A VICIOUS NATIONAL DEBT TRAP

Tharindra Gooneratne lays down the serious consequences for a nation that chooses to live beyond its means

“And when a poor, destitute, penniless person, being served notice, does not pay (interest on time), they hound him… being hounded is suffering in the world.” These strong words appear in the ‘Ina Sutta’ – a discourse that advises Buddhists to refrain from being in debt.

The Bible advises Christians to “not be among those who give pledges, among those who become guarantors for debts.”

And the Mahabharata mentions how one who is indebted lives unhappily whilst the longest ayah (verse) in the Koran refers to debt.

We ardently adhere to our religions and harp on the importance of frugality. Yet, our country is falling into a vicious debt trap before our very eyes.

In the past five years, Sri Lanka’s outstanding central government debt almost doubled from Rs. 5.1 trillion in 2011 to 9.4 trillion rupees in 2016.

At 80 percent, Sri Lanka’s debt to GDP ratio is the second highest in the South Asian region, save for Bhutan. Over 90 percent of government revenue is currently spent on debt servicing. The debt overhang is so severe that Sri Lanka shares the same sovereign credit rating as Rwanda and Uganda.

The primary reason for Sri Lanka’s debt woes is the lack of fiscal discipline. Sri Lanka is a prime example of a welfare state with bloated government expenditure and inadequate revenue sources to finance it.

Our budget deficit has consistently averaged above five percent of GDP over the past five years – Sri Lanka has the ignominy of also having the second highest budget deficit in South Asia, this time behind the Maldives. The government needed to borrow 640 billion rupees to cover the deficit for 2016 alone – that’s not a great example of frugality.

Another reason for the debt overhang is Sri Lanka’s structural problems in the external sector. In 2016, Sri Lanka’s imports exceeded exports by over 1.3 trillion rupees (approximately 11% of GDP).

It has also been woefully inept at attracting foreign direct investment (FDI). FDI in 2016 was a meagre US$ 300 million (to put this in perspective, John Keells Holdings invested 850 million dollars in its Cinnamon Life project alone).

The persistent trade deficit coupled with the inability to attract sufficient FDI has meant that Sri Lanka has had to rely on external borrowings to cover the financing shortfall in the external sector.

White elephant projects have also played a major role in the rapid growth of national debt.

Large-scale infrastructure initiatives such as the Hambantota Port, Mattala Rajapaksa International Airport, Sooriyawewa International Cricket Stadium and Hambantota International Conference Hall have been abysmal failures. The total cost of these four projects alone is estimated to be over 1.5 billion dollars (approximately 2% of GDP).

Other similar projects continue to be a drag on public finances as well.

The biggest risk associated with persistently unsustainable levels of national debt is its negative impact on a government’s manoeuvrability. For example, the Sri Lankan government needs to pay about Rs. 3.5 trillion for debt servicing in the next two years alone, which is the equivalent of 30 percent of GDP. This would undoubtedly severely constrain the state’s financial flexibility.

This risk of reduced financial flexibility is exacerbated by the fact that a substantial proportion of Sri Lanka’s debt is denominated in foreign currency.

In 2016, over four trillion rupees of debt was denominated in foreign currency, representing over 40 percent of outstanding government dues. In the case of local currency denominated debt, the government could in theory print money to settle creditors and prevent default, which is not possible in the case of debt denominated in foreign currency.

Its inability to service such debt puts Sri Lanka at the beck and call of creditor states. We have already witnessed this with China, which alone has claims for over one trillion rupees of Sri Lanka’s debts. Recently, a debt to equity swap initiated by the government to reduce the excessive burden landed China Merchants Port Holdings Company with an 80 percent equity stake in the Hambantota Port.

A two-pronged solution is required to resolve the debt crisis. Short-term solutions such as debt to equity swaps would provide a degree of breathing space to the government.

Another short-term solution would be the privatisation of loss making state owned enterprises (SOEs). According to the Daily Mirror, the cumulative losses in 2005/16 of the top five loss making SOEs alone amounted to 605 billion rupees. This is more than triple the combined amount allocated to the ministries of education and health in Budget 2018.

Such quick fixes will not be the panacea for all our debt woes. Long-term solutions would also be required to curtail the budget deficit and address weaknesses in the external sector. Unfortunately, the implementation of critical austerity measures (to reduce the budget deficit and ‘fix our finances’) would create a drag on economic growth – at least in the short term.

We have lived a life of excesses and it’s time to face the music. After all, it is better to suffer today than be hounded by our creditors tomorrow.