Colombo, December 26 (newsin.asia): Is it time to seriously consider the merits of restructuring the government’s external debt obligations? Sri Lankan authorities said they were negotiating entries to meet the country’s immediate foreign exchange needs. However, there is considerable uncertainty as to whether there would be sufficient inflows to cope with the acute dollar illiquidity over the medium term.

Businesses and even families restructure their debt when predictable future income becomes insufficient to repay debts while maintaining financial viability. The same goes for countries. Over the years, a number of countries have restructured their debt and the pandemic is pushing others to follow suit, the Colombo-based Pathfinder Foundation said in its article on the subject published on Sunday.

Has Sri Lanka reached the point where it would be beneficial to restructure its external debt? What are the costs and benefits of doing this? If debt restructuring is a credible option, how do you go about it?

Should Sri Lanka restructure its external debt?

Foreign revenues over the next two years are extremely unlikely to be sufficient to service external debt obligations while meeting the economy’s basic foreign exchange (Forex) needs. Known external debt repayments stand at US $ 26 billion over the next five years. It is unrealistic to expect to repay around $ 5 billion a year, especially over the next 12-24 months, when foreign capital inflows are not expected to increase to the scale needed to service debt and maintain debt. financing of imports necessary to meet basic needs and support the growth of the economy, especially since the deterioration of Sri Lanka’s sovereign rating has excluded it from international capital markets. Countries scrupulously protect access to these markets in order to have the capacity to refinance their debt and avoid such a situation.

It should be noted that the following chambers of commerce jointly issued a statement highlighting the serious problems their members are facing due to the severe shortage of Forex which was caused mainly by the combination of lost income from tourism and l ” access to international capital markets: Ceylon Chamber of Commerce, FCCISL, Ceylon National Chamber of Industries, Sri Lanka National Chamber of Commerce, Women’s Chamber of Commerce and Industry, Chamber of Young Lankan Entrepreneurs, Chamber of Commerce Sri Lanka International, National Chamber of Exporters and Chamber of Building Trades.

Collectively, these chambers represent almost all sectors of the economy. Their concerns cannot be resolved as there is a diversion of large amounts of foreign exchange from the markets to the Central Bank of Sri Lanka (CBSL) to service the external debt. As a result, there is now a strong case for debt restructuring in order to free up foreign exchange to meet business needs and meet the basic needs of the population, such as food, fuel and pharmaceuticals.

The costs and benefits of external debt restructuring.

The most important disadvantage of restructuring external debt is the immediate loss of access to international capital markets. This is now completely irrelevant for Sri Lanka, as market access was lost when the economy was downgraded to CCC rating. It is now even lower, at CC. As a result, Sri Lanka can no longer borrow in international markets. Another downside is the increased risk premium that Sri Lanka would have to pay when it is finally able to regain market access. However, the increase in the risk premium demanded by the markets as a result of the restructuring is likely to be tempered by the impressive commitment Sri Lanka has shown so far to meet its obligations. Two International Sovereign Bonds (ISBs) of $ 1 billion each were repaid on time in October 2019 and July 2020, despite the depletion of external reserves, imposing sacrifices on domestic businesses and households. This, combined with Sri Lanka’s impeccable debt service record to date, should contain the increase in the cost of future borrowing when possible.

National banks hold both ISBs and Sri Lanka Development Bonds (SLDBs). These two instruments will be impacted by any debt restructuring exercise. Foreign bondholders are extremely unlikely to agree to be exempt from haircuts from domestic entities, primarily banks, which hold U.S. dollar-denominated debt securities issued both abroad and domestically. . Therefore, not only ISBs but also SLDBs should be included in the debt pool to be restructured.

It is important to note that the impact of any discount will not be as painful as some might fear, as many domestic entities have purchased ISBs at an already reduced price in the secondary market. (There would be no such mitigation measures for SLDBS, which is not a negotiable instrument.) If necessary, CBSL should grant some temporary regulatory forbearance to any national bank facing adequacy issues. equity due to discounts imposed on creditors as part of the debt restructuring.

