Opinion: Sri Lanka’s Debt Crisis is more serious than you imagine

debt

Context

A Team of Leading Economists/Analysts in January 2019 alerted the Leaders in Governance that it is likely that the ballooning external debt commitment will lead to a sovereign bond default unless drastic and sustainable actions are taken to:

  • Overcome the culture of running high fiscal deficits indulging in extravagant, conspicuous and unproductive investments/imports and spends.
  • Rapidly expand foreign exchange earnings from goods and services exports
  • Secure value-adding foreign direct investments that generate new employment and livelihood options

Very little success has been realized since then and Sri Lanka is just ahead of a debt crisis.

What does Sri Lanka’s debt look like?

Official statistics state that Sri Lanka’s debt amounts to 82.9% of GDP[1]. However, experts argue that when one accounts for government borrowings from State banks and the Central Bank, as well as private sector foreign borrowings, our debt hits 100% of GDP [2].

While the Ministry of Finance projects that Sri Lanka’s debt will be 72% of GDP in 2022 [3]. Experts argue that it is likely that the debt would increase to 100% of GDP in three years [4] and that our debt doubles in six years [5].

Sri Lanka’s foreign debt is highly vulnerable to external shocks. The exchange rate depreciated by 20% from January 2017 to date due to political instability and Easter attacks 60% of all households are in debt with an average of Rs. 1.4 million debt outstanding per household.

Sad state of Sri Lanka’s household debt?

As per the Household Income and Expenditure Survey of 2016 conducted by the Department of Census and Statistics, average household income per month at the national level was Rs. 62,237 and the average monthly household expenditure was Rs.54, 999. [HIES]

Sixty percent of all households are in debt with an average debt outstanding of Rs. 1.4 million. At an average revenue minus expenditure of Rs. 7,238 this requires repayment over 193 months. If growth slows this time period will lengthen.

This issue has to be addressed via economy-wide increases in productivity and growth along with the generation of higher savings.

“Sri Lanka’s ‘B’ rating balances high government debt and contingent liabilities, a challenging external financing profile and subdued economic growth against higher human development standards and per capita income levels compared with peer medians” Fitch – September 2019

“In absolute terms, government outstanding foreign debt stood at USD 32 billion in 2018. Over the period 2019-2022, Sri Lanka is estimated to require financing of approximately USD 4,000 million on average per annum” IPS – State of the Economy 2019

What is the composition of our debt?

Foreign debt as a % of GDP is 41.2% [6] to be repaid in dollars and domestic debt as a % of GDP is 41.6% [7] to be repaid in rupees.

Foreign debt repayments over 2018-22 amounting to a massive $14.9 billion. To put this in context, the current IMF facility is only $1.5 billion [8].

Sri Lanka’s debt value and the debt composition have changed over the years, from concessional long term loans to non-concessional short term loans (Non-concessional loans in 2006 as % of GDP was at 7% and increased up to 55% in 2018).

Debt service repayments

Debt service payments as a percentage of GDP stood at 14.5 percent in 2018, compared to 11.9 percent in 2017 [9]. Debt service payment as a percentage of total government revenue amounted to 108.8 percent in 2018 [10].

Annual debt repayment is estimated to be USD 5 billion [11]. Interest payments of 2019 account for 41% of recurrent expenditure of the government or 5.9% of GDP [12]. The foreign debt service ratio is at 30% in 2018.

Implications?

Slowdown in economic growth from +4% in 2015 to -3% in 2019:

  • Indicating the increase in the budget deficit in the same period with an estimate of nearly 6% for 2019
  • Slowing growth, increasing budget deficits and resource outflows for debt repayment reduce consumption and investment 
  • Low growth will lead to Sri Lanka being downgraded on ratings translating into higher costs of borrowing [13]

Economic austerity appears to be inevitable and there is no space for high extravagant and unproductive spends. Certainly no space for periodic auctions of non-existent resources in pursuit of political power.

Political Instability and Ethno-Religious tensions drive development deficits and enhance inequalities. Poor and marginalized segments of society will be the most impacted by a crystalized debt crisis.

Easter attacks and the 2018 October Political crisis greatly contributed to slower growth. A quick turnaround unlikely with Presidential/Parliamentary Election due over the next 6 months.

Slower global growth rates, mainly due to Trade war between China & the USA and the tensions in the Middle East will make the situation more unfavorable to Sri Lanka.

How do we tackle this?

Utmost importance that this is acknowledged as a potential tipping point of an impending debt crisis and leadership to drive with commitment bi-partisan urgent reforms essential to mitigate and manage risks.

