{"id":121578,"date":"2021-12-27T17:09:05","date_gmt":"2021-12-28T00:09:05","guid":{"rendered":"http:\/\/www.lankaweb.com\/news\/items\/?p=121578"},"modified":"2021-12-27T17:09:05","modified_gmt":"2021-12-28T00:09:05","slug":"sri-lanka-has-no-choice-but-to-restructure-external-debt-a-pathfinder-perspective","status":"publish","type":"post","link":"https:\/\/www.lankaweb.com\/news\/items\/2021\/12\/27\/sri-lanka-has-no-choice-but-to-restructure-external-debt-a-pathfinder-perspective\/","title":{"rendered":"Sri Lanka has no choice but to Restructure External Debt: A Pathfinder Perspective"},"content":{"rendered":"

Pathfinder\u00a0Perspective <\/em><\/span><\/h2>\n\n\n

Has the time come to consider\nseriously the merits of restructuring the government\u2019s external debt\nobligations?  The Sri Lankan authorities have indicated that they are in\nthe process of negotiating inflows to meet the country\u2019s immediate foreign\nexchange requirements.  However, there is considerable uncertainty as to\nwhether there would be sufficient inflows to meet the acute dollar illiquidity\nover the medium-term.<\/p>\n\n\n\n

Companies and even families\nrestructure their debt when foreseeable future earnings become insufficient to\nrepay debts while maintaining their financial viability.  The same applies\nto countries.  Over the years, a number of countries have restructured\ntheir debt and the pandemic is pushing others to follow suit.  Has Sri\nLanka reached that point when it would be advantageous to restructure its\nexternal debt?  What are the costs and benefits of doing so?  If debt\nrestructuring is a credible option, how one would go about it?  <\/p>\n\n\n\n

Should Sri Lanka restructure its\nexternal debt?<\/strong><\/p>\n\n\n\n

Foreign revenues in the next couple\nof years are extremely unlikely to be suffucuent to service external debt\nobligations, while supporting the essential foreign exchange (Forex)\nrequirements of the economy.  Known external debt repayments amount to\nUSD26 billion over the next five years.  It is unrealistic to expect to\nrepay about USD 5 billion per year, particularly in the next 12-24 months, when\nforeign inflows are unlikely to increase on the scale necessary to service debt\nand finance imports necessary to meet essential needs and support the growth of\nthe economy, particularly as the downgrading of Sri Lanka\u2019s sovereign rating\nhas excluded it from international capital markets.  Countries protect\naccess to these markets scrupulously to have the capacity to roll-over debt and\navoid such a predicament.  <\/p>\n\n\n\n

It is noteworthy that the following\nBusiness Chambers have jointly issued a statement highlighting the severe\nproblems being faced by their members due to the acute shortage of Forex which\nhas been caused primarily by the combination of the loss of tourism earnings\nand access to international capital markets: Ceylon Chamber of Commerce,\nFCCISL, Ceylon National Chamber of Industries, The National Chamber of Commerce\nof Sri Lanka, The Women\u2019s Chamber of Industry and Commerce, Chamber of Young\nLankan Entrepreneurs, The International Chamber of Commerce Sri Lanka, National\nChamber of Exporters and the Chamber of the Construction Industry.  <\/p>\n\n\n\n

Collectively, these Chambers\nrepresent almost all sectors of the economy.  Their concerns cannot be addressed\nwhile there is a diversion of large amounts of Forex from markets to the\nCentral Bank of Sri Lanka (CBSL) to service external debt. As a result, there\nis now a strong case for considering debt restructuring to release foreign\nexchange to meet the needs of businesses and acquire the essential needs of the\npeople, e.g., food, fuel and pharmaceuticals. <\/p>\n\n\n\n

