secure concessions from foreign creditors and facilitate an early resolution, thereby avoiding a prolonged economic crisis in the country, he pointed out.
“As the Central Bank, our position has always been not to restructure domestic debt. Because of the high inflation and higher exchange rate, domestic debt had been restructured to a certain extent,” he said.

When the officials from both the Central Bank and the Ministry of Finance first announced the debt standstill on April 12, last year, they made clear that the rupee debt among others would not be subject to restructuring and only the select categories of foreign debt would go through the process. 
“Even today, I maintain the same position that we didn’t have to restructure domestic debt because they had already been restructured,” Dr. Weerasinghe stressed.

However, he said the foreign debt holders weren’t satisfied only with fiscal and other structural adjustments made in the economy since the beginning of the crisis last year and asked for more in terms of restructuring the domestic debt as they wanted equal treatment of both foreign and domestic debt.
“In a negotiation one has two options. Either you can hold on to a fixed position and do nothing to drag the process for several years or offer some concession from our side to come to a deal”, Dr. Weerasinghe said.

“Our interest was, while understanding that there has to be some compromise, there has to be a domestic contribution while protecting the interest of the Central Bank including the financial system stability, minimising the impact on the Central Bank balance sheet and minimising the impact on EPF as its custodian,” he added. 

Dr. Weerasinghe called what was announced last week was, “the best deal one could achieve”, given the circumstances and considering the country’s weak negotiation position. 

The Domestic Optimisation plan (DDO), which was passed in parliament last week turned out to be better than many had feared as it was positively received by both debt and equity investors who cheered the deal by driving both stocks and bond prices higher in the first week of trading since the deal was made public. 
There is an inverse correlation between the bond yields and the prices.

Contrarians have held the view that the country was not required agreeing to demands for domestic debt restructuring in order to persuade foreign creditors to restructure their debt. 

Their argument is based on the belief that when investors purchase debt issued by Sri Lanka, they inherently assume a certain level of default risk. This is because Sri Lanka lacks the ability to print dollars during times of crisis to repay its dollar-denominated debt.

They also cautioned that domestic debt restructuring would for the first time make government issued rupee debt no longer a risk-free asset from an investor standpoint.