RISK MANAGEMENT INITIATIVES
Shiran Fernando explains how an active strategy could help address debt concerns
Sri Lanka’s public debt has been on the rise, growing to 91.9 percent of GDP in 2018 compared to 84.9 percent in the prior year due to the dual impact of weaker growth and depreciation of the Sri Lankan Rupee against the US Dollar.
Meanwhile, external debt has been estimated at 59 percent of GDP last year while the ratio of external debt to exports of goods and services stood at 258 percent.
These are considered negative indicators for a middle income nation such as Sri Lanka, which has relied on foreign commercial borrowings – mainly by way of international sovereign bonds, as well as syndicated and short-term loans from the foreign currency banking units of domestic banks.
In a slow growth environment and amid a weakening currency, the shock to debt indicators is apparent. To this end, the implementation of an effective strategy is required to manage the risks. And the Central Bank of Sri Lanka, together with inputs from the IMF and World Bank, has developed such a strategy.
PLAN OF ACTION This plan of action – titled the ‘Medium-Term Debt Management Strategy’ (MTDS) – was formulated by the Sri Lankan government and fulfils a structural benchmark of the IMF programme.
It is expected to be followed up by the establishment of an independent debt management agency, which would likely be approved by the end of September, thereby meeting another IMF structural benchmark.
KEY INDICATORS According to the UN agency, the MTDS will look to quantify the main risks stemming from the country’s public debt portfolio, specify the appropriate currency and maturity composition for debt issuance, highlight potential debt issuance options based on cost-risk tradeoffs, and ensure that it is consistent with monetary and fiscal policy.
It will also provide the fiscal space for expenditure on socioeconomic and safety net programmes such as Samurdhi.
THE OBJECTIVES The strategy – which is expected to run until the end of 2023 – is expected to reduce foreign financing over the medium term while enabling the switch from short-term to medium and long-term financial instruments. This would help maintain foreign exchange exposure at the level seen last year.
The share of yearly gross external financing is projected to fall from 48.8 percent to 35 percent in 2019. Meanwhile, foreign debt as a share of GDP is projected to drop to 38.5 percent in 2023 from 45.4 percent last year.
MAJOR RISKS The key risks revolve around foreign currency movements and the ability to roll over existing debt. They also depend on the implementation of the MTDS – in particular, relating to the commitments required of all relevant stakeholders.
The strategy hinges on improvements to the investment environment, which has been affected by the recent terrorist attacks, as well as trade performance and prospects. It assumes that the rupee will depreciate by about three percent against the dollar beyond 2019.
However, if the currency weakens as it did last year, it would be difficult to achieve the targets set for 2023. This highlights the sensitivity of Sri Lanka’s forecasts to external shocks.
WHAT NEXT? The MTDS will be used in developing an Annual Borrowing Plan by the end of this year with the Central Bank and Ministry of Finance working together.
In addition to this, the budget for 2020 will include a review of debt management activities during 2019 compared to the plan identified in the MTDS. This exercise in reviewing debt management will continue from the beginning of 2020 as well.
CHALLENGES Sri Lanka has serviced its debt whenever it has come up for repayment. It has been able to do so mainly by raising more debt in international capital markets.
In recent times, the Central Bank has strived to build foreign exchange reserves through non-debt measures but it faces challenges due to the present economic situation. To this end, the implementation of a prudent debt strategy will communicate the right message to foreign investors and credit rating agencies.
NEW TARGETS Given the shock to the system, mainly in terms of dollar earnings from tourism in 2019, Sri Lanka’s external position will be on a negative footing. The MTDS released at the beginning of April will require a revision of key targets to accommodate the new environment.
With a presidential election expected at the end of this year, the borrowing strategy will need to be calibrated to meet the required external buffers. Such a strategy would also require better communication to the public so that they’re aware of the rising debt trajectory being considered.
These initiatives must be developed with a view to not only ticking a box as part of an IMF programme but being implemented to bear meaningful results.