In this weekly column on The Sunday Morning Business titled “The Coordination Problem”, the scholars and fellows associated with Advocata attempt to explore issues around economics, public policy, the institutions that govern them and their impact on our lives and society.
Originally appeared on The Morning
By Dhananath Fernando
Parenting a child is a difficult task. It is no doubt that educating and teaching a child takes a significant amount of time and effort for all parents. The bigger the pile of homework, the more it becomes an affair of the household, requiring the attention and time from either parents or caregivers.
Some parents take an easy route; instead of encouraging their child to get the work done, they do it themselves and bestow the child with all the credit. This may be owed to the fact that the assigned task is above and beyond the grasp of a child, or simply because parents can’t afford to allocate the time and effort required to assist their child. Undoubtedly, both reasons are not in the best interest of the child and will certainly hamper his or her learning curve and growth.
Given the above phenomenon, I can’t help but notice similarities between common parenting mistakes and the Sri Lankan economy. Our economy has adopted a habit of conveniently ignoring hard reforms for political motives and instant gratification. This has resulted in long-term damage to the country’s economy.
Moody’s Analytics downgraded Sri Lanka’s credit rating from B2 to Caa1 last week with a “Stable” outlook. While the Government has made a statement expressing their disagreement with Moody’s credit rating downgrade. It is important to understand Moody’s rationale in depth. Long-term measures to correct these problems are vital, and hard reforms may be the only way out.
The effective containment of COVID-19 and the recent performance of the stock market has been reiterated by the Government as part of their success story. Additionally, the rebound of exports and foreign worker remittances are highlighted as positives. The Government has further provided a commitment to reduce the debt-to-GDP ratio, serve all external creditors without delays, and uphold a clean record of debt servicing.
However, Moody’s evaluation, which was in the works since April, highlighted concerns over-servicing debt of about $ 4 billion (between 2021 and 2025) with a reserve level of $ 7.4 billion, along with low growth predictions. Moody’s estimation of raising the debt-to-GDP ratio of 100% exceeding the median of 86% in the Caa1 category has been highlighted as a fundamental reason for the downgrade.
Moody’s downgrade forecasts the possibility of Sri Lanka’s credit rating being further downgraded by other rating agencies such as Fitch and S&P in the coming months. This will thrust Sri Lanka into the “Speculative Grade: Very High Risks” category, raising serious concerns over the possibility of acquiring money in international capital markets. The risk attached to this doubles as the coming years are burdened with heavy debt repayments.
How can this be managed?
Prevalent data highlights that consecutive governments have resorted to borrowing in international sovereign bonds at high-interest rates of about 6.6%, with an average repayment period of nine years. It is no doubt that our economic woes are deep-rooted in these poor policy solutions.
It is vital that we acknowledge the damage caused by these measures and formulate a strategy to overcome it.
The diagnosis is clear – our interest payments take 47% of our revenue and 30% of our expenditure.
The first step to manage this downgrade is to build credibility in financial markets. This is both painful and time-consuming. However, this is not an excuse to postpone much-needed reforms. Doing too little too late would lead to severe consequences, further hampering our debt sustainability.
To build credibility, the Government enjoys the benefit of two main strengths, a key strength being the successful management of the COVID-19 pandemic, which has also been praised by the World Health Organisation (WHO). At the international stage, this can be our ticket for a possible debt restructuring, giving the Government leverage to convince the International Monetary Fund (IMF) of a credible debt restructuring plan.
As per the below graphs, a greater portion of our foreign debt is in international sovereign bonds (ISBs). The IMF programme, of course, will come with conditions which are painful, but it will also bring credibility to Sri Lanka within international financial markets. This will require a commitment from the Government to maintain fiscal discipline. Sri Lanka has spent 42% of the last 70 years under an IMF facility. We have approached the IMF 16 times for bailout programmes. This isn’t a point of pride but indicates how irresponsibly our economy has been managed over the years.
An IMF restructuring programme will not uplift Sri Lanka’s credibility to the point where a credit rating downgrade can be reversed. However, it provides additional confidence for creditors and investors who are looking to invest in high-risk markets even at a premium rate.
The second strength is the Government’s opportunity to present a convincing budget with serious reforms in November. The budget needs to have a comprehensive strategy on improving government revenue and achieving a positive primary balance. (Primary balance is the difference between government revenue and government’s non-interest expenditure.)
Both measures are painful, but the Government has the political capital and political strength to pass through key essential reforms. Unfortunately, although we measure ourselves with what we intend to do, the markets and outsiders assess us with what we have done and continue to do.
Similar to parenting a child and encouraging the child to complete their assigned homework, the path to hard reforms is difficult and time-consuming. But we all need to support and help the Government to carry out these hard reforms, as it is ultimately being carried out for the betterment of our beloved motherland and ourselves.
The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.