On the 30th of January, Sri Lanka’s Central Bank announced that it would not draw down the withheld 800 million US dollars (USD) of its International Monetary Fund (IMF) standby facility citing its high interest rate.
In a world starved of capital, disbursing the withheld tranches would have posed a simple conundrum to the IMFs board and shareholders. Unique to such loans, all major shareholders of the IMF abstained from voting for it, not for economic reasons, but to press Sri Lanka to investigate alleged war crimes and crimes against humanity committed during its conduct of the war with the separatist Liberation Tigers of Tamil Eelam.
On the face of it, Sri Lanka has not fulfilled the terms of the facility. It continues to use borrowed money to defend the rupee at a level which the IMF deems 20 percent above fair value. Its current account deficit is 20 percent of gross domestic product (GDP). There has been no visible reform of its public sector utilities. The Ceylon Electricity Board and Ceylon Petroleum Corporation (CEYPETCO) -both state monopolies- are projected to incur losses of hundreds of millions of dollars. The former is set to lose USD 118 million in 2011. CEYPETCO lost USD 259 million in 2010 and forecast to incur similar losses in 2011. Defaulting counterparties to CEYPETCO include state owned enterprises such as its airlines and railways. And, Sri Lanka’s public debt to GDP ratio stood at 78 percent at the end of 2011; one of the highest in the Asia-Pacific region and well above the median for its single-B and double-BB rated peers at 41 and 40 percent respectively. Fiscal consolidation has been difficult to achieve due its defence expenditure, in excess of 4 percent of GDP, hitting record highs.
Sri Lanka has also borrowed heavily to invest in infrastructure projects where economic and social internal rates of return remain well below its cost of capital. Development has been concentrated in its Southern Province. The government has spent over USD 1 billion on developing a port and air port close to the Southern town of Hambantota –its president’s hometown. Unfortunately, Hambantota does not have the economic resources to make such projects viable. It also lacks connectivity to Sri Lanka’s economic hub in its Western Province. A motorway built to link both suffers from chronic choke points and is expensive to use.
The IMF board’s choices were to support Sri Lanka’s costly soft-peg of the rupee, non-compliance of the terms of the standby facility and low-yielding infrastructure projects; or, channel funds to countries which have made the policy adjustments to satisfy its conditions. With shareholders confronting their own economic challenges and under pressure from taxpayers to curb payments to multilateral organisations; this time, there existed a non-trivial probability that Sri Lanka would not have been given the benefit of the doubt.
By choosing not to draw down the outstanding USD 800 million citing higher borrowing costs, i.e. 3.1 percent -a rate lower than countries rated 12 notches higher pay to borrow; Sri Lanka’s policy makers may be content with lower foreign exchange reserves. Although, with a balance of payments deficit of 10 percent of GDP it is difficult to see how. Note, Sri Lanka has borrowed in capital markets at much higher rates through 2010 and 2011. On the other hand, its policy makers may have found the compliance with the standby facility’s terms politically onerous. Either way Sri Lanka has missed out on a very cheap source of funds.
On the 1st of February, the Central Bank announced that it would seek to launch a new USD 1 billion sovereign bond to refinance maturing debt. Yields in the secondary market for Sri Lanka’s USD sovereign bond maturing in 2021 imply that its cost of new funds raised through capital markets will not be less than 6.28 percent for 10 year money -significantly higher than 3.1 percent. Therefore, it is baffling why Sri Lanka’s policy makers would chose not to borrow at the lowest levels available to them.
*The writer was formerly a Director at Barclays Capital, the UKs largest investment bank and French bank Societe Generale. He has extensive experience trading corporate and sovereign bonds and credit derivatives. He also holds a PhD and Masters in economics from the University of Glasgow.