The central bank of a crisis-hit country has outlined measures to restructure local debt as part of efforts to meet the conditions of the IMF bailout.
The Central Bank of Sri Lanka (CBSL) has introduced an extensive plan to restructure domestic debt in order to restore stability in the country, which has been severely impacted by the ongoing crisis. This step was announced on Thursday, June 29, 2023, as the government works to fulfill the requirements set by the International Monetary Fund (IMF) for a $2.9 billion bailout. The IMF funding is crucial for Sri Lanka’s economic recovery, as the country experienced its first-ever default on foreign debt in the previous year.
To achieve the target set by the IMF program, which aims to reduce Sri Lanka’s overall debt to 95 percent of its gross domestic product (GDP) by 2032, debt restructuring is necessary.
Debt restructuring measures are expected to mainly impact foreign debt holders, while domestic debt holders may not experience significant restructuring due to the steep inflation rate of approximately 50% since the pre-pandemic period and the depreciation of the currency by nearly 50%. These factors have already reduced the purchasing power of local debt holders.
Potential restructuring measures may involve tenor extensions, which would extend the repayment period from the original terms, providing institutions with more time to receive their principal amounts. Additionally, there may be coupon haircuts, reducing interest payments received on longer-term bonds held by institutions. This would result in reduced annual or semi-annual interest income.
It is important to note that historically, depositors’ money has not been restructured in previous restructuring efforts in other countries. The safety of hard-earned savings and bank deposits should not be a cause for concern. Most banks have made provisions for potential debt restructuring in their financial statements over the past few years, indicating their preparedness for this process.
Successfully navigating the domestic debt restructuring process without principal haircuts and gaining approval from external borrowers is crucial for Sri Lanka’s economic recovery. Citizens should avoid panic and long queues at banks for withdrawals, as this could lead to potential liquidity issues.
As part of the domestic debt restructuring plan, the CBSL Governor has outlined three options for holders of locally issued dollar-denominated bonds, such as Sri Lanka Development Bonds (SLDBs). The options include a reduction in principle and a change in maturity period and interest rates.
Local currency bonds held by superannuation funds, including pension funds, will undergo an exchange process, swapping them for longer maturity bonds with a fixed interest rate until maturity. The CBSL will also convert its treasury bill holdings into bonds during the second phase of the restructuring initiative.
It is important to note that treasury bills and treasury bond holdings of the banking sector are not included in the domestic debt restructuring plan due to the challenges faced by the sector.
The domestic debt restructuring plan covers a substantial portion of Sri Lanka’s total domestic debt, which amounts to $42 billion. By addressing this debt burden, the initiative aims to generate positive momentum for the renegotiation of the country’s external debt, which stands at $36 billion. The successful implementation of the restructuring is expected to create a favorable environment for ongoing discussions regarding foreign debt restructuring.
Sri Lanka aims to finalize these debt restructuring talks by September, aligning with the first review of its IMF program, showcasing the country’s commitment to resolving its debt challenges and seeking economic stability through collaboration with international financial institutions.
Sri Lanka’s Public Debt Sustainability – Background
Sri Lanka’s public debt burden has become a critical issue for the country’s economy. The accumulation of both domestic and external debt has strained the government’s finances and limited its ability to invest in key sectors. The debt-to-GDP ratio has steadily risen, and debt servicing costs have become a significant burden on the budget. The country’s susceptibility to external shocks, coupled with low revenue generation and high fiscal deficits, has further intensified the challenges of debt sustainability. The Governor of the Central Bank has officially acknowledged the government’s efforts to reduce local debt by granting a 5-day holiday to banks. However, amidst this crisis, the government’s lack of accountability is breeding distrust within the financial market and among the public. The state finance minister has claimed that plans for addressing this issue have not been finalized yet. However, it is misleading to assert that no plans have been prepared for such a delicate matter. If the minister’s statement is accurate, formulating a plan within a span of two or three days would be highly detrimental. Despite the potential catastrophic consequences resulting from the government’s proposed measures, the public is urged not to succumb to unnecessary fear regarding the safety of their deposits.