Restructuring options

Debt restructuring is a long and complex process. After delaying and allowing usable reserves to run out until barely a month of import coverage, it is no longer possible to carry out a soft and preventive restructuring. Three methods are available for restructuring the debt: reprofiling of the principal (extension of maturities); change coupon rates (interest); and depreciation of the principal (haircuts). Given the current situation, Sri Lanka is unlikely to be able to avoid haircuts for its creditors.

It is unrealistic and impractical to expect to restructure external debt without IMF support. Before embarking on external debt restructuring, the IMF must independently validate that Sri Lanka has a strong need to restructure its debt, in order to assure creditors that the Sri Lankan authorities are not opportunistic. The IMF will also need to validate the proposed medium-term fiscal adjustment path to ensure debt sustainability.

Bilateral, commercial and multilateral debt rescheduling requires different treatment. Bilateral debt rescheduling is negotiated with the Paris Club of creditors. It is not possible to get closer to the Paris Club without the support of the IMF. China and India are not members of the Paris Club and separate negotiations would be necessary with them. One option is to seek to initiate an informal “common framework” approach (endorsed by the G20 which includes both China and India). This should be informal as the “common framework” is not available for a middle income country like Sri Lanka.

This approach would have the advantage of including Sri Lanka’s three main bilateral donors: China, India and Japan. Bilateral agreements are likely to focus more on extending deadlines. Commercial creditors could be approached once the deal is reached with bilateral donors. Such sequencing can lead to a better transaction for the debtor country on the basis of an equivalence between all creditors in terms of rescheduling. In this regard, there is considerable interest in inquiring with the Japanese Ministry of Finance on its suggestions regarding the terms of the restructuring. Over the years, Japan has proven to be a flexible and generous creditor in this regard.

On commercial debt, again, it is extremely difficult to proceed without the IMF. Given the current circumstances, Sri Lanka’s commercial debt restructuring program is likely to include a combination of stretched maturities; coupon modification and haircut. Principal repayment haircuts should be avoided, to the extent possible, as they delay credit rating improvement and re-establishment of market access. It is likely now too late for Sri Lanka to avoid a haircut for its trade creditors. It does not make sense to scare the economy and cause hardship for the people to pay 100 cents on the dollar to ISB holders when most outstanding bonds have been discounted by more than 40 percent .

It is not possible to restructure multilateral debt (i.e. debt to the World Bank, Asian Development Bank and IMF) without a complete suspension of relations between Sri Lanka and these institutions. There would be a suspension of all lending activities, including project loans. However, the practice has been for these institutions to provide funding to help the debtor country service the payments owed to each of them once the debt rescheduling plan has been negotiated.

Appointment of advisers

It is customary to appoint a financial adviser and a legal adviser at the start of the restructuring process. The IMF is able to provide a list of potential advisers from which the country concerned can choose.

Conclusion

The unsustainability of Sri Lanka’s external debt is the cumulative effect of economic mismanagement over several decades. The size and persistence of the external financing gap for the foreseeable future make debt restructuring an urgent priority. It should be possible to negotiate a package that provides three years of breathing space to rebuild Sri Lanka’s economy in order to gain and attract sufficient foreign flows to ensure external debt sustainability and put the economy on track. ‘sustained growth. Almost 75% of the state’s external debt is owed to bilateral and commercial creditors, all of which are eligible for rescheduling, providing considerable scope for relief from onerous debt repayments. Now that Sri Lanka has lost access to international capital markets and is extremely unlikely to regain it for a few years due to its CC rating, there are very few downsides and advantages. considerable debt restructuring.

There is no other choice but to restructure our external debt. The positive impact on the dollar’s liquidity will be substantial and could be measured in billions of dollars. It is also timely because the negative social consequences manifest themselves in terms of ever increasing hardship for people, especially the poor and vulnerable. It does not seem realistic to count on short-term liquidity injections or a revival of tourism as well as an increase in exports, FDI and remittances, to overcome the illiquidity of the dollar and its negative consequences during the exchange. the next two years. Paying off debt at the expense of the economy and imposing hardship on the people should not be seen as a badge of honor.

This is A Pathfinder Perspective published by the Pathfinder Foundation can be viewed at https://pathfinderfoundation.org/ Readers’ comments by email at [email protected] are welcome.