DdO and economic recovery beyond IMF

According to the latest figures published by the Finance Ministry, the present administration continues to borrow more money, both domestic and foreign funds and thus increasing the overall debt stock. The total public debt is around US $ 92 billion as at March 31, 2023; it was only US $ 79 billion by end-September 2022, as announced by the Finance Ministry, which is an increase of US $ 13 billion (or a 16 percent increase). 

During the last one year, the government has been working on restructuring the debt, including the domestic debt optimisation (DDO) process, with the intention of achieving what is known as debt sustainability. According to the Central Bank, in order to achieve debt sustainability, Sri Lanka needs to achieve specific debt financing and debt servicing-related targets. 

Accordingly, the external financing gap during the remaining programme period of five years ending 2027 works out to US $ 22.3 billion, which is financed through the International Monetary Fund (IMF)/Asian Development Bank/World Bank support, amounting to US $ 6.7 billion, total debt restructuring relief of US $ 14.1 billion and a sum of US $ 1.5 billion International Sovereign Bonds (ISBs) to be obtained in 2027. 

In other words, it is expected that the debt restructuring effort will take care of approximately US $ 3 billion per year, totalling US $ 14.1 billion over a period of five years.  This debt service reduction during 2023-2027 is to be sufficient to close the external financing gap. In addition, as per the debt sustainability analysis carried out by the IMF, the target of public debt stock to gross domestic product (GDP) is set as below 95 percent of GDP by 2032. 

Further, the average annual financing needs of the government in the 2027-2032 period to remain below 13 percent of GDP and forex debt servicing to remain below 4.5 percent of GDP in each year over 2027-2032. These are tough targets to be achieved and therefore, the government, private sector, trade unions, key opinion leaders (KOLs in civil society) and all the other stakeholders must work in collaboration towards developing their own areas of activities at optimum levels. 

It goes without saying that the success of this programme would depend on undertaking long-neglected structural reforms and increasing export of goods and services through improving productivity and quality of work, both in the private and government sectors. Attracting foreign direct investments through public-private partnerships becomes a necessary prerequisite, in order to increase GDP as well as reducing future forex borrowings.   

Prioritising domestic debt restructuring as opposed to economic growth 

As for GDP growth rates, the Census and Statistics Department reported previously that the economy contracted by a staggering 11.5 percent during the quarter, January to March 2023. Accordingly, Sri Lanka’s last three quarters’ growth rates (all negative) have been as follows: 3Q 2022: -11.8 percent, 4Q 2022: -12.4 percent and 1Q 2023: -11.5 percent. 

During the year 2021, GDP was positive 3.5 percent, despite the negative impact arising from Covid; also, the annual average inflation rate was 7 percent in 2021, although the inflation expectations were high during the first quarter of 2022. Overall inflation has skyrocketed and recorded as 50 percent annual average for the year 2022, partly due to the imported inflation and public expectations of future price increases. 

The 2022 Central Bank report clearly indicated that as people of Sri Lanka consume a considerable share of imported items, the country’s inflation is affected by the movements in global commodity prices and the depreciation of the rupee against the US dollar.   

The exchange rate was allowed to be floated from March 7, 2022 (fixed rate of Rs.203 per US dollar since September 2021) until May 26, 2022, where the exchange rate had gone up to Rs.377 per US dollar and thereafter, it was some kind of a managed float. With the exchange rate moving up, export proceeds and foreign remittances have started flowing in. 

With the import restrictions, including fuel rationing and the suspension of some foreign debt servicing, the overall demand for the US dollar has reduced. At present, the exchange rate is around Rs.310 per US dollar.  

As for inflation figures during 2021, both the headline and core inflation rates – even year-on-year (YoY) inflation – were in single digits except in December 2021, where headline inflation has gone up to 12.1 percent, based on the Colombo Consumer Price Index (CCPI). 

Even in the first three months of 2022, the highest headline and core inflation were 19 percent and 13 percent, respectively. With the exchange rate allowed to be floated, inflation has skyrocketed – the headline and core inflation rates in December 2022 (YoY) were 70 percent and 50 percent, respectively. Since then, it has settled down to 24 percent and 20 percent in May 2023. 

We need to be mindful that it’s not annual average inflation but it’s the YoY basis. Still, it’s higher than the 2022 first quarter figures. This is despite stringent monetary and fiscal policies adopted continuously during the last 12-14 months, at the expense of economic growth, lower household disposable income and under/unemployment. 

It is also true that the present government and the Central Bank have managed to contain future inflationary expectations by taking drastic measures such as bank interest rate hike, trying to reduce money printing as far as possible, passing the increased electricity tariff and indirect taxes/income tax additional burden to people, etc., if not, one could argue overall inflation would have been even more than, say 80 percent.  

