Debt dilemma

Monday, 5 October 2020 02:20 -     - {{hitsCtrl.values.hits}}

  • Govt. settles $ 1 b ISB on Friday
  • Says market sentiment strengthening owing to positive developments
  • Renews commitment to honour all debt obligations
  • Annual external debt repayment commitments falling due in medium term projected to be around $ 5-6 b on average
  • Debt-to-GDP ratio to be reduced to below 70% by 2025 from 86% at present
  • Reduction in interest rates helps Rs. 115 b in savings in the first eight months from Treasury bills and bonds 
  • Rs. 200 b saving envisaged by year end
  • Advocata predicts 2020 worst-case scenario of debt to GDP ratio of 99.7% and best-case scenario at 93.3%
  • Moots centralised public debt office under the Treasury; fast-track of Central Counter Party
  • Calls for adoption of electronic market for Govt. trading, absence of which leads to weak price discovery and transparency

The Government on Friday settled $ 1 billion of maturing International Sovereign Bond (ISB) reinforcing its commitment to honour all commitments as well as reduce the debt to GDP ratio to 70% by 2025.

In a brief statement the Central Bank said late Friday that it successfully completed the settlement of the maturing International Sovereign Bond of $ 1 billion along with the due coupon payments, on behalf of the Government.

“This settlement reconfirms the Government’s unwavering commitment to honour its foreign liabilities, thereby bolstering investor confidence and dispelling any concerns foreign investors may have in relation to the Government’s ability and willingness to maintain its unblemished debt servicing record,” the statement said.

“The domestic foreign exchange market has already reacted positively to this settlement and other recent positive developments in the 

Sri Lankan economy.

With the envisaged inflows to the domestic foreign exchange market supported by proactive measures taken by the Government and the Central Bank, the market sentiment is expected to further strengthen in the period ahead,” the Central Bank added.

Early last week the Government emphasised its commitment to reduce the debt to GDP ratio to below 70% by 2025 after it rose from recent years to 86.8% by end 2019. In 2018 it was from 83.7% and 2016 the ratio was 79%.

The assurance was jointly given by State Minister of Money and Capital Market and Public Enterprise Reforms Nivard Cabraal, Treasury Secretary S.R. Attygalle, and Central Bank Governor Prof. W.D. Lakshman at a media briefing. 

The Government said strategic initiatives to gradually reduce foreign debt and cost of financing have already begun to yield results. 

In 2020 so far substantial savings from new debt contracts in domestic financing have been achieved with significant reduction in interest rates.

It was revealed last week that savings in the first eight months of 2020 from Treasury bills and bonds alone amounted to Rs. 115 billion. By year end, a savings of Rs. 200 billion is expected with the planned issuances and other public debt contracts.

Central Bank in 2020 so far has cut policy rates by 250 basis points and Statutory Reserve Ratio (SRR) by 300 basis points.

The Government also said the exchange rate stability has also impacted the debt stock favourably whilst average time to maturity is expected to length. 

Think tank Advocata Institute last week put total outstanding Government debt at Rs. 13 trillion or 86.8% as at end 2019. In nominal terms debt rose by 8.3% in 2019. The debt comprised of Rs. 6.4 trillion of foreign owned and Rs. 6.6 trillion as domestic.

Advocata warned that Sri Lanka's debt ratio was significantly higher than peers, such as 34% by Bangladesh, 39% by Philippines, 42% by Thailand, 55.6% by Malaysia and Vietnam, and 68% by India.

The Government debt relative to revenue too has gone up to 686% for Sri Lanka in 2019 from 560% in 2016, where as it ranges from a low of 197% (Thailand) and a high of 344% (India) within select Asian countries. 

The rating agency Moody's last week downgraded Sri Lanka's rating to Caa1 from B2 signalling issues with the country's debt sustainability. This year Sri Lanka's foreign debt service forecast is $ 4.2 billion. 

Advocata said in a worst-case scenario for 2020, the debt to GDP ratio is expected to be 99.7%, and a best-case scenario at 93.3%.

It said maturity of domestic debt has been pushed back while that of foreign debt has been brought forward with domestic debt taking a larger proportion of government debt service obligation.

Another observation was ISB’s were issued until 2019 June at high coupon rates. 

During 2019 the Government raised $ 4.4 billion through the issuance of ISBs twice.

The first exercise of 13th ISB raised $ 2.4 billion in March 2019 and comprised two tenures of $ 1 billion with a five-year maturity at a yield of 6.85% and $ 1.4 billion with a 10-year maturity at a yield of 7.85%. 