Nevertheless, it is uncertain whether the government expects an unwarranted fear-based response from the public at this time. The absence of a clear response raises doubts as to whether the government will allow confusion to permeate the country, potentially leading to financial instability. The insolvency of the debt is not a result of natural causes but rather stems from short-sighted governance, fraud, corruption, a failure to heed expert advice, and an arbitrary governance system lacking public accountability. Neglecting this backdrop hinders any meaningful discussion about debt restructuring. Additionally, it is problematic that those responsible for this situation hold positions within both the government and the opposition, yet engage in discussions about debt restructuring. It is a serious issue that they burden the public without making any sacrifices. A minority group of representatives, appointed by us, enjoy the benefits of loans while shifting the ultimate responsibility onto the public. Last year, Sri Lanka publicly acknowledged its inability to repay foreign debt due to a shortage of dollars. The International Monetary Fund (IMF) has intervened solely to pave the way for securing foreign loans. Interestingly, the government has not disclosed any details about utilizing this opportunity to strengthen the economy. They have put forward an argument advocating for the prioritization of writing off domestic loans before foreign loans. Currently, the government is acting upon this rationale. Within the country, the government has primarily borrowed from state banks, insurance corporations, and the general public through treasury bills and bonds.
Moreover, loans have predominantly been sourced from the Employees’ Provident Fund and the Employees’ Trust Fund, which together account for over 80% of the total domestic debt. Approximately 20% of loans have been extended by private banks. Consequently, the burden may fall more heavily on the public, with the private sector experiencing lesser or no impact at all. About 62% of the loans acquired through treasury bills originate from the central bank. Thus, the government and the central bank can collaborate to negotiate and reduce a portion of this debt. However, it is primarily the public who will bear the brunt of the debt incurred through treasury bonds, which amounts to nearly 9 trillion.
Bonds represent long-term loans, and various approaches can be implemented to address them, such as reducing the nominal value of these loans (known as a “haircut”), decreasing a portion of the interest rates assigned to the bonds, or extending the maturity date by several years. However, it remains unclear whether all three approaches will be pursued or if only one or two will be implemented. The IMF report explicitly states that debt reduction should be carried out based on agreements
How to Restore Debt Sustainability?
Restoring debt sustainability in Sri Lanka requires a comprehensive and multi-faceted approach. It necessitates a combination of fiscal discipline, structural reforms, and prudent debt management. The government must prioritize reducing budget deficits and controlling public spending. Enhancing revenue generation through improved tax administration, broadening the tax base, and eliminating tax evasion will provide a sustainable income stream. Simultaneously, the government needs to prioritize expenditures, ensuring resources are allocated efficiently. Structural reforms are crucial to address the root causes of Sri Lanka’s debt sustainability issues. Economic diversification, attracting investments, and fostering entrepreneurship are essential. By reducing reliance on specific sectors, Sri Lanka can mitigate vulnerability to external shocks. The country should create an enabling environment for businesses, promote ease of doing business, and invest in infrastructure development to drive sustainable economic growth.
What makes Domestic Debt Optimization (DDO) crucial?
Domestic Debt Optimization (DDO) is a critical strategy for Sri Lanka to effectively manage its domestic debt burden. DDO involves optimizing the composition, maturity structure, and interest rates of the domestic debt portfolio. By actively managing domestic debt, the government can minimize interest rate risks, reduce borrowing costs, and ensure efficient utilization of financial resources. DDO enables the government to diversify its funding sources and reduce reliance on a limited number of investors or institutions. It promotes the development of a robust domestic bond market, attracting a broader investor base and enhancing liquidity. Through DDO, Sri Lanka can mitigate concentration risks and ensure financial market stability. Additionally, DDO enhances transparency, accountability, and fiscal discipline. It enables better monitoring and reporting of key debt indicators, promoting investor confidence and informed decision-making. By optimizing the domestic debt portfolio, Sri Lanka can create a sustainable and resilient financial environment.
