BALANCING EXTERNAL DEBT
Shiran Fernando discusses investor concerns with managing Sri Lanka’s debt repayments
The topic garnering much attention in Sri Lanka’s economic narrative and post-pandemic revival is how successful the government will be in refinancing its foreign debt. The country’s debt downgrade to the ‘CCC’ category late last year by all international credit rating agencies has fuelled concern about the debt sustainability path of the economy.
Furthermore, the COVID-19 pandemic has also played its part in spotlighting economies that are running high budget deficits while having substantial debt repayments.
POLICY PERSPECTIVE The government has shifted its reliance on foreign borrowings to finance the deficits to domestic borrowing. Given the volatility in the global capital markets and credit downgrades, the prospects of external financing through commercial borrowings have been limited.
In a webinar conducted in late February, Governor of the Central Bank of Sri Lanka (CBSL) Deshamanya Prof. W. D. Lakshman explained that it is following an alternative approach to reduce foreign debt. This approach involves the medium-term objective of reducing the foreign to domestic debt ratio from the current 43:57 to 33:67.
The government is also keen on pursuing a policy of reducing nonessential imports with an emphasis on consumer goods, which would help save foreign currency outflows.
A policy of import substitution on certain items (e.g. raw materials and finished goods) that domestic industries can manufacture has been pursued. It is hoped that such an effort would boost the local economy to only cater to the domestic market but eventually reach export markets.
DEBT SERVICING The concern that most investors and analysts have is the average annual debt repayment of US$ 4.5 billion that Sri Lanka will need to refinance between this year and 2025.
Meanwhile, the lack of access to international capital markets that the country relied on from 2015 to 2019 to refinance debt is looking less likely without an IMF programme.
The alternative to financing this gap is the concern raised by the investors: this year, a one billion dollar bond is maturing from last July. Before then, nearly US$ 1 billion in coupon and interest payments need to be financed. In addition, there’s two billion dollars in multi and bilateral debt.
At the time of writing, CBSL is pursuing a strategy of currency swaps with China and India worth US$ 2.5 billion while engaging the China Development Bank (CDB) for an additional 700 million dollars. In March last year, Sri Lanka received US$ 500 million from CDB. The Central Bank’s view is that these inflows will ease concerns for 2021.
While these arrangements are being negotiated, the timing of inflows is vital given the level of gross official reserves. Reserves fell to 4.8 billion dollars at the end of January, which is the lowest level recorded since September 2009. This is expected to have declined further in February with the Reserve Bank of India (RBI) swap outflow of US$ 400 million.
In terms of imports, reserves were equivalent to 3.7 months of imports by January, which is another metric that investors will be keeping an eye on.
EXTERNAL SECTOR The uncertainty and concern over the debt situation has also seen a high level of volatility in the currency so far this year. By the first week of March, the rupee had depreciated by almost five percent against the US Dollar.
Moreover, CBSL implemented regulations for exporters to cover 25 percent of their exporter proceeds into Sri Lankan Rupees.
The Central Bank has been looking into several avenues to increase foreign inflows. Another measure was to provide an additional Rs. 2 a dollar for each remittance. CBSL has also been purchasing forex in the market, thereby boosting reserves.
To ensure a sustainable path in refinancing debt, Sri Lanka will need to generate more non-debt creating inflows. One such avenue is from higher exports (both exports of goods and services) as well as foreign direct inflows. The latter would have import related expenditure in particular for infrastructure type foreign direct investments (FDIs).
Therefore, the stance of the government in the sale of non-strategic state assets and investments into key areas such as the Port City will need to be clear and encouraging.
The global economy is currently experiencing a period of low interest rates as central banks eased rates last year to support their economies to recover from the effects of the pandemic. While there has been some level of volatility and an upward push in rates (particularly in the US 10-year Treasury bond yield), there are many financial inflows into emerging markets.
If Sri Lanka manages to ease the external debt concerns in the next month or so and yields fall to single digit levels, there is the possibility of attracting foreign portfolio inflows to the bond market. This could be an additional source of foreign inflows.