Why Sri Lanka cannot avoid borrowing from international bondholders in 2028?

Shifting from an economy that is inward and structured towards import substitution into an export-oriented economy is essential 

This is a critical question that Sri Lanka needs to start thinking about now itself. Though, Moodys and Fitch have upgraded us from selective default status, S&P still has Sri Lanka at selective default status. Sri Lanka has yet to come fully out of default status. The year 2028, is when external debt repayments are coming due. What is Sri Lanka’s position?

Why is there no other option but to go back to international bondholders?

From a macroeconomic perspective, Sri Lanka is doing well. It has outperformed expectations with inflation coming down from 70% to deflation point. Its currency is stable and its current account is in the positive. Credit has to go to the present Government for maintaining economic stability. 

Sri Lanka has a large trade deficit of around $ 6 billion annually but this is largely offset by remittances. So Sri Lanka’s current account is set to be positive for this year too. But starting 2028, Sri Lanka is due to repay its external debt obligations which could come out to around $ 3 to $ 4 billion a year as the IMF requires Sri Lanka’s external debt payments to be below 4.5% of GDP. This is where the issue starts. At present, the current account is slightly positive due to a pause in external debt repayments to bilateral and ISB bondholders. But in 2028, payments to bilaterals and bondholders will become due. 

Where can Sri Lanka get the $ 3-4 billion a year starting from 2028 to replay our debt obligations? 

Exports – One option is to get our exports up but this requires structural reforms in trade liberalisation and trade facilitation. We only have two and a half years to go and this is a tough challenge to make the needed reforms and get the industries needed to produce these. 70% of global trade is supplying global value chains of multinational companies. Sri Lanka has missed this bus due to being a protected economy. Even if Sri Lanka immediately starts setting new export industries and liberalising trade, the results will take at least five years to come in. So this is not likely to solve the problems coming in 2028. Our current export industries have limited space to expand exponentially. With the Trump Tariffs and global uncertainty, it will be even more challenging for Sri Lanka to grow its exports in the next three years.  

Cutting imports – The other option is cutting imports by $ 4 billion a year but this will severely slow down the economy and be politically unpopular. 80% of Sri Lanka’s imports are capital and intermediate goods which are needed for local industries to function and restricting imports will bring many local industries to a halt which includes export focused industries which will lead to a reduction in exports leading to an even larger current account deficit. Only 20% of imports are consumer goods. Sri Lanka is already one of the most protected economies in the world so further import restrictions will only affect exports. This will be very painful for the Sri Lankan people. 

Multilateral – This option is also severely constrained as Sri Lanka is a middle income country and it cannot expect such large financing by multilateral institutions such as the World Bank and the Asian Development Bank. Even current multilateral financing is conditional on Sri Lanka’s IMF program to a large extent. 

Other countries – Even during Sri Lanka’s worst economic crisis where there was no fuel for three weeks, 12-hour power cuts, food and medical shortages, no nation other than India came to our aid. Without India’s $ 4 billion in 2022, it is scary to even imagine what would have happened to Sri Lanka. Even in such a situation, we did not receive much from other countries except India’s $ 4 billion. I do not think other countries are going to give $ 3-4 billion every year to us from 2028. India helped us once, but even the Indian government would find it difficult to justify to the Indian parliament on why they should keep giving $ 3-4 billion annually to Sri Lanka. So bilateral borrowing is not an option.

International bondholders – The last option left is going back to international capital markets in 2028 and once again borrowing from ISB bondholders. If we do not take the option of going back to international capital markets, we will have to start repaying external debt using our reserves which according to the IMF projections, will be around $ 13 billion by the end of 2027. This will be a repeat of what happened from 2019 to 2022, when Sri Lanka lost access to international capital markets and we started repaying debt using our reserves. In 2019, Sri Lanka’s reserves were $ 7.9 billion and it only took just over two years to reach bankruptcy. If we try to avoid international capital markets in 2028 and start using reserves to pay back debt, Sri Lanka would be looking at a likely second default by 2032. It can be much earlier than 2032, if Sri Lanka tries to stabilise the currency using the reserves or if there is an economic shock like the Ukraine war, Middle East tensions, Trump tariffs or a drought in Sri Lanka.

Will Sri Lanka have access to international capital markets by 2028?

As I have shown, we do not have much of a choice other than borrowing from international capital markets starting 2028. And if we do not go back to issuing ISBs, we could see a likely second default by the early 2030s. But we are still in selective default by one of the three global rating agencies, S&P. Sri Lanka needs to get to at least B minus to borrow from international bond markets properly and that would be a couple of notches up from the current rating. But even if Sri Lanka gets upgraded to B minus and regains access to international bonds, we would still be borrowing under “highly speculative” bonds which come under junk bonds. This means, these ISBs will have to be borrowed at very high interest rates as they are termed highly speculative. Higher interest rates when borrowing from international capital markets starting 2028, will mean larger debt servicing when these have to be repaid, putting Sri Lanka in further trouble, years down the line. So, Sri Lanka has less than three years’ time to improve its credit ratings.

What is the way out for Sri Lanka?

Sri Lanka should focus on structural reforms to boost economic growth. Structural reforms like trade reforms, regulatory reforms, land reforms, labour reforms and SOE reforms. But the Government should also focus on policies that would grow the tradable sectors which can earn foreign currency. 

Shifting from an economy that is inward and structured towards import substitution into an export-oriented economy is essential. Trade liberalisation and trade facilitation are needed. 70% of global trade is supplying global value chains of multinational companies. Sri Lanka is almost shut out of this trade. For Sri Lanka to enter this type of trade, we need trade liberalisation (more free trade agreements and lower import tariffs) and regulatory reforms. Sri Lanka also needs export focused foreign direct investment, which is what made Vietnam and China into exporting powers. Around 70% of Vietnam’s exports come from companies which have FDI in them. As I mentioned, we cannot immediately become an export oriented economy before 2028 but becoming an export oriented economy will definitely help Sri Lanka gradually move away from needing to borrow from ISB bondholders in the near future. 

Lastly, we need fiscal discipline. Fiscal discipline is key to improve our credit ratings so our borrowing costs are lower. For example, Japan’s debt is around 250% of GDP but Sri Lanka’s is only around 115% of GDP. Japan is healthy in terms of debt sustainability but Sri Lanka is in trouble. Japan’s interest payments are only 6% of Japan’s government revenue while in Sri Lanka it’s around 70% of government revenue. The reason is, Japan’s borrowing costs are low at less than 1% interest rate for 10 year bonds. Another reason is that Japan’s government revenue is 37% of GDP while Sri Lanka’s is struggling to reach 15%. 

Sri Lanka’s future

In my view, we should strategically plan so that Sri Lanka can permanently move away from borrowing from ISB bondholders. But in 2028, we will have no choice but to go to international bondholders. The external financing gap can get higher than $ 3-4 billion because as Sri Lanka’s economy grows, its imports will also grow as Sri Lankan consumers purchase more. The current account deficit may be even close to $ 5 billion in 2028, if exports do not catch up with imports. 

But we do have a choice to avoid going to international bond markets in the long term. Sri Lanka needs to think long term and grow our export sectors so we can reduce the need to borrow from international capital markets in the long term. Southeast Asian nations did this after the 1997 Asian Financial Crisis. Economic security is national security. We have to do the structural reforms, establish strict fiscal discipline, draw in foreign direct investment, develop infrastructure and transform to an export-oriented economy. 

(The writer is an Economist and Director Consulting at Ernst & Young Sri Lanka. He is a regular columnist for the International Monetary Fund and an expert member of the World Economic Forum. The views expressed in this article are strictly the author’s personal views.)