The debt challenge

The ratings downgrade by ratings agency Moody’s this week has worried many who are concerned about the multiple challenges Sri Lanka faces to meet an estimated $ 4.5 billion in debt repayments next year. Even though multiple options including SWAP arrangements and a US Repo have been mooted, much will depend on Budget 2021 that the Government will present in November to set in place policy priorities. 

Sri Lanka with its debt to GDP ratio estimated at about 86% faces having this increase to 100% next year. It is also hampered by a 9% Budget deficit this year, which will need to shrink substantially in the next two years to address investor concerns. These, along with significant tax and other reforms will have to be outlined in the Budget, irrespective of whether the Government will opt for an agreement with the International Monetary Fund (IMF). 

Once the conflict was over, the Government borrowed extensively for infrastructure projects, but failed to jumpstart investment and broaden exports. Sri Lanka will meet its debt repayments this year, but unless reforms and an improvement in the COVID-19 situation changes next year, allowing the country to return to international financial markets, its ability to raise funds to repay debt due in 2021 while keeping the rupee at its current levels will be tough. 

Until 2023, the Government has to repay an estimated $ 13 billion, which is mostly going to have to come through more debt. This, together with low growth, means Sri Lanka will remain on the knife edge economically for the better part of this decade. Sri Lanka can join international calls for assistance, but it will be just another short-term solution. If the Government is serious about turning around the economy, it will have to initiate difficult reforms that have been kicked down the road by successive governments. 

Public revenue needs to grow to about 15% of GDP for Sri Lanka to sustainably fund education, healthcare, housing, and other welfare support needed for as much as 40% of the population. Without taxes, there is simply no other revenue source to achieve this. 

Another tough but crucial step will be reforming State-owned enterprises (SOEs). The Government cannot keep funding its losses, but trimming the public sector will be deeply unpopular. Slashing defence allocations, which have remained the highest component of the budget despite the war ending over a decade ago, and rationalising other expenditure is also important. Strongly connected to this is effectively fighting corruption and proactively promoting transparency, which is the cause that has been ignored in the 20th Amendment. 

Persistent issues, such as the relatively low ranking in the Doing Business Index, high utility costs compared to regional peers, high costs of land acquisition, and rigidity in labour laws and Government procedures remain the main impediments in terms of attracting FDIs to the country. Sri Lanka needs investment and exports to build reserves and repay debt without relying on more borrowings. So far the signs are that international assistance will be limited, making reforms the only realistic path for the Government, should it choose to take the responsible route.

Spurring domestic industries is a positive move, but it will need to be underpinned by a wider set of policies that will give confidence to international markets. Only then will the economy be on a truly sustainable path, and Sri Lanka’s fiscal woes will be addressed.