- Paris Club lenders and India insisted on application of comparability principle
- Shows the hard bargaining Sri Lankan negotiators had to do with the OCC
- Despite agreements being reached, providing any relief to people untenable
- Sri Lanka needs a focussed growth programme in addition to IMF programme
- Govt. expenditure has not been cut; SL still on ‘borrow-live-borrow’ cycle
- After the debt moratorium is over in 2028, the breathing space will end
“There is no hard and fast rule that a creditor will not agree to a haircut of the principal loan. It all depends on the prevailing circumstances mostly ruled by the status of the borrower and the willingness of the creditor,” said former Deputy Governor of the Central Bank, Economist Dr. W.A. Wijewardena, responding to a question posed by The Sunday Morning on President Ranil Wickremesinghe’s statement in Parliament earlier in the week that official bilateral creditors never reduce the principal amount of a loan. He pointed out that Paris Club lenders plus India had insisted right throughout that the comparability principle should be applied to the debt restructuring. “Therefore, the non-availability of a haircut by this group may be due to the need for making the entire restructuring comparable across the two types of creditors, namely, the Paris Club and China. It shows the hard bargaining which the Sri Lankan negotiators had to do with the Official Creditor Committee (OCC) of the Paris Club members,” he added.
Commenting on ongoing discussions with commercial creditors, including International Sovereign Bond (ISB) holders, Dr. Wijewardena said: “According to a public announcement made by the Government last week, there has been a broad agreement which it has agreed to with the ad hoc group of ISB holders who account for about 50% of the ownership of ISBs. For this agreement to be final, it should receive the approval of the OCC of the Paris Club and the International Monetary Fund (IMF).”
Pointing out that Sri Lanka’s total debt still stands at a staggering $ 27.5 billion, he said that in the absence of a haircut, the country’s debt liability should be postponed to the future.
Dr. Wijewardena also said that providing any relief to the people was untenable at this point: “The debt relief will help the Government to wade through the difficult period by saving money that would have been spent on debt repayment. Since the Government is required to reduce this expenditure also in terms of the Extended Fund Facility (EFF) of the IMF, I do not think it is advisable for the Government to use these savings for providing relief to the people… Since the total debt has not been reduced by way of a haircut, the future generations will have to bear a bigger burden of debt repayment after 2028, implying a relief is untenable.”
Looking to the future, Dr. Wijewardena emphasised that Sri Lanka should have a continued balance of payments surplus from 2023 onward to build reserves to the required levels, which would require the country to have a focussed growth programme, in addition to the present IMF stability programme.
Following are excerpts:
Sri Lanka reached debt-related agreements with its official bilateral creditors and with China’s Exim Bank on 26 June. What is your assessment of the agreements in line with the information available at present, especially given that the agreement has not been made public yet?
We all know only the broad outline as announced by the President Ranil Wickremesinghe in his address to the nation and in his clarification to Parliament and not the finer details. Hence, we can comment only on the broad picture.
There were two types of external debt that needed to be restructured in terms of the suspension of the servicing of selected debt by the country in April 2022. They were borrowings from the individual countries, known as bilateral credit, and from commercial sources, mainly by issuing ISBs and from China Development Bank on commercial terms.
By end-2022, that amounted to $ 24.1 billion, made up of $ 9.8 billion by way of bilateral loans and $ 14.3 billion from commercial sources. Due to the debt suspension, arrears had accumulated amounting to $ 777 million payable to bilateral creditors and $ 1,633 million to commercial creditors. Hence, the total restructurable debt, as estimated by the IMF, had amounted to $ 27.1 billion.
Out of this, only debt amounting to $ 10 billion had been restructured by the creditors agreeing to postpone the repayment of the principal beginning from 2028 and ending in 2042. Hence, from 2024 to 2027, Sri Lanka should pay interest to those creditors at about 2% annually as announced by the President. Hence, the annual interest payments will be about $ 200 million, which is an outflow from the country. Since there is a moratorium over the principal, there is a relief for the country during 2024 to 2027 by way of a cessation of the previously contracted outflow of foreign exchange.
