Debt holidays and development

Monday, 27 July 2020 00:07 -     - {{hitsCtrl.values.hits}}

Talks with India to defer debt repayments took a step forward last week as did finalising a $400 million SWAP agreement between the central banks of the two countries. Positive as these steps are in the COVID-19 environment, there is much more that needs to be done by the Government. 

COVID-19 has certainly upset plans for all countries around the world and will pose a myriad of challenges for many months, perhaps even years, to come. Governments are struggling to adapt to the new situation and are rightly concerned about how it will impact vulnerable communities. Sri Lanka, with its high percentage of near-poor, limited revenue streams and large debt, is in a uniquely difficult situation for a middle income country in Asia.

But few people with a genuine understanding of the economy can say that this was only caused on COVID-19. It is true the virus has exacerbated circumstances, but Sri Lanka has been living beyond its means for decades and successive governments are responsible. Eminent economists have argued that Sri Lanka’s track record has been less than impressive since Independence. For decades governments ran up large budget deficits regularly and many opportunities that East Asian countries took advantage of were missed due to bad policymaking and the conflict.

Once the conflict was over the Government borrowed extensively for infrastructure projects, but failed to jumpstart investment and broaden exports. These debts have grown over the last decade and now come to roost. Sri Lanka has to repay $ 3.2 billion from May to December this year including a $ 1 billion bond repayment in October. 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. Struggling with low public revenue, the Government had started slowly rolling back tax concessions it gave in December but COVID-19 forced a change of tactics with a refinancing facility. 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 has received scant attention so far. 

Persistent issues such as 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 chose to take the responsible route.