Sri Lanka

Sri Lanka has no final decision yet on domestic debt re-structuring | EconomyNext

ECONOMYNEXT – Sri Lanka is yet to make a final decision on whether to re-structure domestic creditors participating in an online forum were told by authorities as inflation and depreciation almost halved the value of domestic debt and pushed up nominal tax revenues already.

The “debt re-structuring perimeters” are “still being considered” with the assistance of debt advisors, Sri Lanka authorities have told creditors.

“In particular the issue of domestic debt is looked at very carefully given the impact that it may have on banking sector stability and the overall macro fiscal framework,” they were told.

Sri Lanka’s debt was considered unsustainable following a Debt Sustainability Analysis done by the International Monetary Fund after tax cuts reduced revenues in 2020, and monetary stimulus blew the biggest hole in the balance of payments and central bank reserves since the agency was set up.

The fiscal and monetary stimulus came after state spending increased in the earlier five years from around 17 to 20 percent of GDP due to spending based consolidation (cost-cutting) being junked under ‘revenue based fiscal consolidation’, a peculiarly state expansionist strategy.

Sri Lanka defaulted in 2022 after seven years of flexible inflation targeting with monetary stimulus topped off with fiscal stimulus in 2020 after the International Monetary Fund taught the country how to calculate an output gap, despite having a reserve collecting peg.

Sri Lanka in April 2022 excluded domestic rupee debt and domestic law foreign debt from its debt re-structuring parameter.

Sri Lanka has to re-structure debt to reduce annual gross re-financing needs (roll-over and deficit financing) which is expected to peak to 37 percent of gross domestic product in 2022 and remain high absence of re-structuring.

Uncertainty over early clarity on whether or not domestic debt will be restructured has pushed rupee bond yields up to around 30 percent and discouraged investors from piling into bonds after private credit collapsed, as had happened in earlier currency crises after a float re-established credibility of the peg.

According to a presentation to investors an average 10 percent yield is assumed in one gross financing need scenario analysis with re-structuring.

Sri Lanka has no hopes of achieving low single digit interest rates of around 3 to 4 percent without a single anchor monetary regime, analysts say. When Sri Lanka ran into multiple currency crises inflation as high as 6 percent was being targeted.

Under an IMF program an intermediate regime with discretionary monetary policy (flexible exchange rate/flexible inflation targeting) prone to currency crises due to inherent anchor conflicts is being considered and is due to be legalized.

Domestic debt is automatically re-structured with inflation and depreciation when an intermediate regime (flexible inflation targeting) collapses a process known as High Inflation and Financial Repression (IFR).

By June tax revenues jumped 25 percent as inflation hit 60 percent even as the real economy contracted.

Sri Lanka is expects to continue “follow up technical discussions with IMF Staff, notably
on the DSA” a presentation said.

Some of the debt was taken into the central bank from banks to fund unsustainable credit in the process of triggering the default and reserve losses in from 2020 to 2022.

Bank capital is already stressed with mark to market losses on rupee bonds, a certain re-structuring of sovereign bonds, possible re-structuring of dollar denominated local law bonds (Sri Lanka Development Bonds) and the usual bad loans after a soft-peg collapse. (Colombo/Sept23/2022)

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