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The much larger foreign debt than originally disclosed and the need for further borrowing that will increase foreign debt servicing costs, makes it imperative to contain the trade deficit by restraints in imports and a vigorous thrust in exports.

For quite some time this column has argued that the extent of foreign indebtedness was too high and that the country was heading towards a foreign debt trap. The response of the previous administration to this concern was that it was a “debt mania of retired bankers” and that foreign debt was at an acceptable level and decreasing as a proportion of GDP. The Government continued to borrow foreign funds to finance mega projects that did not yield returns, increase exports or reduce imports.

Extent of foreign debt
By the end of 2013 the foreign debt was disclosed as US$ 44 billion. This was a huge debt for a US$ 60 billion economy. The foreign indebtedness of about 75 per cent of GDP absorbed about one fourth of the country’s export earnings for annual repayments of debt and interest costs in 2013.

The extent of foreign indebtedness that is unfolding is more serious than what was known earlier. It is said to be about US$ 70 billion. This too may not include all the contingent liabilities of the Government. The sudden tenfold increase in the bond issue from US$ 1 billion to US$ 10 billion appears to be due to disclosures of further liabilities. An additional debt of US$ 10 billion is a huge sum. It is as much as one sixth of the country’s GDP. When this additional debt of US$ 10 billion is added to the existing foreign debt of possibly US$ 70 billion, the foreign debt of US$ 80 billion exceeds the GDP.

Interest burden
Furthermore, borrowing an extra US$ 10 billion at an interest rate of 12.5 percent means that with the additional interest payments of US$ 1.25 billion per year for the next thirty years, the debt servicing costs are immense. Since the economy is not likely to grow at that rate, the debt to GDP rate will escalate and future generations will have to pay the remaining part of the bond interest.

High foreign indebtedness could have been justified if borrowed funds were utilised to generate high returns and increased export earnings or reduced imports. However, the use of foreign borrowing for large infrastructure investments did not increase exports or reduce imports and benefit external finances. Instead they increased foreign debt.

Remedial measures
The first means to mitigate this serious problem in external indebtedness should be to avoid borrowing at especially high interest rates. Even if the borrowing of an additional US10 billion was necessary, was there a need to borrow at the exorbitant interest rate of 12.5 percent that is about 10 basis points above LIBOR?
Perhaps no other country has borrowed at such a high interest rate. Even the 9.75 percent borrowing by the last government was excessive. Although it is advantageous to redeem high interest loans with lower interest borrowing, the serious level of indebtedness of the country may not leave much leeway for this strategy.

Where foreign borrowing is needed for further development projects, these must be selected with rates of return to the project higher than the interest rates and with balance of payments implications taken into account lower interest rate multilateral and bilateral sources that are properly evaluated are the best choice.

Short-term action
The large foreign debt and high foreign debt servicing costs necessitate the reduction of the trade deficit to enable a significant balance of payments surplus that could be used to reduce the foreign debt. While export growth is the long term strategy to improve the trade balance, it is not a realistic option as economic reforms that improve the investment climate for export industries takes time. Import restraint is the immediate means of reducing the trade deficit to a reasonable level of around US$ 7 billion from its current US$ 8.3 billion.

A wide range of policies need to be adopted to restrain imports. It is most important that aggregate demand is kept in check by appropriate monetary and fiscal policies. Public expenditure has to be contained so as to not increase imports. Tariffs and import policies must be such as to ensure a manageable amount of imports. The balance of payments implications of all economic policies must be considered.

Long-term export growth
The country’s export performance has been rather disappointing. Exports as a percentage of GDP and the country’s share in world exports have been declining. Economic policies have not been conducive for investment in export industries and foreign direct investment in export industries has been inadequate. A better investment climate has to be created to enable more robust export growth.

There is a need to diversify exports and export markets and maintain healthy relations with countries that matter for our exports. Improved foreign relations with the West that is the main market for manufactured exports and fish could be important in averting setbacks to these exports. The likely revocation of the EU ban on export of fish and the restoration of EU’s GSP Plus status may boost these exports later this year.

At the same time new export opportunities too must be found, especially for new industrial products. Being price competitive is vital to achieve increased exports. Keeping domestic inflation low and the exchange rate competitive is vital to achieve export expansion.

Policy imperatives
The increasing foreign debt servicing costs makes it imperative to contain the trade deficit by restraints in imports and a vigorous thrust in exports. A lower trade deficit would enable a significant balance of payments surplus that could be used to reduce the country’s foreign debt.

Economic policies must be formulated with balance of payments implications in mind. Aggregate demand must be contained through appropriate monetary and fiscal policies. Public expenditure has to be constrained so as to not increase imports. Tariffs and import policies must ensure that imports are not excessive. The reduction of the massive foreign debt is vital for economic stability and sustained economic growth.