Let’s borrow again?
View(s):The statement leads us to an important question: Is that what we expect after making such a massive sacrifice as a nation? We can borrow again! Apparently, it was “the borrowings without underlying fundamentals” that led the economy to collapse. Accordingly, we should be talking about then and now about these fundamentals, and not about the regained ability to borrow again.
At the dawn of the New Year – 2025, I thought of revisiting this issue to stress the gravity of the fundamentals that we need to focus on.
One of the challenges of the new administration is to bring down the cost of vegetables and ease the financial burden faced by consumers.
Improved credit worthiness
Without any political interruptions, it was remarkable that Sri Lanka was able to turn around its economic collapse during the past two years. However, it was not without a cost of adjustment.
The people who were battered with the bitter repercussions of the economic crisis had to face the second blow – the cost of adjustment. Their lives are yet to recover through economic growth. It is the long-term growth that would generate incomes, create jobs, ease the life burden, and reduce poverty.
An important milestone along the path to recovery and progress is the recent conclusion of the debt restructuring process. Along with its final stage of restructuring the international bond holdings, Sri Lanka’s credit worthiness moved one step upward.
So far, the country was “not worthy for credits” as it was somewhere in the “default” category. Fitch Ratings has now upgraded Sri Lanka’s both foreign-currency and local-currency issuer default rating (IDR) to ‘CCC+’ category. However, we must not be overwhelmed by it because CCC+ category signifies that there is still substantial credit risk.
Another international credit agency, Moody’s too followed the suit upgrading the issuer rating to “Caa1” category. Despite the improvements from the previous position, both ratings still reflect weak debt affordability of the country indicating that there is a long way to go upward in improving the country’s credit worthiness. Although the country has access to capital markets, international borrowings require significant risk premium to be paid above the interest rate.
The road ahead
In three years from now (2025-2028), Sri Lanka must be ready to commence its full debt-servicing under the negotiated debt-restructuring. Apart from that, in eight years from now (2025-2032), Sri Lanka must have achieved its debt sustainability targets: public debt-to-GDP should be reduced to 95 per cent by 2032; gross financing needs should be reduced on average to 13 per cent of GDP during 2027-2032; foreign currency debt service should be reduced to below 4.5 per cent of GDP during 2027-2032.
If we examine the above targets carefully, it is not difficult to understand the underlying requirements to achieve the debt sustainability. Among them, perhaps, debt restructuring is the easier part, although it has taken more than two years to complete.
Debt sustainability requires a substantial increase in tax revenue to reduce gross financing needs and to lower the borrowings. In the midst of this requirement, the government has already increased the income tax threshold and lowered the income tax amounts paid under each tax slab. Tax revisions would relieve people’s income tax burden against the government’s need for increasing tax revenue.
However, we must understand that there cannot be a reduction in gross financing need without widening the tax base, minimising tax exemptions, and improving tax revenue. In that sense, it is even better, and management is easier that everyone without exception pays a tax – even as small as 10 rupees. Therefore, gradually tax obligation would be a responsibility of every citizen of the country and would not be merely a burden of a minority.
Foreign debt obligation
The country must also meet its foreign debt obligation, while reducing its size as a percentage of GDP. The country has gradually improved its external finance position in the recent past.
Now, we can buy most of our imports including oil, gas, coal and other essentials without any domestic shortage. The Central Bank has also been able to build its gross foreign reserves up to over US$6 billion. The remaining restrictions on vehicle imports are also scheduled to be released in the coming months.
What are the sources of improving current foreign exchange receipts? Apart from the official borrowings from both multilateral and bilateral sources including project finance, there are two independent sources of foreign exchange inflows: tourism and worker remittances.
Tourism income
We must delve into these two sources and understand their limitations. It is nice to see increasing tourist arrivals again reaching two million this year. It may also grow in the coming years, given the positive branding of the country as one of the best tourist destinations.
Although Sri Lanka has so far come to earn about $4 billion a year, it has a greater potential to improve it in the medium term; many other tourist destinations among Sri Lanka’s neighbouring countries such as India, Thailand, Singapore, Malaysia and Vietnam have shown their remarkable increase in international tourist arrivals and tourism earnings.
However, one important characteristic of all these tourist destinations is noteworthy – they don’t depend on it; they all have been improved their export growth much more than tourism earnings. Although it is nice to see the expanding tourism industry, the external finance position of the country should not depend on it.
Worker remittances
The second source of foreign exchange earnings is the workers remittances which are also on the rise. Even if foreign employment activity generates foreign exchange earnings and created other business and administrative opportunities, from a national point of view its underlying truth is rather depressing.
An increasing worker remittance flow shows that the economy is incapable of absorbing its labour force to participate in the country’s development process and of rewarding their contribution adequately. Unfortunately, over a long period of time Sri Lanka’s worker remittances have been growing faster than the country’s export growth. It has indicated the country’s weakening ability to offer them productive and rewarding job opportunities.
It is politically correct to find foreign employment in the country’s labour force which would ease the unemployment problem. However, increase in outward migration for employment shows the weakness of the economy.
The more the life gets harder in the home country, the larger would be the number of people leaving for foreign jobs and, greater would be the foreign remittance inflows. However, there is no country in the world which has progressed and become developed by forcing people to find jobs outside the country; it’s rather the opposite.
Back to square one
The problems associated with both tourism earnings and worker remittances confirm that Sri Lanka cannot depend on these two sources to cover its foreign exchange needs including the foreign debt obligations. If we keep these two sources aside, we are still at the square one regarding the issue of foreign exchange earnings – that is export growth.
All of the debt sustainability targets are expressed as percentages of GDP. This shows that increasing the value of the “denominator” by maintaining a higher GDP growth can accelerate the achievement of debt sustainability. However, in this case too, it is necessary to understand the importance of economic growth with export growth that generates foreign exchange earnings.
Although contribution to higher GDP growth by every sector is important, not all the sectors contribute to external finance through exports or to internal finance through taxes. The road ahead for Sri Lanka is much more serious than what we have perceived so far. Unless we take this reality seriously, returning back to “capital markets” to continue with further borrowings is unavoidable in the years to come.
As we step into the New Year, let’s face the bumpy road ahead with a renewed sense of seriousness and purpose. May 2025 bring us the wisdom to make sound decisions to execute necessary reforms. Wish you a Happy New Year!
(The writer is Emeritus Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
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