Which parties will bear the responsibility of DDO?
The burden of DDO in Sri Lanka should be shared by multiple stakeholders. The government bears the responsibility of formulating and implementing effective debt management strategies. Financial institutions, such as banks, should adopt responsible lending practices and effective risk management. Investors, both domestic and foreign, should conduct due diligence and diversify their investment portfolios. Regulators and supervisory authorities play a vital role in ensuring market stability and enforcing regulations. International financial institutions and donors can provide technical assistance and financial support to strengthen debt management practices.
Envisaged Terms of Sri Lanka’s Domestic Debt Optimization
Several terms can be envisaged to optimize Sri Lanka’s domestic debt. Refinancing and debt restructuring can alleviate the burden on the government’s finances. Bond issuance and diversification attract a wider range of investors and enhance market stability. Robust risk management strategies mitigate interest rate risks. Market development and investor engagement promote transparency and market efficiency. Debt management capacity building strengthens expertise and systems. Establishing a sustainable debt-to-GDP ratio provides a clear roadmap for debt management. Restoring debt sustainability in Sri Lanka requires a comprehensive approach that addresses fiscal discipline, structural reforms, and prudent debt management. DDO plays a vital role in this process by optimizing the domestic debt portfolio, diversifying funding sources, and enhancing market stability. The burden of DDO should be shared by the government, financial institutions, investors, regulators, and international financial institutions. By implementing the envisaged terms, Sri Lanka can achieve sustainable debt management and pave the way for long-term economic prosperity.
Views on debt restructuring
- Sri Lanka Government View on debt restructuring
The current government in Sri Lanka has recognized the urgent need for debt restructuring to address the country’s mounting debt burden and ensure long-term economic stability. The government has acknowledged the challenges posed by high levels of public debt and the burden of debt servicing on the national budget. It views debt restructuring as a crucial step towards restoring debt sustainability and creating a more sustainable fiscal environment. The government has expressed its commitment to working closely with international financial institutions, such as the International Monetary Fund (IMF), to develop a comprehensive debt restructuring plan. It aims to negotiate with both foreign and domestic debt holders to find mutually beneficial solutions that alleviate the debt burden without causing significant disruptions to the economy or impacting the general public adversely. The government’s approach to debt restructuring emphasizes the importance of striking a balance between reducing the debt burden and ensuring the continued functioning of the financial system. It recognizes the need to protect the interests of domestic debt holders, such as banks, insurance companies, and pension funds, while also addressing the concerns of foreign creditors. Moreover, the government aims to implement debt restructuring measures that promote transparency, accountability, and fiscal discipline. It seeks to improve debt management practices, enhance reporting mechanisms, and strengthen regulatory oversight to ensure the effective implementation of the restructuring plan.
- Opposition’s View on debt restructuring
The opposition in Sri Lanka has expressed various concerns and reservations regarding the government’s approach to debt restructuring. While there may be different perspectives within the opposition, the following are some of the common points raised: Lack of Transparency: The opposition has criticized the government for a perceived lack of transparency in its debt restructuring plans. They argue that the government has not provided sufficient details about the specific terms and conditions of the restructuring, leading to uncertainty and speculation among the public and stakeholders. Socio-economic Impact: Some members of the opposition have raised concerns about the potential socio-economic impact of debt restructuring measures. They argue that certain restructuring measures, such as tenor extensions and coupon haircuts, may adversely affect individuals and institutions relying on the interest income from bonds and investments.
There are concerns about the potential impact on pension funds, insurance companies, and other stakeholders. National Sovereignty: Opposition members have expressed concerns about the potential involvement of external factors, such as international financial institutions and foreign creditors, in the debt restructuring process. They argue that excessive dependence on external entities may compromise national sovereignty and decision-making autonomy. Alternatives to Restructuring: Some opposition voices have called for exploring alternative solutions to address the debt burden.
