There is considerable concern as to whether the country is heading towards a debt trap. This is a situation where the debt service payments are of such a magnitude that servicing of the debt requires further borrowing and then a country moves into a situation of defaulting on its debt servicing and repayment obligations. First and foremost it must be admitted that the country has never defaulted in its repayments. Even though the country has borrowed heavily from both multilateral agencies for several decades and more recently from commercial sources, there has never been an instance of the government failing to repay loans or interest.
A country’s debt consists of both foreign and domestic debt. Most of the anxiety is about the foreign debt burden. In actual fact the domestic debt component in Sri Lanka is higher than the foreign debt component. The domestic debt is 60 percent of the total debt, while the foreign component is the other 40 percent. Both these components of debt constitute the public or government debt. The debt servicing costs of both kinds of debt have to be made from the budget through government revenues. Therefore the total government debt, rather than the foreign debt component, should be considered in evaluating a country’s debt situation. Each of these has its different implications.
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Total government debt has been increasing over the years. At the end of 2008 the total government debt had risen to Rs. 3578 billion, a colossal amount. This is 85 percent of the country’s GDP of the same year. While the public debt has been increasing, it has declined as a proportion of GDP. This is due to the growth of GDP at 6 percent. Although the public debt increased by 18 percent last year, it declined from 85 percent of GDP to 81 percent of GDP in 2008. In 2002 it was higher than the GDP. It was as much as 105 percent of GDP.
The severity of the debt burden is hidden owing to the inflationary conditions that are swelling the GDP. The growth in nominal GDP tends to reduce the debt to GDP ratio, as has happened in recent years. While these ratios in relation to the GDP are indicators of debt burden, more revealing are the debt service ratios. The debt/GDP ratio is giving the impression that the public debt is becoming less burdensome. The fact is that the increasing public debt is creating a severe debt servicing cost that eats into a large proportion of government revenue and cripples the government from spending on much needed areas of state activity. The declining trend shown by comparing with the GDP is not as relevant as the debt servicing costs. In 2008 as much as 90.5 percent of government revenue went to service the debt. It may rise further this year with the downturn in the economy and lower revenue collections. The debt servicing cost could be even more than the estimated revenue for this year.
The foreign debt increased by 10 percent last year to reach Rs. 1,448.7 billion. In 2008 there was a considerable repayment of short term foreign debt that was one of the causes for the decline in reserves. The servicing of the foreign debt required 13.4 percent of export earnings to be spent on it. Although, the foreign debt servicing costs as a percent of export earnings seems a manageable 13.4 percent of export earnings, in the context of the large trade deficit, the foreign debt servicing costs could be an added burden. However in the larger context of a huge trade deficit, the imports exceeding exports by a huge amount, makes the foreign debt servicing cost a strain on the balance of payments. The increasing public debt is a serious problem as it affects the fundamentals of the economy. The public debt has reached proportions when it has become an underlying factor in the poor economic management of the economy. This is not a recent occurrence but one that has been continuously growing. What this large public debt implies is that the country is in a debt cycle.
A very large proportion of government revenue has to be allocated for servicing the debt, thereby leaving little funds for other expenditure. Consequently government has to borrow and that keeps increasing the debt burden. In 2006 as much as 90 percent of government revenue went towards servicing the debt. In 2007 it fell somewhat owing to increased revenue to 87.5 percent of government revenue. Last year debt servicing costs absorbed as much as 90.5 percent of revenue. Spending such a high proportion from current revenue for servicing the debt means that the government has to continue borrowing. In 2008 there was less than 10 percent of revenue left for all other expenditure. Debt servicing accounted for 43 percent of government expenditure that is a higher proportion than the defence budget. This means that the government has to borrow to meet its other needs. So the public debt continues to increase and its servicing costs add further to the deficit and the debt burden. This vicious cycle of debt is a prime cause for the unhealthy state of public finances. The debt burden is, on the one hand, leaving little money for much needed public expenditure, both current and capital, as well as increasing the burdens that future governments and people would have to bear.
There are several other aspects of foreign borrowing that have to be taken into consideration in taking into account the foreign debt burden. Recent increases in debt have been owing to foreign borrowing on commercial rates of interest. The government deviated from the principle of borrowing from multilateral agencies at concessionary interest rates and turned to commercial sources in 2006. The hitherto prudent management of foreign debt by borrowing from multilateral agencies on concessionary interest rates was eschewed in favour of commercial borrowing. Unlike borrowing from international agencies that lend long term, often have a period of grace and interest rates are low, the commercial loans that were obtained are relatively short term and have to be repaid in full at the end of the short period and carry interest rates much higher than the London Inter Bank Borrowing (LIBOR) rate. Therefore the costs of recent foreign borrowing are high and burdensome with the period of repayment being short. The proportion of concessionary debt fell from about 90 percent in 2000 to 80 percent in 2007 and increased to 85 percent last year owing to the repayment of a large amount of commercial loans. This in turn led to the dwindling of the foreign exchange reserves and resort to fresh borrowing this year.
It is estimated that the amortization payments in 2010 would be very high. This may well coincide with a rather difficult year for the country’s balance of payments. Therefore the debt servicing costs portend a serious strain on the country’s resources. It appears that the country is caught in a serious debt trap. It may be that servicing the foreign debt could be managed, but servicing of the total debt would create a serious distortion in public expenditure.
This is one of the serious problems that have not been addressed by successive governments. The debt has been increasing rather than declining. The debt has now increased to proportions when its servicing is a serious burden on the economy.
The extent of the public debt, its high servicing costs and the need to borrow indicate that the country is in serious difficulties. We may not be in a debt trap as yet, but at the threshold of one. The management of the public debt and bringing it down is a fundamental requirement of good management of the economy. |
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