The costs and benefits of external\ndebt restructuring. <\/strong><\/p>\n\n\n\n

The most significant disadvantage of\nrestructuring external debt is an immediate loss of access to international\ncapital markets.  This is now completely irrelevant for Sri Lanka as\nmarket access was lost when the economy was downgraded to a CCC rating. \nIt is now even lower, at CC.  As a result, Sri Lanka can no longer borrow\nin international markets. Another downside is the increase in the risk premium\nSri Lanka would need to pay when it is eventually able to regain market\naccess.  However, the increased risk premium demanded by markets as a\nresult of the restructuring is likely to be tempered by the impressive\ncommitment Sri Lanka has shown in meeting its obligations thus far.  Two\nInternational Sovereign Bonds (ISBs) of USD 1 billion each were repaid on time\nin October 2019 and July 2020, despite having to deplete external reserves, thereby\nimposing sacrifices on domestic businesses and households.  This combined\nwith Sri Lanka\u2019s impeccable debt servicing record to date is likely to contain\nthe increase in the cost of future borrowing when it becomes possible. <\/p>\n\n\n\n

Domestic banks have holdings of both\nISBs and Sri Lanka Development Bonds (SLDBs).  Both these instruments will\nbe impacted by any debt restructuring exercise.  Foreign bond holders are\nextremely unlikely to accept exemption from haircuts of domestic entities,\nmainly banks, which hold US-denominated debt, issued both abroad and\ndomestically. Hence not only ISBs but also SLDBs will need to be included in\nthe pool of debt to be restructured.  <\/strong><\/p>\n\n\n\n

It is important to note that the\nimpact of any haircut will not be as painful as some may fear, since many of\nthe domestic entities have purchased ISBs at an already discounted price in the\nsecondary market.  (There would be no such mitigation for SLDBS, which are\nnot a tradeable instrument.)  If necessary, the CBSL would need to provide\nsome temporary regulatory forbearance to any domestic bank which experiences\ncapital adequacy challenges due to haircuts imposed on creditors as part of the\ndebt restructuring. <\/strong><\/p>\n\n\n\n

Options for Restructuring<\/strong><\/p>\n\n\n\n

Debt restructuring is a long and\ncomplex process.  Having delayed and allowed usable reserves to deplete to\nbarely one month\u2019s import cover, it is no longer possible to achieve a soft\npre-emptive restructuring.  There are three modalities available to\nrestructure debt: reprofiling the principal (extending maturities); modifying\ncoupon (interest) rates; and write-down of principal (haircuts).  Given\nits current circumstances it is unlikely that Sri Lanka could avoid haircuts\nfor its creditors. <\/p>\n\n\n\n

It is unrealistic and impractical to\nexpect to restructure external debt without the support of the IMF. \nBefore embarking on an external debt restructuring one needs the IMF to\nindependently validate that Sri Lanka has a strong need to restructure its\ndebt, in order to assure creditors that the Sri Lankan authorities are not\nbeing opportunistic.  The IMF would also need to validate the proposed\nmedium term fiscal adjustment path to debt sustainability.  <\/p>\n\n\n\n

Rescheduling bilateral, commercial\nand multilateral debt requires different treatments.  Bilateral debt<\/strong>\nrescheduling is negotiated with the Paris Club of creditors.  It is not\npossible to approach the Paris Club without IMF support.  China and India\nare not members of the Paris Club and separate negotiations would be necessary\nwith them.  An option is to seek to initiate an informal Common\nFramework\u201d approach (approved by the G20 which includes both China and\nIndia).  It would need to be informal as the Common Framework\u201d is not\navailable for a middle income country like Sri Lanka.  <\/p>\n\n\n\n

This approach would have the\nadvantage of including Sri Lanka\u2019s three major bilateral donors: China, India\nand Japan. Bilaterals are likely to focus more on stretching maturities. \nCommercial creditors could be approached once a deal is in place with bilateral\ndonors.  Such sequencing can lead to a better deal for the debtor country\non the basis of equivalence across all creditors in terms of the\nrescheduling.  In this respect, there is considerable merit in taking\nsoundings from the Japanese Ministry of Finance regarding their suggestions for\nthe terms of the restructuring.  Over the years, Japan has proved to be a\nflexible and generous creditor in this respect.  <\/p>\n\n\n\n