According to the Debt Bulletin issued by the Ministry of Finance for March 2024, the annual saving on this count is estimated at $ 1,084 million and the total for 2022 to 2027 will be about $ 6,501 million. This is a substantial relief to the Treasury as well as the external sector of Sri Lanka. But this will be added to the principal and Sri Lanka should repay the full debt amounting to about $ 10.6 billion over a prolonged period from 2028 to 2042. Hence, in the case of bilateral credit, the overall debt level has not come down but only the payment terms have been eased.
Since we do not know how the Government will agree with the commercial creditors, we cannot comment on that aspect.
Speaking in Parliament on Tuesday (2), the President said that official bilateral creditors never reduce the principal amount of a loan. However, speaking to The Sunday Morning in April, you said that an ideal outcome should entail a massive haircut of about 51% of Sri Lanka’s bilateral and commercial borrowings. In this backdrop, how do you view the lack of a haircut?
There is no hard and fast rule that a creditor will not agree to a haircut of the principal loan. It all depends on the prevailing circumstances mostly ruled by the status of the borrower (their inability to pay in full) and the willingness of the creditor (to protect at least a part of the amount lent).
Since China does not provide such a haircut to its borrowers as a policy, it can be surmised that there had not been such a relief provided to Sri Lanka by China on its lending to the country which had amounted to $ 4.5 billion, with arrears, as at end of 2022.
Paris Club lenders plus India had insisted right throughout that there should be a comparability principle applied to the debt restructuring. Therefore, the non-availability of a haircut by this group may be due to the need for making the entire restructuring comparable across the two types of creditors, namely, the Paris Club and China. It shows the hard bargaining which the Sri Lankan negotiators had to do with the OCC of the Paris Club members.
If Sri Lanka is to be relieved of external debt indebtedness, as the IMF had estimated in December 2023, the country needed to have a debt relief of $ 14.1 billion after getting a moratorium of $ 2.8 billion. Of the total debt liability of $ 27 billion, this debt relief of $ 14.1 billion amounted to about 51% which should be the written-off component of the total debt.
These estimates have been revised upward by the IMF in May to $ 17.1 billion, made up of a debt relief of $ 10.5 billion and a moratorium of $ 6.6 billion. When the interest in arrears is added to the outstanding debt from the restructurable sources, the total debt still stands at $ 27.5 billion. These three numbers are staggering and show that, in the absence of a haircut, the debt liability should be postponed to the future.
However, Treasury Secretary Mahinda Siriwardana is reported to have announced recently that the debt is being negotiated not on a haircut of the principal but on the relief that is provided to the country through a lower net present value of discounted future outflows. His contention was that if this net value is lower than the projected nominal outflows, it is tantamount to a haircut.
In my view, he is right and wrong in this contention. When a borrower makes a borrowing, it is usual to calculate whether there is a ‘grant element’ in the loan by using this procedure. If the discount rate used for calculating the net present value is higher than the nominal interest rate, the discounted net present value is lower than the total value of the loan. The difference is considered a grant received by the borrower. In this context, the Treasury Secretary is right.
He is wrong because the lower net present value does not give a relief to the country which is already in a debt trap. That country should get a relief on nominal terms and not on hypothetical calculations of which outcome is basically determined by the choice of the discount rate used. Such discount rates are arbitrary and, by using a higher discount rate, it is possible to show a high grant element for the country.
As Sri Lanka gains ground in addressing its debt issues, do you see the masses receiving any relief in the near future and, if yes, will such relief only be election gimmicks? Is giving any relief possible or practical at this point, when the country is yet to sufficiently recover from the economic crisis?
The debt relief and the relief to the people are two different aspects. The debt relief will help the Government to wade through the difficult period by saving money that would have been spent on debt repayment. It reduces gross Government expenditure by about, as I have estimated above, $ 6.5 billion. Since the Government is required to reduce this expenditure also in terms of the IMF EFF, I do not think it is advisable for the Government to use these savings for providing relief to the people.
