Debt restructuring: Between a rock and a hard place?
Dhananath Fernando
16, January 2022
7 min read
Originally appeared on The Morning
By Dhananath Fernando
According to news sources, the President has requested the Chinese Foreign Minister to assist Sri Lanka in restructuring our debt. The Finance Minister too has indicated to Japan and India, our long-standing bilateral partners, the need for more assistance to overcome the economic crisis Sri Lanka is going through.
In a recent press conference, the Central Bank of Sri Lanka (CBSL) Governor also mentioned that discussions for a new loan from China to restructure our debt is underway.
However, it seems that the President and the CBSL Governor have given the term ‘restructuring’ two different meanings. One as run by the Global Times, the Chinese Communist Party-run newspaper, which said: “After President Rajapaksa’s request to restructure debt, Song Wei, a research fellow at the Chinese Academy of International Trade and Economic Cooperation stated that interest-free loans offered by the Chinese Government are applicable for debt relief while the concessional loans raised through the market cannot be written off.”
However, as measures for debt restructuring, the CBSL Governor suggested taking more swap agreements, paying International Sovereign Bonds (ISBs) and bilaterally skewing our debt profile from market borrowing. Considering all this, we are yet to know what would be the final decision.
In Sri Lanka’s external debt profile as at the end of 2020, about 57% was borrowed from financial markets (34% from ISBs and 8% from China Exim Bank).
In my view, we cannot evaluate debt restructuring without really understanding the problem. The issue at hand is that Sri Lanka borrowed money in US Dollar terms with a short maturity at high-interest rates and invested in assets on non-revenue generating non-tradable assets. As a result, we had to borrow money at even higher interest rates to service the interest of previous debts which has snowballed to a point where Sri Lanka has lost access to capital markets.
So the choices are not between ‘good’ vs. ‘bad’. The choices are between ‘worse’ vs. still ‘worse’. That is why it is called an economic crisis. Either measure will result in a catastrophic impact on the people of Sri Lanka. So in this context let us evaluate debt restructuring.
The objective of any debt restructuring is to avoid a similar situation in the future and ensure sovereign debt sustainability. So a debt restructuring plan without an economic reform plan to improve competition, trade, and efficiency of the economy will not bring us any sustainable solution. Rather, it will worsen the situation.
Secondly, debt restructuring is also a very difficult process for a country like Sri Lanka with a limited resource base. Countries such as Argentina and Ecuador defaulted but they have large reserve bases including oil to get back on a path of recovery. But Sri Lanka is a small $ 82 billion economy with no experience on debt restructuring.
Debt restructuring is not an easy process given Sri Lanka’s debt profile. Usually, senior creditors such as the International Monetary Fund (IMF), the World Bank, and the Asian Development Bank (ADB) are unlikely to restructure debt as it is provided at a concessional rate and with a longer maturity period. In restructuring multilateral debt, generally, a new programme would be introduced to recover the previous debt.
Restructuring bilateral debt is complicated. The debt of Paris Club members has to be negotiated at the Paris Club. Australia, Austria, Belgium, Brazil, Canada, Denmark, Finland, France, Germany, Ireland, Israel, Italy, Japan, South Korea, the Netherlands, Norway, Russia, Spain, Sweden, Switzerland, the UK, and the US are the members of Paris Club. So any bilateral debt restructuring from the above nations have to be at the Paris Club. According to data, 10% of our creditors are members of the Paris Club, with Japan being the main bilateral creditor for Sri Lanka.
Our debts with China and India, who are not Paris Club partners, have to be negotiated outside the Paris Club. Generally, any bilateral creditor would not agree to single-handedly bear the entire restructuring loss of one particular country. They will request other partners to assist. Even in the case of China, according to NewsIn Asia, Long Xingchun, a senior research fellow at the Academy of Regional and Global Governance of the Beijing Foreign Studies University, stated that restructuring loans with China alone is insufficient to help the island nation tide over its difficulty, which needs a package plan with other involved parties.
The geopolitical situation in Sri Lanka will give way to more geopolitical externalities in debt restructuring with bilateral partners. But it seems we have to move towards that direction as we have very limited alternatives at hand.
Additionally, bilateral partners will also request to share the debt burden with commercial creditors including ISB holders. This is because in debt restructuring, the main objective is to distribute the loss as much as possible.
Restructuring commercial debt has to be dealt with by international law and it is somewhat an expensive and time-consuming process to reach a consensus with all creditors. According to global debt restructuring expert Prof. Lee Buchheit, it can take about nine months to a few years based on the profile of the debt.
In debt restructuring, there are four parameters generally considered.
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Reducing debt stock or principal amount commonly known as haircuts
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Adjusting the interest rates to be paid or coupon rates commonly known as coupon adjustment
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Extending the repayment or maturity period
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Mix and match of all above
The general practice is creditors ask to conduct a debt sustainability study of the country before deciding the adjustment or deciding which parameters of restructuring are to be used. The only credible organisation to conduct an independent study is the IMF, and that is why in most of the debt restructuring processes, the countries are under the IMF programme. In Sri Lanka’s case, in the event of a restructuring as our President requested, we have to disclose all debt including the debt owed by the State-Owned Enterprises because the restructuring burden will be calculated across the board.
Creditors are generally very reluctant to restructure debt especially when it is due to financial mismanagement. In case of a natural disaster or a negative externality, the negotiation would be easier compared to a situation concerning economic mismanagement.
So the available choices for Sri Lanka are very limited and every choice may have its own set of consequences. Reserves are declining and people often complain about shortages of essentials and interruption of utilities. Businesses are complaining about the inconvenience of working with banks due to difficulties in opening Letters of Credit (LCs). Creditors and investors are embroiled in suspicion and confusion with constant credit rating downgrades. Debt restructuring will be complicated and an open Sri Lanka for geopolitical sensitivities will affect political stability.
The choices at hand are difficult. This column has continuously highlighted the need for reforms since the beginning of the pandemic with full knowledge that delays will limit the alternatives. We need to shift gears and move forward with hard reforms before people become hard on reforms.
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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.
