Repaying foreign debt or financing essential imports?
The available foreign reserves of the country can be used to either repay foreign creditors or to finance imports of essential goods and services required by its citizens. This is the dilemma facing Sri Lanka today.
Repaying the full value of the bond using the limited foreign reserves available would provide a windfall gain to those currently holding these bonds.1 But it will be at great cost to the citizens of the country who will face shortages of essentials like food, medicine, and fuel.
In these circumstances, it is in the best interest of all its citizens, for the government to defer payment of the US dollar 500 million International Sovereign Bonds
(ISB) coming due on 18 January 2022, until the economy can fully recover and rebuild.
Just as an individual with co-morbidities is more vulnerable to develop severe illness if infected with COVID-19 and more to likely require hospitalisation and even treatment in an ICU, Sri Lanka was vulnerable to economic shocks long before COVID-19 struck. The country was already facing several macroeconomic challenges. Muted economic growth. An untenable fiscal position. Although a tough consolidation programme was put in place to bring government finances to a more sustainable path, sweeping tax changes implemented at the end of 2019 reversed this process, with adverse consequences to government revenue collection. Weak external sector due to high foreign debt repayments and inadequate foreign reserves to service these debts.
COVID-19 only exacerbated these macroeconomic challenges. And like a patient who gets over the worst of COVID-19 has a long road to recovery; the economy of Sri Lanka faces many challenges to get back on track.
The onset of COVID-19 in early 2020, only worsened an already grim macroeconomic situation. The country lost the confidence of international markets, and the ability of the sovereign to rollover its external debt became difficult if not impossible. In these circumstances, there was a solid argument for a sovereign debt restructuring. But the response from the government and the Central Bank of Sri Lanka (CBSL) was a firm “No”.
The argument was that Sri Lanka never defaulted on its debt and it was not going to do so now. The official position was also that the government had a ‘plan’ to repay its debt and hence there was no reason to engage in a debt restructuring exercise. However, Sri Lanka faced high debt sustainability risks: the debt to GDP ratio at 110% was one of the highest historically and interest payments to government revenue at over 70% was one of the highest in the world.
Fast forward to 2022. The country’s foreign reserves declined to US $ 3.1 billion.2 Useable reserves are much lower. CBSL has sold over US $ 200 million of the country’s gold reserves to meet its debt obligations. In the first week of 2022, CBSL announced further swap facilities and its commitment to repay the International Sovereign Bond (ISB) of US $ 500 million due in January.
According to statistics from the Central Bank, in addition to the ISB payment, there are pre-determined outflows from foreign reserves amounting to US $ 1.3 billion in the first two months of 2022. Further, based on trade data for the last 5 years, the country on average has a trade deficit of around US $ 2 billion to finance during the first quarter of the year (see Table 1). With expected inflows from tourism under threat with the onset of the Omicron variant and continuing decline in worker remittances, financing this external current account deficit will add further pressure on available foreign reserves. India which accounted for around 20% of recent tourist arrivals is now requiring returnees to the country to quarantine. This will likely further dampen tourist arrivals.
In this context, the country faces a trade-off between using its limited foreign reserves to repay its debt or utilising it to finance essential imports. US $ 500 million is sufficient to finance imports of fuel for five months; or pharmaceuticals for one year; or dairy products for one and a half years of; or fertilizer for two years.
See table 1: Summary of External Sector Performance Q1 – 2017 to 2021 (US $ mn)
Therefore, it is in the best interest of the country and its citizens for the government to defer payment on its debt and use its limited foreign reserves to ensure uninterrupted supply of essential imports. But this requires a plan. To minimise the cost to the economy, the government must immediately engage its creditors in a debt restructuring exercise. This will require a debt sustainability analysis (DSA) by a credible agency to identify the resources required for debt relief and the economic adjustment needed to put the country back on a sustainable path.3 This will be critical to bring creditors to the negotiating table and provide them comfort that the country is able and willing to repay its debt obligations in the future.
The cost of not restructuring is much higher. A non-negotiated default (if and when the country runs out of options to service its debt) would lead to a greater loss of output, loss of access to financing or high cost of future borrowing for the sovereign. It could even spill over to the domestic banking sector, triggering a banking or financial crisis.
The consequences are clear. What will we choose?
