By W A Wijewardena –
Aseni, whiz kid of economics, and her grandfather Sarath Mahatthaya, ex-official of the Finance Ministry, are continuing their conversation of the economics of President Ranil Wickremesinghe, tagged Ranilnomics.
Previously, they discussed the ideological battle which Ranil should win to have his economic policy accepted by the Parliamentary group that support him (available here), the need for dismantling the temporarily suspended imports before they start biting the economy (available here), and what Ranil should do to convince the electorate that he is a true follower of the governance principles practiced by Vajjis during the time of the Buddha which he has publicly pronounced on many occasions (available here). Today they discuss the challenges faced by Sri Lanka when restructuring a part of the foreign debt of the central government as proposed.
Aseni: Sri Lanka is a bankrupt nation today because its Consolidated Fund is overdrawn to the extent of Rs. 1 trillion, and its Central Bank is saddled with a negative foreign reserve position of $ 4.8 billion. As a result, the country cannot continue to ensure an uninterrupted flow of essential imports and repay its foreign debt and pay interest on same, a process known as debt servicing. In this background, Grandpa, the proposed extended fund facility, or EFF, amounting to $ 2.9 billion is viewed as the saviour of the country. But one of the preconditions, among others, is the need for introducing an effective debt restructuring scheme for some selected foreign debt of the government. What is the present position relating to debt restructuring plan of the country?
Sarath: You are correct because this debt restructuring plan is the most crucial condition for the proposed EFF. That is because in terms of the rules of IMF, it cannot lend a member country whose debt is not sustainable. According to IMF, a country’s public debt is sustainable if it can repay the principal and pay interest as agreed without going for exceptional financial assistance or going into default. You can find the details of this from the clarification note issued by IMF here. Sri Lanka’s foreign debt is unsustainable because it has now failed on both counts. The ordinary borrowing sources are no longer available to it. Hence, it must now tap its foreign reserves to do so. But as you have noted, it does not have any foreign reserves now. Therefore, its only option is defaulting these loans.
Sri Lanka has been defining its public debt as that borrowed by the central government only. But public debt is more broadly defined now. It now includes not only what has been borrowed by the central government, but also those loans contracted by provincial governments, government corporations, and social security funds. But there is the broadest definition of public debt now. This has been defined by IMF as that borrowed by the central government, government corporations, government owned banks, the central bank, and those loans obtained by all entities on a guarantee from the government. All these loans pose a risk to a country.
Hence, IMF says that a proper debt sustainability assessment should cover all this borrowing by the broad public sector. This is because focusing only on a narrowly defined public debt gives a misleading consolation to a country. If any loan borrowed by a government entity on a government guarantee is defaulted, its burden will fall on the taxpayers of the country. Because of this reason, any debt restructuring plan should focus on the broadest sense of public sector debt.
Aseni: Hasn’t Sri Lanka Government covered all this borrowing in its present debt restructuring plan?
Sarath: No. It has covered only what the central government has borrowed from commercial sources and from individual countries called bilateral borrowing. Commercial borrowing amounts to about $ 19 billion and that from bilateral sources about $ 14 billion. But the public sector total borrowing is much more than this.
Aseni: Then, it definitely is not a proper plan. But how much are those other loans which the Government has not included?
Sarath: According to the presentation made by the Central Bank and the Ministry of Finance to creditors on 23 September 2022, the central government debt has been $ 70 billion. In addition, there are borrowing by other entities amounting to $ 10 billion. Therefore, the total exposure of the public sector to foreigners amount to $ 80 billion. Sri Lanka does not have foreign reserves to service all these loans. Therefore, the entirety of the foreign loan portfolio of Sri Lanka’s public sector is unsustainable.
Aseni: What this means is that the present restructuring plan is not sufficient to resolve Sri Lanka’s current issues. But what is the position relating to the present plan?
Sarath: As I mentioned, what is being covered is only $ 33 billion out of $ 80 billion. The Government had appointed two advisors, one for finance called Lazard, and the other for law called Clifford Chance. They have prepared a basic document for submission to Sri Lanka’s commercial and bilateral creditors. This plan is not in public domain and, hence, the public does not know its details. It will not be released until a final agreement is reached between creditors and the Sri Lanka Government. But from the experience in other countries, one can predict what it may contain.
Aseni: What is it, Grandpa?
Sarath: The negotiations for restructuring take place in a global environment. In the case of commercial loans, it is done at an informal meeting place called London Club, so said because the meeting is held in London. All other loans, the negotiations are done in Paris and, hence, at the Paris Club. Two of Sri Lanka’s creditors, namely, India and China, are not members of either club. India has obtained a position as an observer at the Paris Club. But China is neither a member nor an observer of either one. It is a total outsider to the process.
Aseni: But will it pose a problem for the debt restructuring process?