They suggest measures such as increasing revenue through improved tax collection, reducing wasteful government expenditure, attracting foreign direct investment, and promoting economic growth as alternatives to or complementary strategies alongside debt restructuring. Political Motivations: Critics from the opposition have also accused the government of using the debt restructuring issue for political gain. They argue that the government may prioritize short-term political considerations over long-term economic and financial stability, potentially leading to suboptimal outcomes in the restructuring process. It is important to note that the opposition’s view on debt restructuring may vary among different political parties and individuals. These concerns and criticisms reflect a range of perspectives and highlight the need for open dialogue and informed decision-making in the process of addressing Sri Lanka’s debt challenges.
- The people’s opinion about debt restructuring
The people’s opinion about debt restructuring in Sri Lanka varies, and it is influenced by several factors. Here are some common perspectives:
Concerns about Economic Stability:
Many people are deeply concerned about the country’s economic stability due to the high levels of public debt. They recognize the need for debt restructuring as a means to address the debt burden and ensure sustainable economic growth. However, there are worries about the potential impact of restructuring measures on the overall economy and individual livelihoods.
Expectations for Transparency and Accountability:
People emphasize the importance of transparency and accountability in the debt restructuring process. They expect the government to provide clear information about the terms and conditions of the restructuring, including how it will affect different stakeholders. There is a desire for open communication, public consultation, and involving relevant experts and civil society in decision-making processes.
Protection of Public Interest:
The general public is concerned about the protection of their interests in the debt restructuring process. They want assurances that the burden of debt restructuring is distributed equitably, ensuring that the most vulnerable populations are not disproportionately affected. There is a desire to safeguard public services, social welfare programs, and infrastructure development amid the restructuring efforts.
Skepticism about Political Motivations:
Some individuals express skepticism about the political motivations behind the debt restructuring. They are concerned that political considerations may overshadow the country’s long-term economic interests, potentially compromising the effectiveness and fairness of the restructuring process. There is a call for prioritizing the national interest over short-term political gains.
Expectations for Long-Term Solutions:
People are looking for debt restructuring measures that provide long-term solutions rather than temporary fixes. They want to see comprehensive reforms addressing underlying issues that led to the accumulation of debt, such as fiscal discipline, efficient governance, and structural economic reforms. There is a desire for a sustainable debt management strategy that ensures future financial stability.
Overall, the people’s opinions about debt restructuring in Sri Lanka reflect a combination of concerns, expectations for transparency and accountability, and a desire for sustainable long-term solutions that protect the public interest and promote economic stability.
Conclusion:
Sri Lanka’s debt restructuring is a critical and complex process, and it is commendable that there are efforts underway to address it. The country’s debt burden has been a significant concern, and this restructuring initiative aims to alleviate the financial strain and pave the way for long-term economic stability. The review acknowledges the importance of transparency and accountability in the process, as well as the need to protect the interests of both domestic and foreign debt holders. It is also worth noting that the article recognizes the potential socio-economic impact of restructuring measures and emphasizes the need for a balanced approach that considers the welfare of the general public. Overall, the review highlights the significance of Sri Lanka’s debt restructuring and its potential to contribute to the country’s economic recovery and sustainable growth.
Hasitha Kasun Hapuarachchi
[Hasitha Kasun Hapuarachchi is a Colombo-based independent researcher specializing in economics. He holds a Bachelor of Economics special degree with first-class honors from Gujarat University in Ahmedabad, India. With a passion for understanding economic systems, Hasitha conducts research projects that provide insights into real-world economic phenomena. He remains up-to-date with the latest advancements in the field, actively contributing to academic debates and discussions. Hasitha’s exceptional analytical skills and comprehensive knowledge make him a respected and influential figure in economics.]
References
- https://www.bqprime.com/economy-finance/sri-lanka-opens-debate-on-domestic-debt-restructuring-programme
- Presentation to the Cabinet by Governor_28 June (PPT)
- https://www.bbc.com/news/business-66049915
- https://www.imf.org/en/Videos/view?vid=6286173458001
- https://cdn.cse.lk/cms-internal/news/PE6Cmx6TQlqawCKF_31Mar2023090940GMT_1680253780616.pdf