SL external debt sustainability: Intervention by Practical Economist keeps the debate live
Monday, 21 July 2014 00:03
Practical Economist’s re-entry to the fray
In a welcome move, an economic analyst writing under the penname ‘Practical Economist’ has responded (available at: http://www.ft.lk/2014/07/16/a-view-of-sri-lankas-external-debt-situation-with-neutral-glasses/) to this writer’s previous articles on Sri Lanka’s external debt sustainability highlighting the misleading conclusions of a press release issued by Central Bank’s Public Debt Department or PDD due to data incompleteness.
These articles could be accessed by visiting the following links: first: http://www.ft.lk/2014/05/26/sri-lankas-external-debt-sustainability-complacency-based-on-incomplete-analysis-may-be-the-worst-enemy/; second: http://www.ft.lk/2014/06/23/central-bank-clarifies-on-debt-sustainability-but-it-begs-more-questions-than-the-ones-answered/; third: http://www.ft.lk/2014/07/07/central-bank-does-it-again-shoot-the-messenger-while-ignoring-the-message/.
The intervention of Practical Economist who has admitted that he was the very same Practical Economist who had an interesting exchange with this writer earlier on Sri Lanka’s output gap is welcome for three reasons.
Even stupid arguments should be welcome since they create a live debate
First, Practical Economist has brought the debate back to life preventing it from having a natural death for lack of reader interest. Sri Lanka’s public at large has of late become apathetic to many issues concerning them. Their silence has been dangerous to the working of the democratic system. To make democracy work, people should speak out openly, agreeing or disagreeing, on vital issues.
This writer recalls a piece of advice given by Professor Michael Jones-Lee of UK’s University of York in 1976 when the students were passively silent in his classes. He said: “You may have the most stupid point, but don’t hesitate to present it because it’ll help us to resolve it together and become wiser.” Thus, in a democracy, even the most stupid argument to of a dissenting citizen should be preferred to the silence of a population.
Criticism helps self-correction
Second, Practical Economist has helped this writer revisit his articles and compare notes in the light of the counterpoints raised by him. The purpose of intellectual debates in civilised societies is not to win them by crushing the opponents but to gain wisdom. This can be done only when criticisms are entertained. It will enable all those concerned to correct themselves if they had been erroneous.
A neutral judge should look at both pluses and minuses
Third, Practical Economist has claimed that his is an exercise to look at the debate ‘with neutral glasses’. That is also welcome because in any debate there should be a neutral arbiter to adjudicate the issues that are being presented by debaters. However, such a neutral judge should possess certain qualities which have been stipulated by the Buddha in Brahmajala Sutta in Digha Nikaya in his advice to Bhikkus angered by those talking ill of him.
The Buddha has said: “Don’t get angry when others talk ill of me; examine carefully their arguments and tell them that in this sense they are correct and in this sense they are incorrect.” Accordingly, an arbiter wearing neutral glasses has to weigh evidence involving both pluses and minuses presented by the debating parties and come up with a balanced stand refraining from defending one side and finding fault with the other. A neutral arbiter does not do justice to the exalted role he has assumed unless he possesses these qualities.
Is Practical Economist neutral?
Practical Economist has, however, not examined the arguments and counterarguments in the debate the way a neutral arbiter should have done. He, like PDD, has not answered the vital questions raised by this writer in the articles mentioned above. Instead, he has presented his own reasons as to why this writer has been incorrect, raising questions unrelated to the issues at hand such as a presumed political bias of this writer and thereby colouring his neutral glasses.
Need for forward-looking indicators
Practical Economist has argued that international organisations like UN ESCAP or IMF present only broad guidelines and therefore they do not fit perfectly into a country’s specific situation. UN ESCAP indicators, he says, are not forward-looking but based on historical facts. Thus, he unknowingly condemns PDD’s approach.
In contrast, Debt Sustainability Analyses conducted by IMF and World Bank are more forward-looking since they take into account different scenarios of shocks involving changes in exchange rate, interest rates and output levels. That was exactly the point which this writer too has made.
"Practical Economist has justified Sri Lanka’s high debt/GDP ratio by quoting countries from the developed world which have even higher debt to GDP ratios. The countries quoted include USA (98%), UK (373%), Canada (73%), Australia (86%), Germany (373%) and New Zealand (111%). This is a dangerous comparison because all these countries are in a position to issue foreign debt in their own currencies and therefore could repay those borrowings by printing their own money. Sri Lanka, to the contrary, has to borrow in foreign currencies, mainly in US dollars, and therefore cannot print dollars to repay those loans. A more appropriate comparison would have been with countries of similar status like Thailand, Malaysia, Indonesia, Bangladesh, India and China where external debt to GDP ratios are much lower than Sri Lanka’s 60% ranging between 10 and 35%"Remittances first to be used to pay for imports
PDD, having relied on historical analyses which are now discarded by Practical Economist, had used a wrong set of data to inform the public that Sri Lanka has “continued to improve its external debt sustainability indicators” as per the UNESCAP indicators prescribed in the Manual on Effective Debt Management.
