Sri Lanka unable to get the consent of all the creditors for a possible debt restructuring because of the intransigence of the leading creditor, China, which holds about 52% of the bilateral debt of the Government.


By
W.A.Wijewardena

President Ranil Wickremesinghe is noted for reminding fellow Sri Lankans that at the time Ceylon gained independence from Britain in 1948, it was a prosperous country which the British had left. Noting the positive stock of foreign reserves which Sri Lanka had inherited, he had said that during the Second World War, the country had even lent the colonial master (visit: https://www.news.lk/fetures/item/10674-economic-policy-statement-made-by-prime-minister-ranil-wickremesinghe-in-parliament). This was true because the bulk of foreign reserves had been invested in the UK.

His other elaboration was that the Gal Oya project, the biggest infrastructure project which the country had undertaken immediately after independence, had been completed purely out of the savings of the country without depending on foreign funding. This is mostly true because at the time of the commencement of the project in 1949 Ceylon had a comfortable foreign reserve balance sufficient for financing 17 months of future imports and the budget had a sizeable surplus in its revenue account which could, in theory, be used to finance the construction of the dam and irrigation canals. However, toward the end of the completion by 1955, the country had foreign exchange problems and to seek foreign funding for settling colonists. But this was a minor component of the total cost and hence, the project was substantially completed with local resources.

Ceylon’s high PCI at independence

When it came to per capita income, as surmised by Wickremesinghe, Ceylon was ranked among the top in Asia. The World Bank Mission that visited Ceylon in 1951 has this to say about per capita income in 1951: “With gross national product at Rs 4452 million, the per capita figure is Rs 570 (equivalent to US $ 120). Next to Malaysia, this is the highest in Southern Asia, and compares favorably with any country in Ceylon’s stage of development. The level of investment, at 11.3% of gross national product, is likewise highly creditable. The average for South-East Asia does not exceed 5%, for Latin America, it was about 8%, and in Western Europe in 1938 it was 12%. Nor is investment by any means solely by the government. More than half of the total is private, and this sector comprises an important element in Ceylon’s present and future prospect for progress” (p 8).

Today Sri Lanka is a bankrupt nation

What the World Bank has said is that though Sri Lanka at that time was not as prosperous as the Western world, it had the prospect for progress with a dynamic private sector and a disciplined government. But all this is to be changed over the next seven decades.

Today, Sri Lanka is a bankrupt nation by any standard. Its Government with an overdrawn balance of Rs. 1 trillion in the main constitutionally established fund called the Consolidated Fund is run on an overdraft from the two state banks and the Central Bank. Not to be outdone, its Central Bank is indebted to the rest of the world causing the net foreign reserves (that is, gross reserves minus bank’s foreign borrowings) to be negative to the extent of $ 4.5 billion.

This is the first time it has happened in its recent history. Amidst this negative reserve outlook, the usable gross foreign reserves have fallen to virtually zero and it cannot borrow anymore from friendly central banks to meet temporary liquidity requirements.


More money from Central Bank

The cash-strapped Government has heavily used the Central Bank money to finance the high budget deficit causing it to hold Treasury bills worth of Rs. 2.6 trillion. With high interest rates on bills at about 30% on average, the Central Bank is set to make a historic domestic rupee income of Rs. 780 billion which will be partly offset by net interest payments on foreign debt and local expenditure of the bank like operational and staff expenses. Yet the historic profit of more than Rs. 650 billion is a cash cow for the cash-strapped Government. If it is transferred to the Government in full, it is tantamount to the notorious money printing of which the Central Bank has been accused recently.

Foreign debt repayment suspension

With no foreign exchange available, the country has suspended the servicing of both commercial and bilateral loans from foreign sources. In its presentation to foreign creditors, the Ministry of Finance has reported the amount involved as $ 33 billion out of a total state sector foreign debt of $ 47 billion. This total debt does not include the country’s outstanding obligation to the Asian Clearing Union amounting to $ 1.9 billion as at end of June 2022 and the borrowing by the private sector and financial institutions from foreign sources amounting to $ 13 billion.

When these two items are added, the total country foreign debt amounts to $ 62 billion or 94% of the estimated GDP of $ 66 billion. Sri Lanka does not have foreign earnings to service these foreign obligations and it is likely that either they should be paid at the expense of other essential imports or defaulted at the end. Only a bankrupt economy is in this pathetic condition.

Sri Lanka from certain prosperity to bankruptcy

Singapore’s founding Prime Minister Lee Kuan Yew has aptly titled the second volume of his autobiography as ‘From Third World to First’. It is the story of how a poor country in 1960s was elevated to a rich country within a single generation by adopting appropriate and prudent economic policies.

If a present Sri Lankan political leader who has experience in the country’s economy for many decades writes his autobiography, the appropriate title may be ‘From Certain Prosperity to Bankruptcy’. This is the distressing situation which President Wickremesinghe is facing today.

Ranil’s goal: Make Sri Lanka rich by 2048

Wickremesinghe on assuming the premiership first in May and presidency later in July 2022 declared that his foremost responsibility is to make a turnaround of the bankrupt economy within one and a half years and thereby put it on a sustainable economic development path by 2024 (available at: https://www.aljazeera.com/news/2022/7/5/i-can-turn-around-sri-lankas-economy-pm-ranil-wickremesinghe).

He even announced the long-term economic development goal of making Sri Lanka a rich country by 2048 when it would celebrate the centenary of independence from the British (available at: https://www.outlookindia.com/international/new-lankan-govt-preparing-25-year-national-economic-policy-to-revive-crisis-hit-economy-president-ranil-wickremesinghe-news-213898).

