Foreign debt commitments trigger macro-financial risks
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File picture of a recent media briefing by the Central Bank
Until recently, there had been a surge in capital flows from advanced countries to developing countries. Foreign loans to low-income countries tripled between 2007 and 2013. Given the near-zero interest rates in US and European capital markets, investors diverted their funds to emerging markets. With its unprecedented growth, the Chinese economy too became a major lender in the global capital markets. These capital flows have provided impetus to emerging market economies like Sri Lanka to narrow down the domestic savings – investment gap, and to improve infrastructure which is essential to speed up economic growth. At the same time, such borrowings taken on commercial rates have become problematic when servicing the debt, particularly in the case of countries like Sri Lanka which have deficits both in the government budget and balance of payments.
Former government’s debt legacy
The previous government had left a foreign debt stock of around US$24 billion when its term of office ended in early January last year. The bulk of these loans were obtained on non-concessional terms through debt securities (Treasury Bonds, Sri Lanka Development Bonds and Sovereign Bonds) and bilateral and multinational commercial loans. A sum of $5.5 billion was raised through seven sovereign bonds during 2007-2014. Commercial borrowings obtained from China (EXIM Bank, CIDB, etc) amounted to around $5 billion during 2006-2014.
The bulk of the borrowed funds was utilised for infrastructure projects. The standard project evaluation criteria do not seem to have been applied in launching major projects like the Mattala Airport and the Hambantota Port and, as a result now they have become a burden to the government budget and external finances. The rates of returns with respect to the ongoing Port City and Lotus Tower projects are also unknown to the public.
In addition to the government’s external debt, there are foreign loans obtained by other entities which are guaranteed by the government, but not recorded in the government’s balance sheets. The government external debt together with such publicly guaranteed debt amounted to around $30 billion by the end of 2014.
Country’s external debt is much bigger
The external debt usually refers to the foreign debt component of the public debt. But the external debt of the country should also include the foreign debt raised by the private sector, as the repayments and interest payments pertaining to such loans have to be met by using the country’s foreign reserves, irrespective of the type of borrower. In 2013, commercial banks were allowed to borrow up to $50 million per annum and blue chip companies up to $10 million per annum, for three years.
Eventually, the state-owned banks (Bank of Ceylon and NSB) and semi-state NDB and DFCC became indirect borrowing sources for the government. The outstanding total external debt of the Government, Central Bank, deposit-taking financial institutions and other entities amounted to $43.7 billion by the end of the 3rd quarter, 2015. It is equivalent to as much as 56.7 per cent of GDP.
Sri Lanka in debt
Sri Lanka is already in a debt crisis, according to the UK-based ‘Jubilee Debt Campaign’ (JDC) which is a part of a global movement demanding freedom from the slavery of unjust debts. Countries having net foreign debt over 30 per cent of GDP, and government’s external debt service payments exceeding 15 per cent of its revenue are classified as ‘countries already in debt crisis’, according to the JDC. Sri Lanka is among the 22 countries that are already in debt crisis along with the debt-ridden Eurozone countries – Greece, Portugal, Ireland, Spain and Cyprus.
However, it is questionable whether it would be accurate to label Sri Lanka as a country ridden with a debt crisis, similar to Greece which has been going through a financial meltdown since 2009. The debt level of Greece has risen from 103 per cent to over 170 per cent of GDP, far above the debt ratio of Sri Lanka. The Greek government was running out of cash by June last year, and action was taken to close the banks temporarily and to impose capital controls. Several bailout packages were offered by the IMF and EU to Greece during the last several years to avoid defaults.
In contrast, Sri Lanka’s plus point is that she has never defaulted her debt repayments. Nevertheless, there are lessons to be learnt from those debt-ridden countries to avoid fiscal disasters, over-borrowing and loan defaults.
Debt service becoming strenuous
The servicing of the debt inherited from the previous government, of course, is the responsibility of the present government. The external debt service commitments for the next 12 months will be around $5 billion consisting of loan repayments of $3.7 billion and interest payments of $1.3 billion. The present government too is compelled to resort to commercial loans. In 2015, the government raised $2.15 billion through two sovereign bond issues. In addition, the Central Bank signed a currency swap agreement with the Reserve Bank of India to draw $1.1 billion in 2015. Around $2 billion was expected to be received from some mystery investors abroad as well.
Given the disturbing outlook of the government budget and the balance of payments, it is not an easy task to meet the mounting debt service commitments. The budget deficit is estimated to rise to around 7 per cent of GDP this year. Export earnings are sufficient to finance only about 60 per cent of imports. Hence, further borrowing from foreign capital markets is unavoidable not only to bridge the trade gap, but also to roll over the maturing debt. Meanwhile, access to capital markets has become more difficult following the US rate hike and the global economic downturn. Sri Lanka is experiencing capital outflows at present as in the case of many other emerging economies.
Slowing down of inward remittances too is already on the cards due to political instability in the Middle East and falling oil prices. These factors lead to further deterioration of the rupee which results in an increase in the rupee cost of debt service payments. In the circumstances, the government is reported to have made a formal request to the IMF for a bailout package. Such facility, of course, will come with stringent conditions so as to put the macroeconomic fundamentals in order. The IMF team that visited the island early this month has already warned the government to make a stronger effort to reduce the budget deficit. The success of the government in fulfilling this long-overdue fiscal adjustment in the midst of political undercurrents is yet to be seen.
(The writer, an economist,
academic and former central
banker, can be reached at
sscolom@gmail.com)