Colombo Telegraph

Is A Sovereign Debt Debacle Looming?

By Kumar David –

Prof. Kumar David

Before getting to my subject, the public debt, I wish to comment on the topic of the month, the community clamour (no longer just a FUTA demand) that government spending on education be increased. Combined government outlay on education and higher education in 2012 is 1.9% of GDP and 6% of government budget and was deemed outrageously low and well below Asian and international norms; Lanka is the worst performer in all of South Asia. What do the 2013 budget proposals laid at the end of September show? Persons of sound mind would expect an improvement. Dead wrong! Believe it or not the precipitate decline in these percentages associated with the Rajapakse Presidency has taken another dive.

The 2013 allocation for the education sector is Rs 65.8 billion (37.9 for education, 27.9 for higher education) and the estimated total government expenditure is Rs 1,189 billion. That is the total allocation has been reduced to 5.5%; a sharp drop of 2.5% from 2012’s 8%. (There are education and training related items in other Ministry votes so the exact number will be slightly higher).

The Central Bank says GDP in 2011 was Rs 6543 billion and it estimates 2012 growth at 6.8%, and 7.3% in 2013 which makes 2013 expected GDP (6534 x 1.068 x 1.073), Rs7500 billion. Horror of horrors; 65.8 as a percentage of 7500 is a miserable, miserly 0.88%, that is less than 1% of GDP! While the nation marches for 6% of GDP, Rajapakse slashes his lousy 1.9% of GDP to a wretched starvation diet of 0.88%.

Sovereign debt explosion

All the figures hereafter are from Central Bank (CB) publications and most from one entitled “Public Debt Management: Performance 2011”, dated 31 July 2012; so I’m up to date. All monies are hereafter stated in billions of Sri Lanka rupees, unless otherwise said; this makes writing and reading simpler. As said the CB estimates 2013 GDP at 7500 but my estimate is lower. The CB’s growth estimates are optimistic; I think the numbers will be 6.5% (2012) and 6% (2013). Hence my 2013 GDP estimate is 7390; but let these differences pass, I will stay with 7500.

At the end of 2011 Sri Lanka’s Public Debt (also called sovereign debt or government debt) stood at 5.1 trillion (a trillion is 1000 billion) consisting of a domestic component of 2.8 trillion and a foreign component of 2.3 trillion. This was 78.5% of 2011 GDP and an improvement from 2010 when the number was 82%, and a nearly 10% improvement from 88% in 2006. This improvement is because GDP grew at a faster rate than debt which continued to expand in absolute magnitude. To run a little ahead, a point I wish to establish in this piece is that GDP growth is slowing while debt expansion is accelerating; hence the Debt/GDP ratio will start rising again from 2012 unless something unforeseeable happens, but the unforeseeable is also the unlikely.

Bear with me while I inflict a few more numbers on you but they are needed. Hereafter D stands for domestic and F for foreign. Borrowing in 2011 was 994 (D:671, F:323) of which net borrowing was 457 (D:233, F:224). Net borrowing is the amount by which loans taken exceed loans amortised or repaid. Net borrowing is the measure of how much deeper into debt the country is sinking. This relates to the point about debt growing albeit in recent years at a slower pace than GDP.

Debt servicing

We need to consider interest payment and capital repayment separately. If one takes new loans to repay maturing loans that can be described as the stand-still case. If one takes loans not only for that purpose but also to pay interest on existing loans, that is a dangerous debt spiral; there is a caveat to this gloomy remark that I will concede later.

To keep matters simple I will quote numbers for 2011, instead of using the trend curve. The costs of debt servicing in 2011 was 895 (D:728, F:167) of which the break down into repayment of principal and interest payments were as follows; principal 539 (D:440, F:99) and interest 356 (D:288, F:68). Observe that both in principal amortisation and interest payment the foreign burden in much lighter than the domestic. This is thanks to a large portion of foreign loans being on concessionary, low-interest, long repayment or bi-lateral terms. This is changing as the government, increasingly broke, is compelled to raise funds on tougher commercial terms in international markets (sovereign bonds). Domestic borrowing is at high local-market interest rates and maturity may be quick (T-bills maturing in less than a year) or medium term (3 to 10 year T-bonds). I apologise for so many statistics, they are boring, but if you want to get a handle on the debt hole in which we will soon bury ourselves you have to bear with me.

With this apology I have earned the right to inflict one last debt statistic on you. What are the debt servicing requirements relative to revenue and expenditure? If we stick with 2011 real numbers, instead of estimates (2012) or budgets (2013), 2011 interest payment alone on the Public Debt was 37.6% of government revenue and 26.1% of government expenditure. Wow you will say, but there is worse to come; in the same year debt servicing (amortisation and interest together) work out as 94% of government revenue and 66% of expenditure. How the devil does the government run at all, you may ask, if 94% of its revenue goes to service debt? Ah there’s the trick; notionally it does not use revenue for this purpose at all, it simply takes new debt to amortise old debt and pay interest on debt.