Sarath: Yes. Out of the total amount to be restructured, China owns about 52% of the debt amounting to $ 7.3 billion and India about 12% amounting to $ 1.7 billion. The normal method of debt restructuring is that the creditors will be asked to forego a certain percentage of the principal, say about 30-40% called a haircut, and elongation of the repayment period. This haircut will cause losses to creditors. Therefore, their agreement should be reached for the loss. Sri Lanka’s creditors including India may agree to this process.
However, China’s policy has been different. China does not agree to extend this facility to its debtors because, if extended, it will have to offer the same concessions to other debtors spread across Europe, Asia, Africa, and Latin America. Its total credit to these countries amounts to about $ 1.5 trillion. The biggest borrower has been Russia which has borrowed about $ 300 billion, and that country is not in a position to service its debt due to the Ukraine war and the consequential sanctions by Western countries. If China makes a special concession to Sri Lanka, it will have to offer the same to other countries too. Suppose Sri Lanka’s haircut is 30% of the principal and China has agreed to it. Then, all these other borrowers too may ask for the same concession, and it will amount to a loss of about $ 450 billion. This is too much of a loss for China and it is unaffordable today.
Aseni: This is a serious issue. What kind of concessions is China willing to extend to its defaulting debtors?
Sarath: China offers a refinancing facility to such debtors. This is how it works. Suppose China has given $ 100 million as a loan to a country and that country cannot service that debt. It is going to default it. What China will do is that it will give a new loan of $ 100 million to that country so that it repays the old loan to China. Therefore, in the books of China and the borrowing country, it is a new loan with a new repayment schedule. It is, therefore, no longer in the default list. But this will simply take the borrower out of the default list. Its foreign borrowing is the same and it will have to repay it under new conditions. China had also offered this concession to Sri Lanka too. But the government had not acceded to it.
China has not moved away from this position. Recently, it has agreed with Ecuador to extend the repayment period of two loans, one from China Development Bank amounting to $ 1.4 billion and the other from China Export-Import Bank amounting to $ 1.8 billion. It will relieve the Ecuadorian government of the pressure for using the current foreign exchange flows for repaying these loans. But the Ecuadorian debtor position is the same. You can find details of this arrangement here. Unless Sri Lanka negotiates hard which China, it will also have to be happy with such an arrangement.
Aseni: It is a serious choice for Sri Lanka. But how will it affect the other creditors?
Sarath: Yes, it is a serious choice. The implication is that other creditors of Sri Lanka too will ask for the same concession which Sri Lanka should extend to China. If the same concession is given to other creditors too, then, it will not reduce Sri Lanka’s foreign debt position. Over the years, it will simply make the matters worse for Sri Lanka. Hence, China’s recalcitrance will derail Sri Lanka’s debt restructuring plan. If restructuring does not take place, Sri Lanka’s debt becomes unsustainable. If Sri Lanka’s debt is unsustainable, Sri Lanka cannot get the bailout package from IMF. If it does not get the bailout package, its present economic crisis will become worse.
Aseni: So, China is the holdout country. What can Sri Lanka do to resolve this impasse?
Sarath: It is no longer an economic issue for Sri Lanka. It is now a geopolitical issue. On one side, there is China. On the other side, there are the countries that belong to the Western group. In the middle, there is India which is more tilted toward the Western group than toward China. Sri Lanka Government is trapped in this power game. If Sri Lanka can get China on board of both the London Club and the Paris Club, then, it is a diplomatic victory for the country. So, it is an acid test for the Ranil Wickremesinghe administration.
But even if China gets on board, the narrow coverage of the structuring of the country’s debt amounting to $ 33 billion out of a total of $ 80 billion will not help the country to get out of the present economic malaise. Sri Lanka does not have enough foreign exchange and hence, it cannot service all this debt. As a result, it will end up as a defaulter when it cannot repay its debt. This is a serious situation for the country. It should not be ignored by the Government.
Aseni: My learning takeaway from this discussion is as follows. According to IMF, debt sustainability is a position where a country cannot repay its debt without extraordinary financing arrangements or a situation where it should default its debt. Public debt is very broadly defined to include the foreign borrowings of the central government, other governmental agencies, government banks, the central bank, and any debt contracted by governmental institutions or other parties on guarantees issued by the government. This debt of Sri Lanka as at the end of August 2022 is $ 80 billion whereas the government is planning to restructure only $ 33 billion out of it.
Sri Lanka does not have foreign exchange to service this debt and its present choice is to default it. Debt restructuring is important for Sri Lanka because the proposed bailout package from IMF is crucially dependent on it. If Sri Lanka cannot obtain this bailout package, it will have to face very serious consequences in the future because it cannot ensure the import program for foods, medicines, fuel, and necessary raw materials.
China holds about 52% of the bilateral and commercial debt and so, if it does not agree to the plan, the whole debt restructuring program is derailed. Hence, it is no more an economic issue but a geopolitical issue. It also provides an acid test for the measurement of the success of the foreign policy of the Ranil Wickremesinghe administration.
*The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at email@example.com