  • Case study 1 : Bangladesh political parties agreed on a common economic programme and kept the policy agenda consistent. This has resulted in consistent higher growth rates and attracts value-adding Foreign direct investments
  • Case study 2 : Both Sri Lanka and Pakistan won the ICC Cricket world cup in 1992 and 1996 as a result of visionary leadership and Team Work of Imran Khan and Arjuna Ranathunga regardless of the skill levels of the individual players

We need to understand how the country came to this point

From 2000-2016, the total spending grew at a compounded annual rate of 12% (from Rs335,822 million to Rs2,333,883 million), with the deficit following suit (Rs119,396 million to Rs640,326 million). Foreign financing of the deficit grew from Rs495 million to Rs429,130 million during the same period [13]

Debt is simply taxation postponed, with interest added. Money printing can tide over in the short term but ultimately results in inflation and currency depreciation. The need, therefore, is to reign in expenditure, which must start with a proper plan, committed implementation and role model leadership action.

Medium-Term Expenditure Framework (MTEF)

Three-to-five year rolling plans, the important features of which are as follows: [14]

  • Extends the timeframe of budgeting from 1 year to 3-5 years.
  • Projects the future cost of existing programmes and approved policy changes (baseline).
  • Establishes hard spending limits – fiscal targets (i.e. deficit or total spending).
  • Establishes a procedure for proposing any new policy initiatives and drives productivity, quality improvements, innovation, economy, efficiency, and effectiveness
  • Adopt accruals accounting, generate timely management information, results-oriented management, diligent implementation follow-up and learns lessons from Post Audits
  • Rolls the MTEF forward each year, adding a year in the end.

Better allocation of scarce funds

The Treasury can work backward from revenue, assuming no changes in the tax structure and the deficit target to arrive at the overall spending limits. Matching this with projected costs of current programmes will indicate if there is space available in the budget for new policy initiatives.

The overall spending limit is a ‘hard’ limit, but within the overall limit, reallocation can take place. This forces the Cabinet to consider spending priorities – where should limited resources be allocated? The Cabinet can determine soft ceilings for ministries that need to ‘win’ competitively on the basis of plans submitted [15].

Larger Reform Agenda

  • Reduce waste by way of SOE losses, corruption, monumental investments – Increase domestic output and foreign inflows 
  • All SOE’s to be listed in Colombo Stock Exchange
  • Take the slack away from the labour market
  • Address low female participation and poor youth participation
  • Divert investments away from “brick and mortar” to human capital with emphasis on “STEAM” [16]
  • Only concessional loans to be utilized for infrastructure development work
  • Re-evaluate the import tariff structure to promote austerity with political leadership setting example
  • Promote Savings, Productivity, and Quality Improvements, Research led Innovations as a Work Ethic
  • Project denominated bonds for building infrastructure which will improve transparency and bring down risk premium

Imminent High Risks  Require Disciplined Management & Legislative Controls

  • Fiscal Responsibilities Act failed to be implemented with no sanctions on failure!
  • Will a strengthened Fiscal Responsibilities Act bring required macro discipline?
  • Will the Active Liability Management Act be effectively implemented?
  • Can the new Monetary Law Act &  the Macro-Prudential Authority assure future stability?
  • Would embedding discipline via constitutional controls ensure sustainable stability
  • Example: Swiss “Debt Brake” applied since 2003, via Article 126 Constitutional Provisions, be our role model for Spending Control and Fiscal Restraint ( Now an EU Standard) [17]

By Independent Economist

Notes:

1. Government of Sri Lanka, Ministry of Finance, Annual Report (2018, provisional data)
2. W. A. Wijewardene, Bankrupt Sri Lanka Incorporated: Prospective rescuers should come up with a common policy, Daily FT, October 14th 2019, http://www.ft.lk/columns/Bankrupt-Sri-Lanka-Incorporated-Prospective-rescuers-should-come-up-with-a-common-policy/4-687534 (Accessed October 21st 2019)
3. Government of Sri Lanka, Ministry of Finance, Fiscal Management Report (2019)
4. Anura Ekenayake, ‘National Debt and Risks’ (2019)
5. Ibid
6. Government of Sri Lanka, Ministry of Finance Annual Report (2018)
7. Ibid
8. Ravi Ratnasabapathy, ‘Bringing sanity to public finances’, Echelon, July 10th 2018, https://echelon.lk/bringing-sanity-to-public-finances/ (Accessed October 21st 2019) 
9. Government of Sri Lanka, Ministry of Finance Annual Report (2018)
10. Ibid
11. Central Bank of Sri Lanka,  Annual Report (2018)
12. Ibid
13. Anura Ekanayake, ‘National Debt and Risks’ (2019)
14. Ravi Ratnasabapathy, ‘Bringing sanity to public finances’, Echelon, July 10th 2018, https://echelon.lk/bringing-sanity-to-public-finances/ (Accessed October 21st 2019) 

15. Ravi Ratnasabapathy, ‘Bringing sanity to public finances’, Echelon, July 10th 2018, https://echelon.lk/bringing-sanity-to-public-finances/ (Accessed October 21st 2019)

16. Anura Ekanayake, ‘National Debt and Risks’ (2019)

17. https://www.loc.gov/law/help/debt-brake/switzerland.php

HIES – Household Income and expenditure survey 2016 – Page 38 – http://www.statistics.gov.lk/HIES/HIES2016/HIES2016_FinalReport.pdf