In June 2019, ISBs amounting to $ 2 billion were issued, which comprised $ 500 million with a five-year maturity at a yield of 6.35% and $ 1.5 billion with a long 10-year maturity at a yield of 7.55% per annum.

Advocata also said current deficit financing mainly through Government securities mainly Treasury bills.

According to Central Bank Government debt to GDP ratio increased to 86.8% in 2019, reflecting the impact of higher net borrowings to finance the enlarged budget deficit, while the relatively low nominal GDP also contributed to increase the debt to GDP ratio. 

In absolute terms, the outstanding central government debt increased by 8.3% (Rs. 1,001 billion) to Rs. 13,031.5 billion at end 2019 in comparison to the increase of 15.9% (Rs. 1,647.7 billion) recorded at end 2018. The share of domestic and foreign debt as a percentage of GDP rose to 44.1% and 42.6%, respectively, at end 2019 from 42.3% and 41.5%, respectively, at end 2018. Of the increase of the debt stock, a sum of Rs. 93.6 billion can be attributed to the discount factor, which is the net amount of the difference between the book value and the face value of issuances of Treasury bills and Treasury bonds in 2019. 

The parity variation contributed to an increase of Rs. 12.4 billion of the central government debt stock in 2019 compared to the notable increase of Rs. 1,063.2 billion in 2018.

The outstanding public debt, which includes the debt of central government, foreign project loans received by SOBEs and public guaranteed debt, increased to 94.3% of GDP at end 2019 from 91.7% of GDP at end 2018. This was mainly due to an increase in central government debt during 2019. 

In absolute terms, the total outstanding public debt increased to Rs. 14,155.3 billion at end 2019 from Rs. 13,178.4 billion at end 2018. The outstanding central government debt, which is the largest share of public debt, increased by 8.3% to Rs. 13,031.5 billion at end 2019, accounting for 92.1% of the total public debt. 

Putting debt sustainability under spotlight last week Advocata said Sri Lanka needs to implement several key reforms. 

One was a centralised public debt office under the treasury and the adoption of electronic market for Government Securities trading absence of which leads to weak price discovery and transparency.

It also said lack of large-scale retail participations (approximately 40,000 active CDS accounts) was another drawback whilst the need to fast-track the implementation of Central Counter Party (CCP) was another recommendation. 

Advocata also said Sri Lanka Development Bonds (SLDBs) need to be dematerialised and made fungible by issuing based on price not yield.

Prof. Ricardo Hausmann from Harvard University speaking at ‘Deep Dive,’ virtual conference organised by Advocata Institute said the more important measure is to look at the interest burden to tax revenue as opposed to the commonly cited debt to GDP ratio. 

"I think it's unfortunate that people talk about debt to GDP ratio, instead they should be talking about interest burden to tax revenue ratio. Japan has a debt to GDP ratio of 230%, and it's all contracted at zero interest rate. 230% at zero interest rate, you have to raise zero taxes to pay for that. 86% debt at 7% interest rate, you're talking about almost 6% of GDP in interest burden compared to Japan that has to pay zero.”

Sri Lanka has one of the worst interest burdens to tax revenue measures in the world, according to Professor Hausmann.

Early this year, the Central Bank via its 2019 Annual Report warned that increasing foreign debt servicing obligations could pose risks to Sri Lanka’s macroeconomic stability in the medium term, requiring urgent measures to enhance the country’s foreign exchange earnings continued with measures to discourage excessive expenditure on non-essential imports. 

Following Sri Lanka’s graduation to the middle income category as per the IMF classification in 2010, the availability of concessional foreign financing declined rapidly.

Moreover, Sri Lanka’s recent advancement to the upper middle income country status is likely to restrict access to concessional funding sources further. 

The composition change in Sri Lanka’s foreign debt profile with a shift to costlier commercial borrowing from concessional borrowing requires prudent management of the debt profile to ensure external debt sustainability. Furthermore, annual external debt repayment commitments falling due in the medium term are projected to be around $ 5 to 6 billion, on average. 

In this context, Central Bank envisaged that Sri Lanka would need to rollover the existing debt by issuing ISBs and syndicated loan facilities from international financial markets.

These commercial borrowings are generally characterised by higher interest costs together with relatively short maturities than concessional sources. Rising foreign debt obligations could exert pressure on international reserves, the exchange rate and fiscal operations, it said. 

Along with the active liability management framework, Central Bank stressed it was vital that fiscal consolidation efforts are continued through improved revenue mobilisation and prudent spending while adopting sound fiscal rules to ensure overall public debt sustainability as well as external debt sustainability. Further revisions to Sri Lanka’s sovereign rating could result in raising the cost of rolling over the increased commercial debt stock in the period ahead.