Sri Lanka bond market dull after FinMin statement on local debt restructuring

ECONOMYNEXT – Sri Lanka’s domestic debt is included in the perimeter of an International Monetary Fund analysis on debt restructuring though some domestic creditors could be ‘ring fenced’ according to a statement by the Finance Ministry.

An IMF debt sustainability analysis has determined that Sri Lanka’s debt is unsustainable.

‘”…[I]n the case of Sri Lanka the perimeter of the IMF DSA includes all public and publicly guaranteed (“PPG”) debt, i.e., external debt (including USD denominated instruments issued under local law), domestic debt (the service of which represents a significant share of our Gross Financing Needs) and SOEs’ debt,” the statement said.

“For this reason, we shall not a priori exclude any particular category of debt from our debt treatment strategy, except as would be seen customary in such exercise.

“However, each category of debt should be looked at from different angles, bearing in mind the potential impact a specific treatment may have on our overall macroeconomic and fiscal framework, and without jeopardizing the capacity of the economy to rebound from the current social and economic crisis.

“Indeed, a deterioration of the overall framework would further deteriorate the debt dynamics, thus requiring a deeper relief to restore long term debt sustainability.”

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The value of domestic debt has already halved due to a collapse do the currency and high inflation and any other will subject them to a second re-structuring.

A key target in an IMF program is to get the annual Gross Financing Need (GFN) down. However the economy inflates, the GFN as well as the debt to GDP ratio falls automatically.

Unlike foreign investors who are unwilling to roll-over debt, domestic holders are rolling over debt. As the economy stabilizes and inflation and interest rates fall interest costs fall.

Outside of domestic currency holders, foreign holders who are denominated in foreign currency however have been promised equal treatment or inter-creditor equity.

The IMF, World Bank and Asian Development Bank would be exempted from re-structuring.

The IMF DSA perimeter also includes central bank swaps.

Sri Lanka is asking for emergency debt given since the beginning of 2022 to be excluded from re-structuring.

“…Authorities are proposing to exclude from the perimeter of debt treatment all emergency assistance credit lines provided since the beginning of the year as well as all swap lines.”

Sri Lanka defaulted on its foreign debt in April 2022. Sri Lanka ran out of reserves after printing money to keep rates down for two years after cutting taxes in 2019 to target an output gap (stimulus).

In five preceding years Sri Lanka’s international sovereign debt soared almost three times from around 5 billion US dollars to 14 billion as the country experienced repeated currency crises while operating flexible inflation targeting with output gap targeting (stimulus) and the country lost the ability settle foreign debt with current receipts.

The Ceylon Petroleum Corporation seperately ran up debts of around 3.0 billion dollars as the country lost the ability to pay for current imports under flexible inflation targeting with stimulus.

Sri Lanka experienced a currency crisis in 2018 despite taxes being hiked and the deficit brought down while operating flexible inflation targeting with stimulus.

Currency crises are problem associated with soft-pegs which are neither a hard peg nor a clean float (now called a flexible exchange rate) that use aggressive open market operation or other injections (mainly sterilizing outflows) to suppress rates despite operating a reserve collecting peg.

Sri Lanka used floating rate style open market operations while operating the flexible exchange rate.

Sri Lanka’s central bank set up in 1950 by a US money doctor in the style of Argentina’s with BCRA with extensive sterilization powers has a history of suppressing rates and triggering currency crises and going to the IMF for bailouts.

Sri Lanka has a long history of printing money to suppress rates and has gone to the IMF 16 times. Such countries can default on foreign debt soon after getting market access and continue to default every two Fed cycles.

Sri Lanka was targeting inflation as high as 6 percent during the last three currency crises, which is more than twice the rate used by more successful inflation targeting countries.

The IMF and Washington policy makers have tried to solve Latin America’s debt crisis – which started to get more acute from 1980 when monetary instability worsened – with various plans but failed as they were unable to contain monetary instability.

Argentina defaults after bouts of sterilized reserve sales and steep currency collapses with debt to GDP ratios of around 60 percent, deficits of 5 percent, while Mexico has defaulted with budget surpluses. (Colombo/Nov02/2022)

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