Two issues were raised by this writer: First, PDD cannot claim that the country’s external debt sustainability has improved just by taking into account only the central government’s external debt; second, even the numbers relating to the central government’s external debt and parameters used for calculating indicators have not been in accordance with the recommendations of UNESCAP Manual.
One area of contention was the use of remittances as a parameter for calculating the debt sustainability of the country. Practical Economist says that it is quite right for Sri Lanka to include remittances as a steady flow of foreign exchange since they are available to service its debt, an apparent justification of what PDD had done stealthily violating the Bank’s governance code. But when a country has a massive trade deficit exceeding this steady flow, remittances are first used to buy imports thereby weakening the cushion it may provide to service external debt. Since Sri Lanka cannot crunch imports, external debt has always been repaid by reissuing the same or by borrowing new funds. Thus, Central Bank’s Economic Research Department consisting of theoretical economists has very correctly chosen not to view remittances in this sense.
Results of the debt vulnerability yardstick not encouraging
This writer too, like Practical Economist, argued that the country should go for a forward-looking debt vulnerability yardstick rather than historical indicators.
This is what this writer said in his first article on the subject: “There are many other indicators suggested by both the UN ESCAP Manual and IMF’s External Debt Statistics to assess a country’s external debt sustainability. One such indicator used by ESCAP in its Economic and Social Survey for 2013 is the External Debt Vulnerability Yardstick (p 32). In this Yardstick, the sum of short term external debt, quarterly imports based on four quarter moving average and estimated international portfolio investment is expressed as a percentage of the external reserves of a country. It thus measures the number of times a country’s short term obligations are bigger than its available foreign reserves. By using the numbers reported in the Central Bank Annual Report for 2013, this yardstick was calculated in respect of 2012 and 2013. It amounted to 197% and 188% in the respective two years placing Sri Lanka in the category of most vulnerable countries.”
Thus, there is no difference between Practical Economist and this writer about the need for using appropriate indicators for assessing the country’s external debt sustainability.
Commercial borrowings should be used productively
Practical Economist has argued that when Sri Lanka’s income is rising, there is no danger of the country going for commercial and non-concessionary borrowings.
This writer agrees subject to qualifications. In his first article, he wrote: “This is not to suggest that commercial and non-concessionary borrowings are undesirable for Sri Lanka. The country’s savings – partly due to low private savings and partly due to government’s excess consumption over revenue, a situation called government’s dissavings – are around 18 to 20%. But its investment requirements are between 30 to 35%. Hence, the consequential massive savings-investment gap has to be financed by using the savings of foreigners, mobilised through borrowing and direct investments. Borrowings add to country’s debt, while direct investments don’t. However, direct investments have been at a very low level – less than $ 1 billion on average – generating a little over 1% of GDP. The country does not get worthwhile foreign direct investments due to its poor track record in several key areas: protection of property rights, rule of law, law and order and ease of doing business. Hence, the only source available for maintaining a high investment ratio is to generate funds from foreigners through borrowing and there-again, borrowing from commercial markets. However, since the foreign commercial borrowings increase the country’s risk and reduce its debt sustainability, they should be used only in projects that are voted as high priority after carefully conducted cost-benefit analyses. But if they are used in low yielding projects that have been chosen haphazardly, then, such foreign commercial borrowings increase only the country’s risks.”
It appears that the learned Practical Economist has missed this point.
Danger of condemning critics without knowing facts
Practical Economist has also made sweeping statements not relevant to the issue at hand or substantiated by actual facts. He has said that in the past there had really been situations where the country had got into external debt vulnerability and the economic advisors in those times had not advised the then governments of the imminent debt crises. He has expressed his surprise why this writer did not see the unfavourable macroeconomic and external debt situation in the country in 1989 as alarming.
During this period, this writer was only a Deputy Director of Economic Research in the Central Bank and not in the privileged position of serving as an economic advisor to the then government. But in a paper he published in the Central Bank Staff Studies (Vol 16, No 1 & 2 – April-September 1986) under the title ‘External Debt Management Strategies: The Case of Sri Lanka,’ he warned the policy-makers not to be guided by not-so-bad past indicators but be alert to the emerging critical situation when the debt issues are examined from a forward-looking perspective.
This is what he said in that paper: “Sri Lanka’s indebtedness to the outside world continued to rise in nominal terms in the 1980s in response to a high investment program implemented after the adoption of the open economy policies by the country in 1977(.....) Accordingly, Sri Lanka’s outstanding external debt rose from SDR 1322 million in 1980 by about three-fold to SDR 3361 million in 1987 raising the debt/GDP ratio from 45% to 74%. The worrisome implications underlying the increased indebtedness were felt by the country toward the middle of the decade, when the signs of a general slowing down of the economy was witnessed after 1986.” (p 104).
His recommendation in the paper was that the country should not go for risky commercial borrowings and instead use non-debt sources like foreign direct investments to meet the foreign exchange demand and boost the economic growth (p 134). These two recommendations perfectly fit into the current situation in Sri Lanka.
