Wednesday, June 29, 2022
Home > Events > Sri Lanka’s Foreign Debt & Reserve: Are they dropping to alarming levels?

Sri Lanka’s Foreign Debt & Reserve: Are they dropping to alarming levels?

Since 2014 our country’s foreign debt began a sharp rise, reaching 42.9% of the country’s GDP in the year 2019. The onset of COVID-19 pandemic induced global recession accelerated the crisis and by 2021 the foreign debt rose to 101% of the nation’s GDP causing an economic issue. Foreign reserves are assets or claims that a country holds in a foreign soil. These assets fall into a wide variety of instruments ranging from short-term claims in money markets to long-term investments. In Sri Lanka, the Central Bank of Sri Lanka (CBSL) is the sole authority empowered by law to manage the international reserves of the country. This article attempts to overview present foreign debt and reserve crisis in the country and examine possible solutions for minimise the crisis.
Good History
During the early years of 1950, Sri Lanka had a large amount of foreign reserves accumulated due to the rubber and tea price boom with the Korean War. It declined from US dollars 233 million in 1956 to US dollars 90 million by 1960. Reserves declined further to US dollars 42 million in 1970, which were sufficient to finance 2.1 months of imports. In 1975 reserves stood at US dollars 57 million, which were sufficient to finance imports by 1.7 months. Reserves position of the country improved by 1976 to a level sufficient to cover 3 months of imports. In 1977, Sri Lanka unified its exchange rate with a currency depreciation and moved to a system of managed floating with a partial liberalisation of external trade and payments. In this environment during the post 1977 era, there has been a substantial expansion and diversification in the country’s external transactions. Sri Lanka diversified the currency basket of the reserves to include French Franc, Japanese Yen and Deutsche Mark. Further, it managed to increase its foreign reserves from US dollars 278 million in 1977 to US dollars 2,029 million by end 1997, which was sufficient to finance 6.4 months of imports. However, external reserves declined continuously from 1997 to reach US dollars 1,049 million by end 2000 largely owing to the escalation of war requiring higher expenditure on imports, higher petroleum prices and slowing down in export earnings. Reserves reached US dollars 3,500 million in 2007 and the Bank commenced assessing alternative investment opportunities. However, reserves declined sharply to US dollars 1,300 million by early 2009 as foreign investors in sovereign securities withdrew their investments. However, with the ending of war and Stand-by Arrangement (SBA) facility with IMF, reserves improved sharply and by October 2010 it stood at an unprecedented level of US dollars 7 billion.
Present Situation: Is it really a crisis?
With the rapid economic growth Sri Lanka has transferred from a low-income country to a middle-income country. While this is progress for a country, it also means that Sri Lanka can no longer access concessionary loans by multilateral agencies and bilateral donors. This means that the land which Sri Lanka had in the 90’s had way better terms and conditions and was sufficient enough for the country to pay than it has now. However, reality is beyond the expectation, as we observed the real facts in the country. Sri Lanka foreign exchange reserves was measured at 3.6 billion US dollars in June 2021, compared with 3.5 US dollars billionn in the previous month. Sri Lanka foreign exchange reserves data is updated monthly, available from 1956 to date. The data reached an all-time high of 9.0 billion US dollars in April 2018 and a record low of 38.0 million in April 1970. Leading up to 2021, several rating Agencies downgraded Sri Lanka’s sovereign credit ratings: Standard and Poor’s downgraded Sri Lanka’s sovereign credit ratings to CCC+/C from B-/B, Moody’s downgraded Sri Lanka’s “long-term foreign-currency issuer and senior unsecured ratings” to Caa1 from B2, while Fitch Ratings downgraded Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to CCC from B. All these moves indicate concerns about Sri Lanka’s ability to fulfil foreign debt repayments.
Present Strategies:
Are they rational?
Export restriction
At the moment one of the biggest economic issue is foreign currency maintenance in the country. The government has proposed new policies to limit the ways of foreign currency outflow from the country. This is possible short-term action in order to keep the currency within the country for gain short term economic stability. Due to the ongoing pandemic, the government was able to restrict a number of imports, including the halt on the vehicle import assisted in reducing the foreign currency outflow. Back in 2020 alone, this managed to reduce the outflow by $3.9 billion, which is a 20% more reduction than the year before.
