Sunday Times 2
Getting out of a debt hole: Some advice for Lanka’s establishment
As I write this article, Sri Lanka has its back to the wall. There is a raging foreign exchange (forex) crisis with low levels of reserves held by the Central Bank, a significant monthly trade deficit, large foreign debt repayments this year and for years to come, and no obvious way out of this crisis.
The public debate hovers around whether the country should go to the IMF and restructure the debt, or borrow more from China and other Asian countries, or even default on the debt. None of these is attractive, but more importantly, none of these options will by themselves fix the long-term problem that Sri Lanka has. Any kind of new debt or a debt restructuring will simply give Sri Lanka a short-term respite, but the forex monster will soon be back asking for more. This article takes a longer-term view, as we need to know what the solution to Sri Lanka’s problem is, before we look at what short-term tactical steps are available.
My hope in writing this article is to stimulate a broad discussion within the Sri Lankan establishment — the government, the private sector, the media and Sri Lankans with an interest in the subject — and move the conversation away from a narrow debate of whether to restructure or default. I have written a detailed article which is available on the Sunday Times website. There is also a dedicated website where the subject can be debated in depth: https://www.managing-debt-blueprint-for-sri-lanka.co.uk
Sri Lanka has many more options than just debt restructuring or defaulting on the debt. To understand what those options are, it is important to understand what debt is and that there is a big difference between domestic debt denominated in Sri Lanka Rupees (LKR) and foreign debt denominated in USD and other currencies. The detailed article explains these differences.
Sri Lanka’s debt crisis is not about domestic debt in LKR but external debt – debt to foreign institutions. So, you would assume that Sri Lanka’s external debt must be very high when compared with that of other countries. But surprisingly that is not the case. While Sri Lanka has an external debt of 63% of GDP, the US has an external debt of 109% of GDP and the UK is at 345% of GDP! Are you surprised then that nobody talks about those debts? The amount of debt Sri Lanka has is not by itself the root cause of our problem. There are other issues that need to be understood so that Sri Lanka can be clear about the choices it has made in the past and what choices are open to it in the future. Why can the UK have five times as much external debt in proportion to its economy than Sri Lanka can have? The detailed article addresses this mystery.
The next question the detailed article explores is whether Sri Lanka could be said to be bankrupt. A test that accountants use to determine whether a company is insolvent is to ask whether that company can pay its debt “as it arises”. On that basis and with reference to Sri Lanka’s foreign debt, we know it is struggling to repay debt as it arises — although it has dutifully done so up to now. But that is not the only criterion when assessing a company’s health. More important than that test is to ask what the balance sheet of the company looks like – i.e. what do its assets look like when compared with its liabilities.
Surprisingly economists never look at this metric. Sri Lanka in fact shines on this measure. Credit Suisse bank publishes a global wealth report for all countries annually. In that it estimates Sri Lanka’s gross assets at $400 billion, along with an external debt figure of $50b, and therefore Sri Lanka has a net asset position of $350b. By that measure Sri Lanka is not bankrupt and is far from bankruptcy. Sri Lanka is a relatively wealthy country and is placed at world number 58. Are you surprised that nobody told you that before? Why is it not written in every newspaper as part of the analysis on how to manage Sri Lanka’s debt?
The problem for Sri Lanka hinges on how the country’s debt is secured to its ample assets. Foreign markets perceive that they do not have sufficient security over the lending they have done to us. This is where Sri Lanka and the UK differ. Lenders to the UK are certain they will be repaid when that repayment is due and that they will receive interest payments from the UK’s borrowers. Not so with us. This is primarily a mistake of our own making. Goading the government to default on debt payments is a great example of how not to instil confidence in those who lend to us. In fact, to default on debt is essentially a form of theft. The Sri Lanka government should not consider that under any circumstance. The detailed article explains in much more detail why that is the case.
The detailed article also addresses the question of whether Sri Lanka should go to the IMF. IMF help is not necessary in the author’s view and more importantly it can only bring temporary relief. Sri Lanka has a persistent trade and current account deficit as we all know. Unless that is tackled, no amount of IMF help will resolve the long-term debt issue – Sri Lanka will simply get into a deeper and deeper debt trap. Whether Sri Lanka borrows from the West or from China or from other Asian countries, debt that cannot be repaid is a trap. Make no mistake.
There are three things Sri Lanka can do to get out of the debt hole it is in. None of these involves the IMF or debt default. Here’s how:
We must first fix our laws so that foreigners can have constitutionally guaranteed property rights over Sri Lankan assets when we choose to provide those assets as debt security. It is our decision whether we offer such security or not, but when we do so, the ownership rights must be 100% bullet proof. The constitution must guarantee it so that future governments cannot simply reverse it, and courts must uphold those rights. Just doing this would put us at a similar level of trust to the UK.
We must be willing to sell Sri Lankan assets (such as beachfront property) if that is what is needed to repay some of the debt. It will not be possible to do this at the right price if #1 point above is not in place. The buyer must know that the property he bought cannot be taken away from him just because of a change of government.
And finally, we need to fix our long-term trade deficit with an Industrial Policy. We will explore that in the rest of this article.
An important thing to note about the items above is that Sri Lanka can do all these things by itself. We do not need foreign help to fix our laws or to create a domestic industrial policy. And we do not need the IMF to do these things either.
We know that Sri Lanka has had a trade and current account deficit for decades. The detailed article points out that, as Prof Howard Nicholas has demonstrated with his research, developing countries without an industrial policy have a persistent current account deficit. The IMF and Western pundits always argue that government-led industrial policies are not a good idea for developing nations. That’s funny as that is exactly what the rich world did to get to where they are. Check out the famous book by Prof Ha-Joon Chang “Kicking Away the Ladder” on this subject. As he shows, the West is simply trying to kick away the ladder that they themselves used to get to the top of the world.
The detailed article then wraps up with advice on how the government should setup an industrial policy. Here are the key points:
The government should begin by identifying industrial sectors and global supply chains that Sri Lanka can target.
The government should then create independent agencies to oversee each such industrial sector
Foster clusters of companies that target the sector
Never support or invest in a single company
Setup the agencies, write the rules, and then step back
Give the agencies independence like the Central Bank has independence. Ensure there is no political interference. Government must never interfere in operational matters of companies, or of the cluster, but just set policy
If the government is going to print money, give it out as grants for innovation
Never subsidise individual companies or protect individual companies from failure. Better companies will arise from the death of a poor performer. If the company cannot compete in the world market its all the better that it gives up its resources, especially the human resources, so others can do better.
This then is a blueprint on how Sri Lanka can emerge from its current forex woes. I chose to publish this article on the 4th February because this is the way to true independence and sovereignty.
The future is in Sri Lanka’s hands. We can fix this by ourselves.