When revenue account in deficit, borrowings are used for consumption
Referring to another historical fact, Practical Economist has exclaimed: “It is now well-known that Sri Lanka borrowed $ 792 million from the USA at high rates of interest to buy wheat to eat bread from 1965 to 2001!” His reference here is to the famous PL 480 arrangement which Sri Lanka had with USA to get wheat flour from that country to meet Sri Lanka’s chronic and acute food shortage especially during 1970-77. This was done under counterpart agreements whereby Sri Lanka paid for such wheat imports by maintaining a rupee deposit account in the Central Bank. Thus, there was no immediate payment of foreign exchange by the country.
The allegation made by Practical Economist is a point initially made by a top policy-maker at various public forums apparently in an attempt at demonising past administrations. It appears that Practical Economist has copied it without giving due credit to that policy-maker or reference to the present situation. The present situation is that the Government runs a deficit in its revenue account where the Government’s consumption exceeds its revenue. Therefore some of the borrowings even today are used for consumption. Without drawing on the wisdom of theoretical economists one cannot say which is worse: eating American bread or spending on wasteful Government consumption.
Sri Lanka cannot print dollars to repay debt
Practical Economist has justified Sri Lanka’s high debt/GDP ratio by quoting countries from the developed world which have even higher debt to GDP ratios. The countries quoted include USA (98%), UK (373%), Canada (73%), Australia (86%), Germany (373%) and New Zealand (111%). This is a dangerous comparison because all these countries are in a position to issue foreign debt in their own currencies and therefore could repay those borrowings by printing their own money.
Sri Lanka, to the contrary, has to borrow in foreign currencies, mainly in US dollars, and therefore cannot print dollars to repay those loans. A more appropriate comparison would have been with countries of similar status like Thailand, Malaysia, Indonesia, Bangladesh, India and China where external debt to GDP ratios are much lower than Sri Lanka’s 60% ranging between 10 and 35%.
Need for reading IMF statements between the lines
Practical Economist has also claimed that none of the international agencies like IMF or World Bank or rating agencies has warned Sri Lanka about an imminent external debt crisis. The reports submitted by these agencies have to be read with two qualifications.
First, Sri Lanka is also a shareholder of these institutions and therefore they use a diplomatic language to communicate their concerns to ‘their own owner-masters’. They do not use cynical phrases like ‘letting the cat out of the bag’ in order to stress their point. Hence, one has to read between the lines to really understand what they communicate.
Second, their reports use technical language based on rigorous economic concepts to communicate their views and unless one is conversant with those theoretical concepts, he is unable to gauge their true meanings. This is like a laboratory report on a patient that can be read properly only by a qualified physician. This shows the deficiency with which one suffers if he has no sound-footing in theoretical economics.
IMF has indeed alerted the Government
The recent reports issued by IMF do not support the claim made by Practical Economist. In its Article IV Consultation Report in May 2013 (available at: http://www.imf.org/external/pubs/cat/longres.aspx?sk=40539.0), IMF Mission has assessed the foreign reserve adequacy as well as the external debt sustainability under different scenarios.
About foreign reserve adequacy, IMF in its usual polite and technical language has observed that though reserves have increased “coverage still appears somewhat low when judged several commonly used metrics” (p 14). These metrics have been reported in a small diagram on the same page. Accordingly, in terms of Sri Lanka’s short term debt amortisation needs and going by the virtual fixed exchange regime being currently practised, foreign reserves are totally inadequate prompting IMF to advise that external position needs further “strengthening”, the diplomatic language which it uses to alert its owners.
As for external debt sustainability, Sri Lanka’s stress testing, a forward-looking measure of risk assessment, does not report a healthy picture if the exchange rate depreciates or interest rates increase or growth rates falter (Appendix on Debt Sustainability Analysis in the Report). Theoretical economists know that these are real possibilities that do not permit policy-makers to be complacent.
Caution about commercial borrowings by IMF
About commercial borrowings, the then IMF’s Resident Representative, Koshy Mathai, in a press briefing on 3 December 2013 (available at: http://www.imf.org/external/np/tr/2013/tr120313.htm) has confirmed this writer’s stand. He said that commercial borrowings “have to be done in a prudent way, the rates have to be looked at carefully, and—as we (IMF) emphasise in the report—the returns that are gotten on the investments financed by those borrowings have to be sufficient to cover the borrowing costs. That simple idea always has to be kept in mind”.
These are very polite statements and their real meaning between lines has to be read correctly before claiming that IMF has not put Sri Lanka on alert.
About rating agencies, Sri Lanka has been continuously rated below ‘junk bonds,’ alerting investors that there is a high probability of loan default.
Fallout from Practical Economist
The previous PDD press releases were indictments against the Monetary Board and senior officers of the Central Bank, respectively. The intervention of Practical Economist who has taken pride in being practical and not theoretical is apparently an indictment against Central Bank economists who are technically-sound professionals with mastery of theoretical economics.
(W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected])