Who’s benefiting from govt’s economic policy at whose expense?

Sri Lanka printed two trillion rupees during the last couple of months

If the government policy or something that remotely smacks as such is an overwhelming incorrigibility, its economic policy wins the cup. Though the government’s stated economic policy is more of hallucinations and rumblings of pie in the sky schemes, there is at least one area that it seems to be serious: its pledge to continue with debt servicing even after the country’s sovereign bonds are downgraded and foreign reserves are in a net negative.   
 Last week, the Governor of Central Bank Ajith Nivard Cabraal announced in a tweet that the government had allocated US$ 500 million to pay an international sovereign bond that would mature on January 18. “It’s a shame that some #investors lost out because of organized negative stories spread by certain vested interests,” he lamented in the tweet. Earlier, he gloated that the foreign reserves had spiked up to US$ 3.1 billion. The reason: a 10 billion Yuan currency swap from China.   

US$ 500 million is a drop in the sea of Sri Lanka’s external debt servicing commitments due this year. The country has to pay US$ 6.9 billion in principles and interests for its external debt commitments this year, including another US$ 1 billion international sovereign bond that matures in July this year. The government has pledged to repay all, but how it is done, against its net negative foreign reserves is not clear. Its external debt service commitments for this year is more than 600% of its actual foreign reserves, which would be US$1.1 billion after settling the ISB in January).   

Sri Lanka is simply not in a position to service enormous external debt. That is reflective in the country’s credit ratings; Fitch Ratings has downgraded Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CC’, from ‘CC, meaning it entails “a very high level of credit risk “   
With its current credit score, Sri Lanka can not issue bonds and other instruments of sovereign debt in the international financial market. Even before it was downgraded to C category, the Central Bank bond issuances were undersubscribed throughout the last year, leading the government to abandon it altogether.   

Throughout the last decade, since the country’s first international sovereign bond issuance in 2007, Sri Lanka has been re-issuing fresh bonds to roll over the ones that had matured. However, that window has been gradually closing throughout the last year and is completely closed now, due to the country’s depleting foreign reserves against its foreign loan repayment commitments. Countries repay their sovereign bonds in order to borrow more. A default when a country was still enjoying a healthy credit score would lead to an immediate downgrade, making it difficult or impossible to borrow. However, Sri Lanka is broke and irrespective of the government’s commitment, international credit rating agencies have deemed it as a default risk. As a result, it is completely shut out from the international financial market.   

That would also mean, it does not make sense to continue with servicing of external debt. It seems repaying the bounds against the predications of the rating agencies is the government’s way of showing creditworthiness. The government has effectively drained the country’s foreign reserves which were around the US $7.5 billion in November, 2019 - when Gotabaya Rajapaksa was elected president -to the US $ 1.6 billion in November, last year, by eating into reserves to pay off external debt commitments.   

This effectively worsened the country’s external finances, which led to downgrades of the credit score. But, worse still, it led to an unprecedented domestic economic crisis. Long queues for cooking gas, milk powder and rice are a product of the foreign exchange crisis that was made worse by diverting limited hard currency to service external debt. Building materials are in short supply and prices have skyrocketed. The entire constructions sector is in limbo, risking the livelihood of hundreds of thousands of workers.   

President Gotabaya Rajapaksa has no qualms in defending his folly of a ban on chemical fertilizer. While the President is a special case of anachronism, one can still argue the ban on chemical fertilizer was driven by the foreign exchange crisis and to get rid of the fertilizer subsidy which cost around US$ 300 to 400 million. It effectively decimated the entire agricultural sector.   

Decent people are being forced into petty theft to feed their families. One man, a heart patient, sliced his throat to escape vigilante justice after he was caught shoplifting. The misplaced economic policy is contributing to the brutalization of society. Every time the government diverts limited foreign reserves to pay foreign debt and gloats as it is a seminal feat, the domestic economic crisis gets worse, queues longer and basic food items scarcer.   
Then, when it prints money to finance a lofty relief package of Rs. 229 billion (on the top of 2 trillion rupees printed during the last couple of months) it feeds into a vicious cycle of inflation. Food inflation in December was 22.1%, according to the data released by the department of census and statistics.   
Then, why is the government insisting on this myopic policy?   

One for sure, a good deal of ego fuelled idiosyncrasy is at play. This smacks of a previous bravado of volunteering to go to the ‘electric chair,’ instead of setting in place a basic accountability mechanism. The result was an ongoing investigation by the UN high commissioner for human rights. As for the economy, the result is already devastating, and could well lead to a potential disorganized default.   
Second is the fallacy that a debt restructuring would limit its future ability to borrow. However, serial defaulters such as Argentina are also the most prolific borrowers from the international finance market. Investors do not buy sovereign bounds based on the past conduct of a state, but on its future repaying capacity, as for Sri Lanka, that is nil.   

The third and most likely scenario is the government’s reluctance to commit itself to a debt restructuring plan with the IMF, which would require a good deal of fiscal discipline. That might compel some far-reaching economic reforms, which though painful in short term, would be beneficial in the long term. However, these conditions might expose the real status of the economy, forcing the government to float the unrealistically pegged rupee and to cut down on the bloated public sector workforce and abandon certain policies, such as billions allocated for local government bodies,- which in truth is aimed at nurturing a patronage system.   

Fourth, someone should look into who is buying the Sri Lankan bonds that were traded in the secondary market at huge discounts, when investors who feared a default sell them en masse. Those buyers of the secondary market are bound to make a quick buck when the government settles bonds in their quoted value at their maturity.   
Much of Sri Lanka’s external debt commitment of US $ 6.9 billion for this year is in bilateral and multilateral loans, which the government is trying to restructure. A request to that effect was renewed yesterday when the Chinese foreign minister met the president early this week. That is the right thing to do. Similarly, the government should restructure its finance commitments obtained from the international finance market. To that end, it should commit to an IMF programme for debt restructuring. Instead, it is seeking to procrastinate the crisis, probably to hand it to its successor. Every passing day of the government’s dogmatism comes at the expense of the Sri Lankan public who are struggling to feed their families. The daily struggle of average households is unprecedented in recent memory. Vistas for prosperity, they call it...   

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