On Commercial debt<\/strong>, here\nagain, it is exceedingly difficult to proceed without the IMF.  Given its\ncurrent circumstances, the restructuring package for Sri Lanka\u2019s commercial\ndebt is likely to include a combination of stretching maturities; coupon\nmodification and a haircut.  Haircuts on repayment of principal should be\navoided, if at all possible, as they delay rating improvement and regaining\nmarket access. It is likely that it is now too late for Sri Lanka to avoid a\nhaircut for its commercial creditors.  It makes little sense to scar\nthe economy and cause hardship to the people in order to pay ISB holders 100\ncents in the dollar when most of the bonds outstanding have been discounted by\nmore than 40 per cent.   <\/strong><\/p>\n\n\n\n

It is not possible to restructure Multilateral\ndebt<\/strong> (i.e., debt owed to the World Bank, the Asian Development Bank and the\nIMF) without a complete suspension of the relationship between Sri Lanka and\nthese institutions. There would be a suspension of all lending activity\nincluding project loans. However, the practice has been for to these\ninstitutions to provide financing to assist the debtor country to service the\npayments owed to each of them, once the debt rescheduling package is\nnegotiated. <\/p>\n\n\n\n

Appointment of Advisers<\/strong><\/p>\n\n\n\n

It is customary to appoint a\nfinancial and a legal adviser at the outset of the restructuring process. \nThe IMF is able to provide a list of potential advisers from which the country\nconcerned can choose. <\/p>\n\n\n\n

Pathfinder Perspective – Conclusion<\/strong><\/p>\n\n\n\n

The unsustainability of Sri Lanka\u2019s\nexternal debt is the cumulative effect of poor economic management over several\ndecades. The size and persistence of the external financing gap for the\nforeseeable future makes debt restructuring an urgent priority.<\/strong> It should\nbe possible to negotiate a package which provides three years of breathing\nspace to rebuild Sri Lanka\u2019s economy to earn and attract sufficient foreign\ninflows to achieve external debt sustainability and place the economy on a path\nof sustained growth.  Nearly 75% of Government external debt is owed to\nbilateral and commercial creditors, all of which is eligible for rescheduling,\nthus providing considerable scope for relief from onerous debt repayments. Now\nthat Sri Lanka has lost access to international capital markets and is\nextremely unlikely to regain it for some years due to its CC rating, there is\nvery little downside and very considerable upside to debt restructuring.  <\/p>\n\n\n\n

There is now no choice but to\nrestructure our external debt. The positive impact on dollar liquidity will be\nsubstantial and could be measured in billions of dollars.  It is also\ntimely as the negative social consequences are manifesting themselves in terms\nof ever-increasing hardships for the people, particularly the poor and vulnerable. \nIt does not seem realistic to count on short term liquidity injections or a\nreliance on a revival in tourism as well as increased exports, FDI and\nremittances, to overcome the dollar illiquidity and its negative consequences\nin the next couple of years.  Paying back debt at the expense of scarring\nthe economy and imposing hardships on the people should not be seen as a badge\nof honour. This is\nA Pathfinder Perspective issued by the Pathfinder Foundation can view on https:\/\/pathfinderfoundation.org\/<\/a> \nReaders\u2019 comments via email to pm@pathfinderfoundation.org<\/a><\/strong> are welcome. <\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

Pathfinder\u00a0Perspective Has the time come to consider seriously the merits of restructuring the government\u2019s external debt obligations?  The Sri Lankan authorities have indicated that they are in the process of negotiating inflows to meet the country\u2019s immediate foreign exchange requirements.  However, there is considerable uncertainty as to whether there would be sufficient inflows to meet […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":true,"template":"","format":"standard","meta":{"footnotes":""},"categories":[102],"tags":[],"class_list":["post-121578","post","type-post","status-publish","format-standard","hentry","category-economy"],"_links":{"self":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/posts\/121578","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/comments?post=121578"}],"version-history":[{"count":0,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/posts\/121578\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/media?parent=121578"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/categories?post=121578"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.lankaweb.com\/news\/items\/wp-json\/wp\/v2\/tags?post=121578"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}