Dr. Roshan Perera is a Senior Research Fellow at the Advocata Institute and the former Director of the Central Bank of Sri Lanka
Dr. Sarath Rajapatirana is the Chair of the Academic Programme at Advocata Institute and the former Economic Adviser at the World Bank. He was the Director and the main author of the 1987 World Development Report on Trade and Industrialisation.
The Advocata Institute is an Independent Public Policy Think Tank. Learn more about Advocata’s work at www.advocata.org.
Seven factors of concern at upcoming Monetary Policy Review
by Sanath Nanayakkare
The Central Bank of Sri Lanka (CBSL) is scheduled to announce its latest monetary policy review on 20th January 2022, with all eyes on dwindling foreign reserves and foreign currency exchange in the country.
In this context, First Capital Research has named 7 factors of concern that could be taken into account at the upcoming monetary policy review. They are as follows.
* Foreign Reserves USD 3.1 billion – Dec 2021
* Inflation CCPI 12.1% – Dec 2021
* GDP Growth -1.5% – 3Q2021
* Private Credit LKR 60.5 billion – Nov 2021
* 03M T-Bill rate 8.38% as at 12.01.22
Liquidity and CBSL Holdings LKR -364.0 billion and LKR 1.42 trillion
Balance of Trade (BOT) and Balance of Payment (BOP) USD -6.5 billion and USD -3.3 billion for Jan-Oct 21
First Capital Research’s Policy Rate Forecast – Jan 2022-Apr 2022 notes that they believe the CBSL may highly consider tightening the monetary policy rates in this policy review but given the concerns over economic growth, there is a probability of 40% for CBSL to maintain its policy stance at current levels.
“With high frequent indicators improving in line with expectations, we have eliminated any probability of a rate cut. We expect a continued increase in probability for a rate hike in order to prevent overheating of the economy amidst the given fiscal and monetary stimulus,” they said.
As per First Capital’s view, CBSL either can choose to hike policy rates by 50bps or 100bps or hold policy rates steady, while a rate cut is off the table due to the high debt repayment and the high domestic borrowing requirement.
First Capital believes that there is a 60% probability for a rate hike due to the remedial actions required in achieving external stability.
However, there is also a 40% probability to maintain the policy rates at its current level in order to further improve the high frequency indicators.30%, they noted.
Sri Lanka’s dash brand enters international markets
Multichemi International Ltd, which manufactures and distributes a wide range of products under dash, one of Sri Lanka’s leading detergent and household care brands, has begun exporting its products to several international markets in Asia and Oceania, with plans also to enter Africa. The dash brand includes a wide range of products in car care, household care, home fragrances and laundry care sectors. Multichemi International Ltd, which has been awarded ISO 9001:2015 certification, is a Sri Lankan pioneer in environment-friendly cleaning products, having launched the country’s first biodegradable, safe cleaning products over 28 years ago.
Amila Wijesinghe, General Manager of the Company said,”Having conquered the domestic market, we are now ready to capture the international market. We are confident that our products which are of high quality will receive a good demand overseas as well. The feedback we have received so far from our overseas customers is extremely encouraging. We are dedicated to taking our products to the international market, to bring in foreign currency to the country and help uplift the economy”,
Janaka Abeysinghe appointed SLT CEO
Sri Lanka Telecom PLC has announced the appointment of Janaka Abeysinghe as its Chief Executive Officer (CEO) with effect from February 1, 2022.
The incumbent CEO Kiththi Perera will be overseas on leave for a period of two years to pursue higher studies, according to a stock market filing by the company.
Abeysinghe joined SLT in 1991. In his present role, he leads the enterprise and wholesale business of SLT that provides integrated voice and data solutions to enterprises, government institutions, domestic telco operators and global wholesale carriers.
In his career at SLT spanning 29 years, he has held a number of senior positions, including general manager Enterprise and International Sales and has extensive experience in the areas of Enterprise Digital Services, Enterprise Communications Solutions, Data Communications, Business Development, Domestic and International Switching Operations and Global Wholesale Voice & Data Business.
He holds a Master’s Degree in Electrical and Computer Engineering from the University of Kansas, USA and a BSc degree in Electronics and Telecommunications Engineering with a First Class Honours from the University of Moratuwa.
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