It will enable the Government to continue with the existing public services. The relief to people will require the Government to spend more money on wages, salaries, and poor-relief programmes. Since the total debt has not been reduced by way of a haircut, the future generations will have to bear a bigger burden of debt repayment after 2028, implying a relief is untenable.
How do you view the developments relating to reaching an agreement with commercial creditors, including ISB holders?
According to a public announcement made by the Government through the London Stock Exchange last week, there has been a broad agreement which it has agreed to with the ad hoc group of ISB holders who account for about 50% of the ownership of ISBs. For this agreement to be final, it should receive the approval of the OCC of the Paris Club and the IMF.
The statement relates only to four ISBs with a value of $ 4.4 billion but the annexures to the announcement are related to all the ISBs issued. If the other ISB holders agree to it, it incorporates a reduction of the interest in arrears by 11% and the cut of the principal value by about 28% initially.
However, since it is linked to a GDP value related restructuring, known as Macro-Linked Bonds (MLBs), these terms will change to the disadvantage of the country if the GDP values are higher than the projected values. Hence, there is a great deal of uncertainty about this restructuring plan.
Besides, China Development Bank, which is also a major commercial creditor in this group, has not made any announcement as to whether it will go by the agreed plan.
You also said that Sri Lanka was running on a ‘borrow-live-borrow’ cycle that enhances the debt stock, which is not the ideal solution, and may have to go for another IMF facility in 2028. As things stand, how do you view the ongoing IMF programme? Do you think we will be able to complete it successfully, and will we need to turn to the IMF yet again?
Despite the increases in the tax revenue and conversion of the major State-Owned Enterprises to a state of profitability, Government expenditure has not been cut, requiring the country to live on this ‘borrow-live-borrow’ cycle.
After the debt moratorium is over in 2028, the breathing space will end, requiring the Government to borrow more to finance its total gross expenditure. This is evident from the total public debt, both domestic and foreign, that has risen to $ 100 billion by end-March 2024, as reported by the Ministry of Finance in its Debt Bulletin referred to above, from $ 84 billion as at end-2022.
Following this cycle, during the first three months of 2024, the public debt has increased by $ 4.5 billion, mainly due to the Government’s higher borrowing from domestic sources, which have been converted to dollar values by using a lower exchange rate. This is not a situation about which Sri Lanka can be complacent.
Given the state of the country’s forex reserves, its balance of payments problem, and ongoing and upcoming debt repayments, where and how is Sri Lanka going to find the money to pay its debts and stay afloat? Where should we set our sights in order to ensure survival and growth?
Sri Lanka’s foreign reserve numbers amounting to $ 5.4 billion are misstated by the Central Bank by adding the yuan swap facility of $ 1.4 billion to the country’s reserves. On two counts, this is a wrong treatment.
First, the yuan is not a freely convertible currency, which is the main criterion used for recognising a currency as a reserve currency. Second, there is the prohibitive condition in this swap facility that the monies could be used only when the country’s foreign reserves are equal to at least three months of imports. Hence, the usable reserves are only $ 4 billion, which the Central Bank has collected by buying from the market.
The conventional method of assessing reserve adequacy is to compare the reserve stock to future import of goods and services and to maintain a reserve stock sufficient to finance at least three months of such imports. This is faulty because if there is an unexpected fall in the earnings from the export of goods and services, the country cannot maintain its import programme, preventing industries from having the needed raw materials and consumers from enjoying consumer goods, which includes medicines as well.
Hence, the IMF has introduced a new metric for assessing reserve adequacy, known as ARA, considering the short- to medium-term forex obligations and the unanticipated forex outflows due to high inflation and loss of export earnings. If a country has at least a full coverage, like India or Thailand in this region, that country is in a comfortable position. In the case of Sri Lanka, the assessment of reserve adequacy in May 2024 shows that the usable reserves are simply less than 40% of the required amounts as at end-2023.
Hence, Sri Lanka should have a continued balance of payments surplus from 2023 onward to build reserves to the required levels. That will require the country to have a focussed growth programme, in addition to the present IMF stability programme, to increase annual economic growth in general and growth in earnings from the export of goods and services in particular.⍐
