Sri Lanka advised not to restructure domestic debt

• Former CB Governor Dr. Indrajit Coomaraswamy says govt. must be firm in IMF negotiations 
• Stresses need to be “very clear” to the Fund about domestic debt being out of bounds
• Says IMF will push for it because if SL agrees to restructure its domestic debt the hit on external creditors would be less
• Points out domestic debt restructuring would create massive impact on balance sheets of banks, could lead to a major financial crisis
• Says SL always has the option of servicing the domestic debt through Central Bank financing though it could stoke inflation

By Shabiya Ali Ahlam
As Sri Lanka is gearing up for a major exercise with the International Monetary Fund (IMF) to restructure its debt, the government must be firm in its negotiations with the multilateral lender to avoid any proposals to restructure its domestic debt, a top economist opined. 

Senior economist and former Central Bank Governor Indrajit Coomaraswamy cautioned that any restructuring effort targeting domestic debt would be detrimental to the national economy and its recovery efforts.

 “Let me say upfront, very clearly, we should not go anywhere near restructuring domestically. It is not necessary and we have to be very clear to the IMF about that,” Coomaraswamy told a virtual investor event organised by CT CLSA this week.

The former Central Bank Governor explained that the IMF is most likely to push for restructuring of domestic debt too because if Sri Lanka agrees to restructure its domestic debt the hit on external creditors would be less.

“We have to be very clear to them that the domestic debt is off bounds. The question we should ask them is, by doing this, is it more likely that you will get your money repaid,” reiterated Coomaraswamy. “We have to draw a line in the sand and say no,” he asserted.

As the Central Bank has the ability to participate in the primary market there is always the option of servicing the domestic debt through Central Bank financing, 
he pointed out. 

However, the price of doing that would be handling inflation, which is highly regressive, Coomaraswamy noted.

Bringing domestic debt into the restructuring picture would also not go well for the economy due to Sri Lanka’s banking system being highly exposed to the sovereign.

The domestic debt restructuring would typically create an impact on the balance sheets of banks, which in-turn could lead to a major financial crisis. “My understanding is that even donors from other countries have shown a willingness to finance the recapitalisation of domestic financial institutions if they’re the threat to the financial system. So that can be looked after.  But domestic debt, if we put our hand into that, I think it will seriously undermine the stability of the financial system,” stressed Coomaraswamy.

Prior to providing IMF support to Sri Lanka, an External Debt Restructuring (EDR) exercise is more likely to take place. A report by CT CLSA highlighted that within this framework external commercial debt and bilateral debt could be considered as the key areas to be restructured with possible hair-cuts introduced on ISBs and SLDBs.

However, given the significance and relatively low debt servicing cost, CT CLSA said external multilateral debt could be continued without a possible restructure, but asserted it will be best to refrain from restructuring the domestic debt quantum.