Dispossession by Domestic Debt Restructuring

The government’s proposed domestic debt restructuring plan is going to be devastating for the most marginalized working people, like plantation and garment workers

The domestic debt restructuring plan announced by the Government last Wednesday and passed by parliament on Saturday, targets only one significant domestic financial asset, namely retirement funds. Far reaching changes to the future of working people’s lives are never a done deal, and much can change between the Government’s plan and what can be politically sustained as resistance mounts. Why did the Government target retirement funds, what is the cost to working people and what alternatives are available? 

 
Domestic debt

Sri Lanka defaulted on its external debt last year and is now in debt restructuring negotiations with international bondholders as well as bilateral donors such as China, Japan and India. While Sri Lanka did not default on its domestic debt, the Government wants to restructure its domestic debt for three reasons. First, to pander to the demands of international bondholders, who would like to see a lower debt stock to be repaid from the revenues, and reduce the risks associated with repaying their debt. Second, because it is blindly committed to the targets set by the IMF of reducing annual debt servicing to 13% of GDP. Third, because the Government wants to keep both the international bondholders and the IMF happy, so that it can, as per the IMF targets, float International Sovereign Bonds starting in 2027.

With its stale majority in parliament, the Wickremesinghe-Rajapaksa Government has pushed through a domestic debt restructuring vote. However, negotiating with the global vultures that make up international bondholders is going to be a much more difficult task, even if the Government is requesting a meagre 30% haircut – meaning, reduction in value – on the defaulted external debt. Even more insidious are the moves to borrow again in international capital markets, which was one of the central causes of the current debt crisis. Finally, external debt and domestic debt are completely different. Whereas external debt can only be repaid with hard currency limited by the difference between foreign earnings and our import bill, domestic debt is in rupees. The latter entails different possibilities such as, for example, re-profiling current rupee debt with longer term rupee debt.   

Defaulting on, and for that matter restructuring, domestic debt is extremely dangerous as it can lead to the collapse of the domestic financial system. Therefore, the Government has decided to focus on retirement funds. Sadly, it is this constituency of retired people, whose entire future depends on their retirement savings and who are therefore extremely vulnerable economically and socially, as they have no way of obtaining new income, that are now coming under attack.   

Retirement funds

What the Central Bank and the Treasury refer to as superannuation funds consist of the EPF, ETF and a range of much smaller public and private funds. Together, they make up 14% of the country’s financial sector assets. Furthermore, about 90% of these retirement funds are invested in Treasury Bonds. In the case of EPF, 97% of it last year was invested in Treasury Bonds.   
In this context, the economic crisis last year led to the real value of retirement funds declining by over 40% due to the one-time rise in the cost of living with inflation and the devaluation of the rupee. For example, if someone had retired this year and cashed in their EPF in the hope of building a house, they would have been only able to build half their planned house.   

Meanwhile, the interest rates for Treasury Bonds also rose to a high of 31% last year and are now averaging about 22%. But if domestic debt restructuring is implemented, that is going to be reduced to 12% until 2025 and then 9% after that. Accordingly, it will be difficult for retirement funds such as EPF to regain losses that have occurred during the economic crisis. Next, the average after-tax interest over the last few years has ranged between 9% and 10%. With the Government’s restructuring plan, the interest rate on the Treasury Bonds for retirement funds will be reduced to 9%, and the operational costs of the funds and the taxes will bring returns even lower. Retirement funds will experience little real growth. It is even possible that they will undergo contraction in real terms, depending on the level of inflation.   

The Government wants to cut the interest rates of the Treasury Bonds held by retirement funds to save 0.5% of GDP every year for the next decade so that the Gross Financing Needs (GFN) of the Government come down to the IMF recommendation of 13% of GDP. If we estimate the compounded impact of this cut of 0.5% of GDP, it amounts to a loss of close to 30% of the value of the retirement funds when they are cashed in ten years later. In other words, the average value of all retirement funds over the last five years has been 17.7% of GDP, and with 0.5% of GDP in value lost every year over a decade, the total value of the retirement funds will decline to 12.5% of GDP. In this context, if a person worked over the next ten years and then retired at the end of that period, someone who earlier would get Rs. 3 million in EPF would only get Rs 2.1 million to live on for the rest of their lives. This is going to be devastating for the most marginalized working people like estate and garment workers, who were in fact forced to defer on their daily needs for the purpose of saving for retirement. 

 
Alternative moves

The 0.5% of GDP equivalent to 3.3% of the Budget could have been raised by wealth taxes, so that the working people’s retirement funds would have been spared, and the wealthy made to pay for the financing needed to meet the IMF conditions. This measure would have required just a 3.3% increase in revenue with a wealth tax. Furthermore, of the 13% in GFN, roughly a third, or 4.5%,is for external debt payment. The IMF can arbitrate, and the Government should demand, a higher haircut than the 30% for which is now being called. But global financial interests continue to prevail with IMF complicity. The Government accepts their terms without any pushback.   
Throughout all this, the Central Bank Governor claims domestic debt restructuring is voluntary. But if retirement funds choose not to undertake debt restructuring, the Central Bank Governor threatens a penalty. This would entail an increase in taxes from 14% to 30%, bringing down returns from 9% to 7%. What the Government is now calling Domestic Debt Optimization, then, for the working people is in fact Domestic Debt Dispossession! The working people should reject such dispossession and dare the Government to tax their retirement funds. And in light of an illegitimate parliament, they can take up the slogan: No taxation without representation!