A Recent History
Over the recent past, the Sri Lankan general public has shown a great deal of interest in the subject of national debt. This has been due to expressions like the country’s “debt trap” and “debt crisis” used extensively in political debates and propaganda. The government in power as well as the opposition has blamed one another for bringing the country into such a debt trap or a debt crisis. A gripping fear of a possibility of debt default with all its adverse consequences has been widely generated. A generally accepted rule of thumb in measuring the gravity of a country’s debt problem has been to indicate the total outstanding debt as a ratio of the country’s GDP.
In this measure, the level of aggregated debt is related to a concept of total revenue generated during a financial year. Such national debt ratio can be considered equivalent to that of a corporate balance sheet ratio of debt to equity. Figure-1 captures the behavior of Sri Lanka’s Debt/GDP ratio during 2002-18. The data indicates that during key points in time, the debt levels have being significantly higher than what it is now. However, no one spoke of a debt crisis or debt trap at those times of high debt to GDP ratio – e.g. during the early 2000s. In fact, after 2004 the ratio has been generally below 100pct. In most years after 2004, the ratio was indeed below its current debt to GDP ratio of 83pct.
The total debt stock, as at 2018, remains at USD 73.7 billion. Of this the foreign currency debt is USD 36.4 billion – 49pct of total debt or 43.3pct of GDP. The remainder is LKR based debt stock. This is still manageable given that Sri Lanka can always roll over its existing LKR based debt without too much of a problem. The banking sector’s appetite for risk free assets is high and there are the captive sources like EPF and ETF. These indeed have been the natural long term players in debt markets.
Sri Lanka’s Shift to Commercial Borrowings
The portfolio of foreign currency loans is categorized into three sub sections, namely, a) concessional, b) non-concessional and c) commercial loans. Prior to 2013, 85pct of foreign borrowings was on concessional terms (see Figure-2). This has changed in 2009 with Sri Lanka successfully entering the international sovereign bond market in its debut. This also amounted to taking the pressure off domestic financing, which until then was the only source apart from donor funding that was available. The concessional external borrowings from multi-lateral agencies and bi-lateral funding sources have continued to be on a declining trend on a net basis since 2008.
Sri Lanka was pushed into international financial markets mainly due to the fact that concessional funding was not available after the country moved up to a lower ‘Middle Income’ country status from around 2004. In fact, IMF, IDA and the World Bank have taken Sri Lanka out of the “financially vulnerable” country status, on the grounds that the country as a ‘Middle Income Country’ has the ability to access international financial markets. Sri Lanka is not among the group of 37 ‘heavily indebted poor countries’ (HIPC), which are eligible for special assistance from the IMF and the World Bank.
As at 2018, Sri Lanka’s total foreign currency debt portfolio was USD 35.4 billion. Of this only USD 9.1 billion was obtained at commercial rates from financial market sources. The remainder is at concessional and non-concessional development funding rates. In other words 53pct of the foreign loans are commercial/non-concessional.
The foreign currency debt mix is dominated by USD borrowings given that our cash inflows from external revenue sources are also predominantly based in USD. This helps the country to manage any exchange rate volatility, as the matching of cash flows does not impact the debt servicing. In 2017, infact, 61pct of the total foreign debt portfolio comprised of USD, while the next largest was in SDR (20pct) followed by Yen loans (12pct) (Figure-3).
The bilateral debt component in Sri Lanka has contributed to modern infrastructure development much more than multilateral debt (i.e. WB). A closer examination of our foreign debt profile indicates that it has long term maturities. More than 75pct of the loan portfolio is maturing beyond 5 years (Figure-5). Market borrowings comprise only 39pct of the total. Refinancing of debt stock per se is not therefore, an issue. Debt servicing is the main concern.
External Debt Holders
The noise around the China debt trap too has found its resurgence since 2014. Given the investment into capital formation pursued by the then government, these investments were undertaken given the dilapidated and outdated infrastructure Sri Lanka had prior to the war ending. Therefore, such investments were paramount in order to create investor appetite for setting plants beyond the boundaries of the Western Province.
However, the data contradicts the China debt trap rhetoric created by politicians and non-academics as it is unsubstantiated and ill conceived; in fact the largest form of external debt is by way of International Bond issuances, while bilateral borrowings are from the ADB, World Bank, and Japan, while China comes in at 4th place (Figure-6). In this context what is important to understand is that all internal bonds are fungible and hence there is no financing risk but a mere cost of financing the stock of bonds.
Sri Lanka’s export earnings are one important source of cash flow which technically can be used to service the country’s current foreign debt. The higher the potential for foreign currency earnings through exports, the better it is. The country as potential lenders are unlikely then to be over-concerned about the borrower country’s capacity for repayment. International rating agencies would consider it good for Sri Lanka if our export earnings are growing on a year on year basis at a satisfactory rate. This also reduces the foreign exchange exposure attached with rupee based debt servicing.
Sri Lanka’s foreign currency denominated commercial debt as a percentage of exports, continued to show vulnerability as year on year growth of export earnings declined in 2009, 2012 and 2015. The volatility of our merchandise exports continue. The declines in export receipts (i.e. income) have added significant pressure on the ability to service foreign debt. This has made the cash flow conditions for foreign debt management per se challenging. The need is to secure USD cash flows/revenues from revenue generating activities and assets and / or cutting down USD import expenses further. This appears to be the path towards managing our ability to maintain this debt to equity mix.
Foreign Debt Servicing
The ratio of debt service ratio to merchandise exports is the ratio that gives us comfort on the ability to service our external debt payments (i.e. principal + interest). A country’s international finances are deemed healthier when this ratio is low and ranges between 10pct to 20pct. In other words, the lower the ratio the better, as it indicates that the country consumes less of export earnings to pay off its foreign debt. The ratio of total debt service payments to exports is therefore, an important measure of a country’s ability to service foreign currency loans/debt obligations. This ratio had remained well within the stipulated norms of 10pct-20pct from 2011 to 2015. The ratio has deteriorated, moving out of the applicable norm, from 2016reflecting the impact of bunching of repayments on medium term external debt. The decline of this ratio in 2018 reflects the impact of the rise in merchandise export revenues in that year.
By: Dr Kenneth De Zilwa