This is conceptual; actually monies are consolidated in a few holdings, so the distinction I am making is not physical but an accounting one. If you pay your club booze bill out of your wife’s savings or your wife raids your unguarded wallet to get that new sari, well it’s a bit like that. But you can’t forever blur the fact that you are boozing out of the family’s long-term nest egg. In fairness there is another point. A part of the amortisation is recouped via new loans – what I called the stand-still option – so it is only when you incur additional or “net borrowing”, and/or when you incur debt because you can’t pay the interest, that you are eroding the nation’s (or the family’s) future.

Now to the caveat that I promised to concede; borrowing for the sake of increasing output, repaying debt, and eventually doing even better, is great. That’s what every growing business does; borrow, build factory, produce, repay loan, after that its money for jam. Government’s can and have done this and many success stories of today are nations who borrowed for growth and are today lenders to their erstwhile benefactors. The point however is that as far as GoSL is concerned this is beside the point; this country is not getting into debt to enhance growth, it is borrowing for all the wrong reasons. More on that later.

Spiralling budget deficit

Recently released statistics show that the budget deficit for the first half of 2012 was a frightening 61% or 38% depending on how you do your sums. The deficit of Rs 303 billion for the first six months is 61% of revenue (Rs 497 billion) or 38% of expenditure (Rs 800 billion) for the same period. There is a theory of increased revenue flows in the second half of a year due to enhanced tax collections, but I think this is exaggerated; most tax is from excise duties, indirect taxes and customs duties, and there is no reason to expect a large spike in revenue during the rest of the year.

Therefore it is reasonable to forecast that the budget deficit for year 2012 will, in round numbers, be about Rs 600 billion, while revenue and expenditure can be pro-rated to Rs 1000 billion and Rs 1600 billion, respectively. Obviously this is not formal forecasting but good enough to convey a flavour of the parlous state of economic health. How does this compare with last year? Quite bad; the end of year budget deficit for 2012 will be about 40% higher than the 2011 deficit; the half year deficits were Rs 217 billion and Rs 303 billion in the first six months of 2011 and 2012, respectively.

The trade imbalances

Putting it in round numbers, which is the best we can do at this stage since the first seven months only provide a trend line for where we may be at the end of year, gross 2012 import outgoings will be about $22 billion and export earnings about $11 billion. With an aggressive policy of import discouragement the government may be able to reduce this mountain of $11 billion deficit in the foreign trade account by a little, but not too much. Exports certainly cannot be grown by anything above trend by any policy formulations that can take effect within three months and in any case everyone is at the mercy of a contracting European market and a doggedly slack US economy. Hence it is reasonable to forecast that export earnings will only cover 50 to 60% of import expenditure in 2012 and frankly I do not expect better in 2013. The Central Bank research unit’s forecasts in the accompanying figure are more pessimistic than mine.

If we are out of pocket to the tune of $11 billion on foreign trade and services how to balance the books and cook what cannot be balanced – that is reconcile the balance of payments. Remittances, that is what the ladies (and a few gentlemen) who work mostly in the Middle East send home, may reach $6 billion in 2012. Tourism may with difficulty bring in another $ 1 billion. The government has pipe dreams of attracting foreign direct investment (FDI) of $ 1.7 to $2 billion in 2012. This is pie in the sky, a significant shortfall is certain. Truthfully, all this together will cover say $8 billion of the shortfall in the trade account. Short-term cash flows into portfolio accounts (stock market and private currency inflows) and bank borrowing of foreign currencies can help a bit, but in the end GoSL will resort to massive high interest foreign commercial borrowings by issuing sovereign bonds. Grants and the ever faithful IMF will help. I would not be surprised if GoSL’s total foreign indebtedness increases by a further $ 3 billion in year 2012.

The way out

From the start of the GoSL-IMF deal more than two years ago I maintained that stories of slashing budget deficit to 6.2% of GDP and lowering the total sovereign debt to 65% of GDP were fables. Palpable trends have vindicated my doubts. The basic error in government economic policy is that it is chasing a financial myth of blossoming into an Asia miracle, relying on soft and volatile sectors like tourism, and it is putting its eggs in grandiose white-elephant baskets. This strategy has failed; the way out is to shift out of what my friend Sumanasiri Liyanage calls shallow development and for the state’s emphasis to turn to the real economy of industry, agriculture and real services, not an illusory financial economy and soft sectors.

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