It seems the government has given the highest priority to undertake DDO and containing inflation created by the imported inflation, instead of focussing on GDP growth and minimising unemployment. The on-going process of domestic debt restructuring would help to substantially reduce the external debt burden through future negotiations with the external creditors. 

President Ranil Wickremesinghe has announced that the government anticipates the restructuring of foreign debt of US $ 17 billion, out of a total foreign debt of US $ 45 billion, within a five-year term. The Cabinet approval has been granted for the DDO proposal put forward by the Finance Ministry on June 28. 

It is understood that the T-bill and T-bond holdings of the banking sector have been excluded from the DDO, considering the significant stress on the banking sector at present, due to the increasing NPLs. It is proposed that the T-bonds of superannuation funds be exchanged for longer maturity T-bonds. Wickremesinghe should be commended for his decision to table the DDR proposal for debate in Parliament, scheduled on July 1 and 2, 2023. 

Analysis of origin and nature of debt stock

As for the debt restructuring process, it is important to critically analyse the existing stock of total debt – domestic and foreign debt, the origin and nature of the debt stock and composition of its holders/creditors. The lesson learnt from the experience in Greece and Lebanon in debt restructuring would be that a more comprehensive analysis of the origin of debt is more important than just following a debt restructuring mechanism (even though it’s highly sophisticated in terms of the IMF recipe).

Sri Lanka’s total government debt was only Rs.80 billion by end-1982, which includes some of the foreign loans obtained for the accelerated Mahaweli development programme. Since then, the government debt has been increasing at a much faster rate, reaching Rs.13,031 billion by end-2019. 

The country’s total outstanding external debt has increased to US $ 54.8 billion in 2019 and it has come down to US $ 50.7 billion by end-2021. The total outstanding external debt as a percent of GDP rose to 65 percent by end-2019 and it had reduced to 60 percent by end-2021. Sri Lanka’s external debt service has been ever increasing and by end-2019, it was around US $ 5.8 billion per year. The debt sustainability was badly affected by the continuous borrowing through ISBs, especially during the period 2014-2019; the outstanding ISBs increased by another US $ 11.5 billion from ISB stock of US $ 3.5 billion, as at end-2012. 

However, a sum of US $ 2,5 billion of outstanding ISBs has been settled during the period 2020 till end-March 2022. This is in spite of poor export performance, due to lockdowns and disruptions during the Covid period, significant reduction in tourist income/other forex inflows and many challenges to stimulate economic growth. 

Since 2020, up to now, no further borrowings under ISBs have been obtained. At present, the ISB outstanding balance is US $ 12.5 billion, out of the total public debt of US $ 92 billion (domestic debt of US $ 47 billion plus external debt of US $ 45 billion as at March 31, 2023, as per the Finance Ministry quarterly debt bulletin). 

Debt, if obtained, must be used to invest judiciously in enterprises that will create wealth, so that the enterprise could pay back its own debt. Unfortunately, this has not happened in Sri Lanka. There had not been many investments in infrastructure development despite foreign commercial borrowings obtained, especially during the period 2014-2019. Part of these loans obtained at high commercial interest rates would have gone for consumption and servicing outstanding debt. 

The two biggest expenditure items utilising forex loans are for energy (fossil fuels, cooking gas, etc.) and for food. Sri Lanka’s economy is not determined by Sri Lankans only; it is a function of the external markets. This could be tackled by adopting a sustainable economic development path, focusing on social and environmental factors and making Sri Lanka’s economy near self-sufficiency in energy and food, whilst following the social market economic model as practiced by the government.

Trade-off between economic recovery and inflation/debt restructuring

Normally, during an economic recovery, which occurs after a recession, GDP grows, incomes rise and unemployment falls as the economy rebounds. The process of economic recovery shall not create additional burden to households and small and medium businesses. They have already been affected due to high cost of living, under or unemployment, disposable income reduction, lower demand for goods and services produced by the small and medium enterprises (SMEs), due to lack of purchasing power of consumers, etc. 

The writer has been advocating this point in the previous articles as well to the effect that the government should have focused on GDP growth and thus facilitating SMEs and other affected subsectors to come back and engage in business activities. This is important in order to avoid any social unrest. 

Maintaining political stability, addressing household income inequalities, short-run trade-off between inflation and GDP growth through pragmatic economic policies are necessary prerequisites for the economic recovery. The government must make every endeavour to cut down on its expenditure to match the revenue and any deficit to be financed through non-inflationary borrowings and strengthen accountability and transparency to the people
through Parliament. 

This is a time of reckoning when the country needs to come together and set aside ideology and egos and focus on problem-solving. This is a daunting task and the government and opposition would have to work in collaboration – a truly national government, where power could be shared at the centre. This would become the most critical success factor.

(Jayampathy Molligoda is a former Sri Lanka Tea Board Chairman and company Director)