This goal requires Sri Lanka to reach a per capita Gross National Product level of about $ 12,000 by 2048 from the present $ 3,000 level. Given a population growth of 1% per annum, this goal requires Sri Lanka to maintain an annual real economic growth of at least 7% continuously over the next two and a half decades. With an expected negative real economic growth of about 5% in 2023, the real battle of reaching this goal should start from 2024. However, the slow economic recovery between 1 to 2% till 2026, Sri Lanka will have to run faster from 2027 over the next 21 years to reach the per capita Gross National Product level of $ 12,000 in 2048.

A rough estimate shows that the annual real economic growth rate should be a minimum of 9% over this period. It requires Sri Lanka to invest annually about 35-40% of GDP. But with domestic savings not exceeding 25%, a massive amount of foreign funding is needed to maintain this required investment level. But it will drive Sri Lanka to square one forcing it to accumulate foreign debt and getting into a second round of a debt trap. This need be carefully managed.

Elusive economic turnaround

Now the hope of a quick economic turnaround is going to be elusive. Sri Lanka expected a bailout package from IMF to tide over the immediate foreign exchange problem of the country. Though a larger amount was solicited, IMF finally agreed to extend an extended fund facility of $ 2.9 billion drawable in four years in half-yearly instalments provided Sri Lanka completes several pre-announced pre-conditions. All these pre-conditions were being gradually met by Sri Lanka except one crucial one.

That is, agreeing for a foreign debt restructuring program with foreign creditors since, in the rating of IMF, Sri Lanka’s foreign debt was not sustainable.

In terms of the rules of IMF, it cannot lend a country whose public debt is not sustainable. Therefore, even if all other conditions are met, IMF cannot lend Sri Lanka until this last condition has been met.

Following this, Sri Lanka Government started working on this condition by appointing two advisors, Lazard for financial matters and Clifford Chance for legal matters. Even with that expert advice, Sri Lanka was not able to get the consent of all the creditors for a possible debt restructuring because of the intransigence of the leading creditor, China, which holds about 52% of the bilateral debt of the Government.

This was because China’s policy has been not to go for a reduction in the principal or interest income, known as a haircut, but to give a new loan to settle the old loan, a procedure known as loan refinancing. China cannot go for a haircut because if it afforded that concession to Sri Lanka, it should offer the same to all other debtors that have borrowed from China. However, as revealed by Wickremesinghe at the CCC sponsored Sri Lanka Economic Summit 2022, the Chinese government seems to have washed its hands and asked Sri Lanka to directly negotiate with the two creditors, China Exim Bank and China Development Bank which are wholly owned by the government (see:https://www.presidentsoffice.gov.lk/index.php/2022/12/06/measures-taken-to-introduce-a-strong-new-economic-system-that-can-face-2050-president/).

Thus, Sri Lanka should now restart negotiations with China all over again. The conclusion date is therefore getting postponed delaying the receipt of IMF bailout too. Sri Lanka had earlier expected to get China on board by August 2022. But this was postponed to November, and later to December. Now it seems that it will be done in the first quarter of 2023. If Sri Lanka succeeds in getting China’s support for the debt restructuring plan in the first quarter 2023, the IMF bailout will be delivered only after March 2023.

Other issues

But there are two other issues that have arisen. One is how to survive through these intervening months. The other is how to avoid the possible demand for restructuring of the domestic debt of the Government.

How to survive till IMF money is received

Sri Lanka’s usable foreign reserves are down to near zero levels, and the expectation of a possible surplus in the current account of the balance of payments is far remote. Even with the crunching of imports through import controls, non-availability of forex, and reduction in the demand for fuel via rationing by the QR system of distribution, Sri Lanka’s trade deficit in 2022 will be around $ 5 billion, down from $ 8 billion in 2021. The consequential deficit in the current account will create a serious forex liquidity issue for Sri Lanka until an IMF bailout is arranged for the country.

The World Bank and the ADB which have promised an intervening bridging financing have affirmed that they will do so only after Sri Lanka receives the IMF bailout facility. Hence, Sri Lanka needs to get a sizeable trade financing facility from friendly countries to maintain the essential import program during this period. Failure to do so will force all Sri Lankans to go through a harsh period unprecedented in the recent history. To prepare the nation to accept this harsh reality will be the biggest challenge faced by the Ranil Wickremesinghe administration.

Avoiding domestic debt restructuring

So far, the foreign creditors have not raised the issue of restructuring Sri Lanka’s domestic debt. That is because the new Central Bank management has managed to obtain the entirety of the fund requirements arising from the issue of Treasury bills and bonds from the market. To facilitate it, the bank has allowed the bill and bond rates to move up to a level of around 30%. But this has raised the entire interest rate structure of the country to a higher level forcing the business sector, supported by political authorities, to agitate for immediate reduction in interest rates.

The Central Bank is now caught in a dilemma. Inflation rate is slowing not due to a reduction in prices caused by a fall in the aggregate demand or an increase in the aggregate supply or due to a combination of both. It is simply a technical development under which the rate of growth will become slower due to the high level of prices that had prevailed in the corresponding month in the previous year. Therefore, there is no relief to the consumers through the reduction in the inflation rate. As such, the Central Bank may allow the interest rates to fall at the risk of having to restructure the domestic debt. If it happens, the biggest casualty will be the Central Bank which holds some Rs. 2.6 trillion worth of Treasury bills.

A 20% haircut on Treasury bills will completely wipe out the entirety of the capital base of the bank needing the Government to spend its scarce funds for recapitalising the same. The other casualties are EPF, ETF, NSB, and financial institutions. If they are required to suffer heavy losses, the whole financial sector will face the threat of collapse.

What this means is that converting the bankrupt nation to solvency will be a challenging task for Sri Lanka in 2023. If this is not done quickly, the goal of making Sri Lanka a rich country by 2048 will be an elusive one.

Courtesy:Daily FT