April 16, 2022
Read this article in English | සිංහල | தமிழ்
Story & Analysis Umesh Moramudali Edited by Aisha Nazim Translated by Mohammed Fairooz & Nishadi Gunatilake
“We have lost the ability to repay foreign debt. It has come to a point that making debt payments are challenging and impossible.” - Central Bank Governor Dr. Nandalal Weerasinghe
On 12th April, a mere two days before the Sinhala and Tamil New Year, the Sri Lankan government announced that it will suspend foreign debt repayments and restructure debt with the support of the International Monetary Fund (IMF). Dr. Nandalal Weerasinghe, the Governor of Central Bank of Sri Lanka (CBSL), and the newly-appointed Secretary to the Treasury, K.M.M Siriwardane termed this as a ‘pre-emptive negotiated default’ pending debt restructuring along with the support of the IMF. In a layperson’s terms, this means that Sri Lanka has currently paused repaying its foreign loans, and will require more time to complete payments.
This is the first time a Sri Lankan government has defaulted on debt repayment since independence. In other words, this is Sri Lanka’s first Sovereign Default. Our island nation has never been in a mess like this, and there is no easy way out.
But how did we end up here? and why is our only alternative IMF assistance?
In our previous analyses, we outlined our economy’s structural weaknesses, and how Sri Lanka’s foreign debt stock kept soaring. For many economists, it was clear that sovereign default, debt restructuring and IMF bailout were on the cards, and that the country will face several difficult years ahead.
We have to remember that foreign debts need to be repaid in foreign currency — generally, in USD. Our ability to repay these debts largely depends on our capacity to earn foreign currency (which is where we are lacking) largely due to low exports. The fewer foreign currency earnings a country has, the more difficult it is to repay foreign debt.
Now that Sri Lanka suspended most of its foreign loan repayments, we can use most of its foreign reserves to pay for essential imports; as opposed to trying to do both: paying for imports, and paying off foreign loans. If we try to repay foreign loans when foreign currency reserves are low, there’s not much left available to import goods. This in turn forces countries to cut down on imports.
The current economic crisis is unprecedented due to a few reasons.
As News Curry so aptly put it, our President’s Soothsayer Gnanakka didn’t foresee default in our stars. Image credit: News Curry.
Firstly, Sri Lanka was unable to borrow from international capital markets through issuing International Sovereign Bonds (ISBs) after April 2019, due to constant downgrading of Sri Lanka’s credit ratings. This made it extremely difficult to repay ISBs maturing in 2020-2022. Issuing new ISBs became a difficult task subsequent to a downgrade of Sri Lanka’s credit ratings in late 2019 caused by tax cuts provided by then-newly elected President Gotabaya in late 2019. This credit downgrade then was followed by a series of downgrades in response to the adverse macroeconomic implications of COVID-19 which made it impossible to issue ISBs. That in turn restricted Sri Lanka’s ability to borrow foreign currency (USD in this case, the most needed foreign currency for Sri Lanka).
<aside> 👉🏽 ISBs are commercial borrowings that are not tied to a project. This means the government has complete liberty concerning how it wants to spend the money. The government also receives the entire amount of the requested loan in one go. ISBs are also costlier than project loans.
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Why are these credit ratings such a big deal?
<aside> 👉🏽 Credit ratings of a country are an indication of the country’s ability to repay loans. Therefore, a downgrade of such a rating implies a deterioration of the ability to repay loans. Lower the credit ratings are, lower the ability to repay loans.
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In the case of Sri Lanka, rating agencies warned that tax cuts provided in 2019 would create a significant revenue loss, which in turn would reduce Sri Lanka’s ability to make foreign loan repayments. By 2020, Sri Lanka already had a high budget deficit (government expenditure exceeds government revenue) and further tax cut means a further reduction of tax revenue, resulting in an even higher budget deficit. This compelled the government to borrow more and more, without having a substantial revenue increase.
As one can see this is a serious macroeconomic concern — one which led to a credit rating downgrade.