SL told to frontload funds committed by official lenders to avoid foreign debt debacle

• IIF says a new IMF programme and multilateral lenders’ support key to frontload funds
• Cites extreme import compression as other option to avoid severe loss of reserves
• Committed official loans to SL estimated at US $ 6bn for 2020-2025 period
• Cumulative financing gaps projected to rise to US $ 2-US $ 5bn range next year
• SL has external debt obligations to tune of US $ 4.5bn per annum for next few years 
• SL’s gross foreign reserves stood at US $ 7.1bn at end-July

By Nishel Fernando 
Frontloading of funds committed by Sri Lanka’s official lenders under a fresh International Monetary Fund (IMF) programme is a viable option for the country to ease significant external financing gaps expected to materialise in 2020-21 and to avert severe foreign reserve losses, according to the Institute of International Finance (IIF), the Washington-based global association of the finance industry.

“Significant external financing gaps in 2020-21 will materialise unless official lenders frontload a large share of the funds they have committed to Sri Lanka. Frontloading is only a realistic option under a new IMF programme that reverses recent tax cuts and adopts substantial adjustment measures to improve a wobbly fiscal outlook,” the IIF stated in its latest report themed ‘Economic Views – Sri Lanka’s External Funding Gaps’. 

The IIF pointed out that the undisbursed funds committed by non-IMF official lenders for the next five years are larger than its projected financing gaps in 2020-21. 
The committed official loans are estimated at US $ 6 billion for the 2020-2025 period, while cumulative financing gaps are projected to rise to around the US $ 2-US $ 5 billion range, next year. 

However, the IIF doubted whether the country’s official lenders would come forward to frontload their committed funds, without an extensive official support. Hence, it outlined the need for backing an IMF programme to convince these lenders.  

“An IMF programme would be the starting point to catalyse flows from other official lenders. Even then, strong adjustment measures would be needed to convince official lenders to step in, if market access proves impossible. We think fiscal policy and the public debt outlook are crucial aspects of any adjustment programme and determinants of how willing official lenders could be to close financing gaps,” the authors of the IIF report opined. 

In addition, the report highlighted that extreme import compression remains the other option for Sri Lanka to avert severe foreign reserve losses. 

For last several years, Sri Lanka funded current account deficits issuing international sovereign bonds (ISBs). However, the IIF pointed out that market access is far from guaranteed at the current juncture for the country, even to roll over the maturing ISBs. 

“Financing deficits and rolling over maturing debt in these circumstances will be tough,” it added.  

Despite a significant contraction of the current account deficit in the first quarter of the year, due to import compression (aided by import restrictions), the IIF projected a current account deficit slightly above 3 percent of GDP this year, mainly owing to the loss of tourism revenue due to the COVID-19 pandemic. 

It noted zero tourist arrivals in the second quarter, implying an export loss of around 0.5 percent of annual GDP in the second quarter alone.

However, the IIF expects the current account deficit to narrow in 2021, assuming exports start to normalise and oil remains around US $ 45 per a barrel. 

The report highlighted that the main challenge for the country’s external front is with funding external debt amortisation, which is estimated to be around US $ 4.5 billion per annum, over the next few years.

According to the IIF estimates, public amortisation and the current account deficit together stand at 70 percent of the country’s official foreign reserves. 

“If we include short-term private debt, the ratio rises to nearly 200 percent. However, rollover of short-term private debt has been resilient. Risk lies in public financing needs,” it said.
Hence, it stressed that the country requires extensive official support to avoid severe reserve losses.

Sri Lanka’s gross foreign reserves stood at US $ 7.1 billion at end-July.