This also resulted in a roughly $2 billion drop in the trade debt. In 2020, fuel imports were reduced by $1.35 billion, accounting for more than 60 percent of the trade deficit reduction. However, due to increase of oil prices in the global market, the fuel import bill has increased in 2021 and putting further pressure on foreign reserve in 2021. The strategy of managing foreign debt through curtailing imports is not a sustainable solution for our country since more than half of imports are intermediary and capital goods. The continuous restriction of imports will curtail economic growth. which is not something that Sri Lanka can afford right now.
Currency Swaps: is its good option?
New government’s strategies have mainly focused on import restriction and currency swaps. A currency swap is an agreement in which two parties exchange the principal amount of a loan and the interest in one currency for the principal and interest in another currency. At the inception of the swap, the equivalent principal amounts are exchanged at the spot rate. Recently Bangladesh cleared a $200 million currency swap facility for Sri Lanka, to help boost our economy, becoming the first South Asian country to extend crucial financial assistance to Sri Lanka. In 2021, Sri Lankan government has obtained financial assistance from China, through a $1.5 billion currency swap arrangement, and a $500 million loan, in addition to the 4,500 million extended last year.
Sri Lanka has inked a deal to borrow 500 million US dollars from the EXIM Bank of Korea for projects from 2020 to 2022, at rock bottom interest rates and it will provide loans of up to 40-year payback with 10-year grace at rates of 0.15 percent and 0.20 percent. India also extended a $400 million currency swap facility from the reserve bank of India and it was settled in February 2021. The SAARC Finance SWAP facility from the Reserve Bank of India of USD 400 million expected in August 2021, and the special SWAP facility of USD 1,000 million being negotiated with the Indian counterpart. These are in addition to the receipt of around US dollars 800 million under the IMF SDR allocation expected in August 2021, and the Central Bank purchases of export proceeds and worker remittances from the market, which would help the Central Bank to build Official Reserves through non-debt inflows of around USD 700 million annually in the period ahead. However all those swaps facilities need to be re-paid timely with interest rates.
Modern Monitory Theory – Is slipping deeper into imbalance?
While looking at the whole situation with the eyes wide open and informed, the whole debt situation with Sri Lanka seems to be even more worrisome than it was in the 90s and is more hopeless than before. Since the country will have outstanding sovereign bonds reaching maturity every year up to 2030, the country will have to spend a significant amount of foreign currency earnings to repay these commercial loans. The only sustainable solution lies in addressing the structural weaknesses of the economy and cannot solve using short term solutions. To resolve the debt crisis, Sri Lanka needs a credible fiscal plan and monetary policy, taxes have to be hiked in order to repay debt and interest rates and opening of imports will allow taxes to flow back to the Treasury. While it is possible to raise rates and generate dollars to repay foreign debt by curtailing domestic credit, it is not practical to do it on an ongoing basis for many years. According to economist Bell wether “To solve Sri Lanka’s ‘budgetary problem’ in repaying debt, Treasuries auctions have to succeed. When that is done, the ‘transfer problem’ of foreign exchange will be automatically solved. But this is beyond the ken of Keynesians. Instead with failed Treasury bill auctions filled with printed money Modern Monitory Theory (MMT) the country is slipping deeper into imbalances”. MMT says that governments create new money by using fiscal policy and that the primary risk once the economy reaches full employment is inflation, which can be addressed by gathering taxes to reduce the spending capacity of the private sector. However, this leads to significant BOP vulnerabilities. Consequently, even if the foreign debt-to-GDP ratio is less than what it was two decades ago, Sri Lanka’s vulnerabilities are a lot more severe and alarming, because the debt dynamics of the country have completely shifted to a new paradigm. Besides, it was evident that, Sri Lanka has requested financial assistance from China which is something that might worsen the situation even more. The solution of borrowing money from China does not seem to be a solution at all.

Prof. Aruna Shanthaarchchi,
Professor in Economics
Department of Economics and Statistics – Sabaragamuwa University of Sri Lanka

Leave a Reply

Your email address will not be published. Required fields are marked *