The Sri Lankan think tank Pathfinder Foundation has strongly recommended that the Lankan government urgently go in for debt restructuring and bridge financing given the fact that there is an acute foreign exchange shortage and the country has to repay loans amounting to US$ 6.9 billion this year alone.
The report was based on an in-depth discussion by a team of experts from three countries, India, Japan, and Sri Lanka, on the current financial crisis faced by Sri Lanka. The study group’s recommendations are to be presented to the three governments viz. India, Japan, and Sri Lanka for debt restructuring and bridge financing to address the economic crisis.
The report noted that Sri Lanka’s foreign exchange reserves are at dangerously low levels ($1.6 billion or less than one month of imports), especially given the U$ 6.9 billion in debt service payments due in 2022. The acute shortage of foreign exchange is due to the COVID-19 pandemic, causing a sharp decline in tourism earnings, and reduced overseas worker’s remittances. It has also disrupted Sri Lanka’s own efforts to improve the debt sustainability.
It further noted that the International Sovereign Bond payment (US$ 500 million) on 18th January 2022 was made possible only through the very timely SWAP (US$ 400 million) from the Reserve Bank of India and the deferral of a payment (US$ 500 million) to India under the Asian Clearing Union (ACU).
“Both of these are short-term interventions. The former is a three-month facility, which can be renewed twice (i. e. nine months) before the requirement of at least a staff-level agreement with the IMF. The ACU payment has been deferred for two months (now due in March 2022). Without this much needed support from India, Sri Lanka would have defaulted on the recent ISB payment and triggered an economic and humanitarian crisis,” the report said.
Painting a grim picture, the report said that the low level of reserves is leading to shortages of imports that are causing, on top of the COVID-19 pandemic, additional hardship to everyday Sri Lankans. People stand in long lines for cooking gas; powdered milk is unavailable; power cuts are frequent; medicines are becoming difficult to find, while the cost of staple food items are sky rocketing.
Identifying the “real problem” the report said that Sri Lanka’s external debt is “unsustainable.” It pointed out that the revenue that the government will earn, even under the most optimistic scenarios, will be insufficient to cover public expenditures and meet debt service payments over the coming years. Known external debt repayments over the next five years amount to US$ 26 billion, or about US$ 5 billion a year, which is over 80 % of government revenue in 2020.
The report recalled that when in 2019, Sri Lanka cut taxes and experienced a drop in tax revenues, the three major rating agencies downgraded the country to C, which is near-default level. In January of this year, when the Governor of the Central Bank announced that Sri Lanka had secured the funds to meet the US$ 500 million bond payment, S&P downgraded Sri Lanka further!
Sri Lanka should not continue meeting its debt-service payments in full—and starving its people of essential imports–when everybody, including market participants, knows that the country cannot sustain this strategy, the report said.
Debt Management
Suggesting a way out, the report said: “The only choice is for Sri Lanka to undertake a managed debt restructuring, whereby the country reaches an agreement with its creditors to reduce the overall debt to a sustainable level. The process begins with the appointment of financial and legal advisors. The restructuring is greatly facilitated by approaching the IMF for support on two items. First, the IMF can undertake the analysis to determine the sustainable level of debt. This analysis serves as an anchor for the negotiations with the creditors. Secondly, if Sri Lanka has a program with the IMF, that increases investors’ confidence that the new debt level is sustainable. It could also lead to additional resources from the IMF, the World Bank, Asian Development Bank and other partners.”
According to the report, these negotiations are likely to take about six months.
Bridging Finance
Btu in the meantime, there is urgent need for “bridging finance” to meet the severe shortfall in USD liquidity over this period. Failure to mobilize this bridging finance will lead to severe shortages of food, fuel and pharmaceuticals, causing a great deal of hardship and possibly social unrest, pushing individuals to leave the country through legal and illegal channels.
The Foundation suggests that with the initiation of debt restructuring negotiations, debt servicing would be suspended, so the requirements would be US$ 3.5 billion per semester.
“There is a possibility that Sri Lanka will receive a US$ 1 billion SWAP from a national government and an additional US$ 0.5 billion of usable reserves from a private entity but these have not been confirmed. In the absence of these inflows, there is a financing gap of US$ 3.5 billion over the next six months, which should be filled to avert a humanitarian disaster. While the above is admittedly an estimate, the governments of Sri Lanka, Japan and India could agree on a figure that can be reviewed on a quarterly basis.”
“The government of Sri Lanka, along with Japan and India as major development partners, can collaborate on a program of debt restructuring and bridge financing in the following way: The Government of Sri Lanka initiate a managed debt restructuring by appointing the financial and legal advisors. The Government approaches the IMF for assistance with the debt restructuring.”
Japan and India can give Bridge Financing
Following the initiation of the debt restructuring, the government of Sri Lanka requests the Governments of Japan and India to provide impetus to the restructuring exercise and develop programs for providing bridge financing to Sri Lanka during the negotiations. The bridging finance could take the form of humanitarian assistance through lines of credit to support essential imports. These will be one-time financial transfers, which will end with the conclusion of the debt restructuring negotiations.
Japan and India should encourage the international community to apply to Sri Lanka’s case the principles of G-20 Common Framework as well as the Debt Service Suspension Initiative (DSSI) for lower income countries.
Under current policies, Sri Lanka will not regain access to international capital markets for at least another 18 months. The problems have been amplified by the decline in remittances from US$ 7.1 billion in 2020 to US$ 5.5 billion last year. However there is a silver lining: Tourism earnings are expected to recover from US$ 261 million in 2021. They were US$ 4.3 billion in 2018, the report noted.
