Policy changes needed to make external debt sustainable

0

By PKBalachandran

Colombo, April 23 (Counterpoint): Sri Lanka is negotiating with the IMF for assistance to overcome the current currency crisis. But IMF prescriptions could be difficult. He has already made it clear that Sri Lanka needs to get its house in order before aid can flow, even in the form of the emergency Rapid Financing Instrument (RFI).

IMF representative in Sri Lanka Masahiro Nozaki told Reuters that since Sri Lanka’s external debt is unsustainable, it must take steps to ensure debt sustainability. It must restructure debts owed to foreign entities, including China. The IMF should also ask Sri Lanka to adopt caution and austerity to avoid waste.

According to IMF’s Dalia Hakura, to properly assess a country’s debt sustainability, the IMF takes into account all types of debt that pose a risk to a country’s public finances. “If a loss-making public enterprise is unable to service its debt, the burden ultimately falls on the central government, as this debt is guaranteed by the state, resulting in an unexpected weakening of the sustainability of a country’s debt,” she said.

“Payment defaults can cause borrowing countries to lose market access and incur higher borrowing costs, in addition to hurting growth and investment,” Hakura adds.

A country’s debt capacity also depends on several factors such as the quality of institutions, debt management capacity, government policies, macroeconomic fundamentals and the global economic environment.

In an article by http://www.managing-debt-blueprint-for-sri-lanka.co.uk// On the Sri Lankan case, UK-based Aravind Korala argues that turning to the IMF for help can only provide temporary relief. The IMF can at best ask creditors to accept a “haircut” or to cancel part of the debt. Unless Sri Lanka makes structural, ideological and political changes, it will continue to turn periodically to the IMF for temporary palliatives, he warns.

Korala argues that if Sri Lankans let go of some of their ingrained fears and prejudices and reformed their systems, the island’s considerable resources could be greatly enhanced to enable it to borrow without worrying about repayment. Sri Lanka has an external debt of around $50 billion. About $6 billion of that is due to be repaid in 2022. Korala says that debt, by itself, is not the problem. The problem is Sri Lanka’s inability to repay its debt due to a lack of resources.

The United States has an external debt of 22 trillion US dollars. The UK has five times more foreign debt than Sri Lanka. But the United States and the United Kingdom have no debt servicing problem. They are able to reimburse, while Sri Lanka is not. To say that Sri Lanka is poor will not be correct, according to Korala. According to the Global Wealth Report by Credit Suisse and the McKinsey Global Institute, Sri Lanka’s net wealth stands at $351 billion after deducting $50 billion in external debt.

Sri Lanka’s debt-to-asset ratio is 13% compared to 62% for the UK. How then is the UK not in warmer water and Sri Lanka is, Korala asks. The reason for this is that UK debt is “secured debt” while Sri Lanka’s debt is “unsecured debt”. When foreign parties lend to a UK institution, that debt is secured by assets held by the borrowing UK institution. If the UK borrower is unable to repay the debt, the lender will seize that asset, sell it and collect the debt. And if there is a dispute between borrower and lender, the UK courts would resolve the issue impartially and effectively, Korala says.

Therefore, for debt sustainability, asset creation is very important. Modern states facilitate the creation of assets by domestic and foreign investors. The Chinese have enormous assets in the United States, which help the country to develop. Americans don’t feel insecure about it. But Sri Lanka does not allow foreign ownership of assets for fear of losing sovereignty. “Sri Lanka can change the situation overnight by changing the laws to ensure foreign ownership of Sri Lankan assets and ensuring that foreign debt will always be paid and repaid – in accordance with the law,” says Korala.

There is no shortage of lenders as they make money by lending. They are not even in a hurry to get their money back as long as they collect the interest. But they need to be assured that the borrower is continuing to pay the interest, that there is no risk of default, and that the courts will help with recovery.

To increase national wealth which will induce creditors to lend with confidence, Sri Lanka should enter the global economy by inviting foreign investors, allowing them to acquire assets to create wealth and industrialize to increase exports and earn foreign exchange. Sri Lanka should join the global value chain so that production, export and employment are created. Assets can be sold to make money, as the government is considering doing. When the port city of Colombo is fully built, the total amount of wealth created by it will likely exceed US$100 billion, if property rights are granted, Korala predicts.

Sri Lanka is in the red because it imports more than it exports. Efforts should be made to increase exports through product and market diversification. The government should not support loss-making companies. But allowing companies to sink or swim, while encouraging technical innovation, R&D and increased productivity. Industries and sectors in which Sri Lanka has a natural advantage should be encouraged for investment and trade rather than trying to replicate what other countries can do better. The way to ensure debt sustainability is through the creation of wealth through domestic and foreign investment and exports.

Sri Lanka must also borrow carefully and not take on short-term debt as it has done since 2014. The diplomat, economist Umesh Moramudali says that in the early 1990s the majority of Sri Lanka’s external debt consisted of concessional loans, most of which were provided by multilateral and bilateral development agencies such as the World Bank, AfDB and JAICA. These loans had a long repayment period, a considerable grace period and came with a low interest rate. Most of these concessional loan repayments were spread over 25 to 40 years with a low interest rate of around 1% or less.

However, following Sri Lanka’s transition to middle-income status, its ability to access concessional loans from multilateral agencies and bilateral donors has diminished, he points out. Sri Lanka therefore had to seek other sources of foreign funding. “Due to heavy reliance on International Sovereign Bonds (ISBs), the composition of Sri Lanka’s external debt has completely changed. In 2019, 56% of foreign loans were commercial borrowings, most of which were ISBs,” says Moramudali. ISBs have a payback period of 5 to 10 years with an annual interest rate above 6% to be paid semi-annually. On top of that, there are principal payments. In other words, the total amount borrowed from an ISB is settled on the bond’s maturity date, all at once, rather than being spread over the years through annual repayments, adds- he.

Sri Lanka may need to reduce expensive commercial loans and borrow from cheaper sources. But the ideal solution is to seek international investment and not loans, as President Gotabaya Rajapaksa has advocated since he came to power in 2019. Combined with other changes suggested by Korala, Sri Lanka could avoid falling in the debt trap. in the foreseeable future.

TO FINISH

Share.

Comments are closed.