BANKS SHIELDED FROM DOMESTIC DEBT RESTRUCTURING

Domestic Debt Restructuring is necessary and critical to realign the economy towards recovery and stability, and the government has confined the much anticipated domestic debt restructuring to pension funds while leaving banks largely unaffected, sources privy to the matter told our sister concern EconomyNext.

Provident funds, set to bear the brunt of the restructuring, will receive bonds with coupons that progressively diminish from 12% to 9% over their lifespan. However, the government has sought to mollify pensioners by assuring that returns will not dip below 9%.

The Domestic Debt Restructuring (DDR) – also known as Domestic Debt Optimization (DDO) to soften connotation – strategy received the green light from the cabinet of ministers on June 28. According to a widely shared presentation alleged to be from the cabinet, pension funds that elude restructuring could face heightened tax burdens, EconomyNext reported the same day.

The scheme also prescribes a 30% haircut for dollar bonds and loans, aligning with one of the proposed options offered to foreign bondholders. An alternate path proposes transitioning these bonds into a rupee instrument.

Sri Lanka’s banks, already bruised by a flurry of bad loans and the looming haircut on sovereign bond portfolios, have been shielded from further harm by the authorities to preserve financial stability.

The parliament will review the debt strategy via its committee on public finance before a thorough debate in the parliamentary chambers. Meanwhile, interest rates have started a downward trajectory.

The banking sector holds a little over 20% of Treasury bonds valued at around Rs3.1 trillion and 20% of Treasury bills worth over Rs650 billion.

To encourage pension funds to participate in this voluntary scheme, non-participating funds will be subject to an income tax rate of 30%, double the current rate of 14%, leaving little choice but to join the restructuring or optimization scheme.

Provident fund members will see the returns on their bonds dwindle over time from 12% to 9%. The government’s promise of a floor of 9% offers some reassurance, but it still represents a decrease in expected income for pensioners. The tactics to prompt pension funds’ participation in the restructuring scheme – doubling the income tax rate to 30% for non-participants – appear coercive and likely to be perceived negatively, stirring social unrest. However, the downward trajectory of interest rates may benefit borrowers in the short term by making loans cheaper.

Domestic debt restructuring is a tricky business. Governments often prioritize shielding banks as pivotal in maintaining economic stability. Shaky banks, integral to economic functions like lending and payment systems, could trigger a financial crisis. Argentina (2001) and Greece (2010) focused on banking stability in their debt crisis aftermath, but their examples are torrid.

On the other hand, superannuation funds, though significant for individuals, do not possess the same systemic risk. However, burdening them could strain retiree incomes, highlighting a tightrope governments walk between maintaining financial stability and securing citizen livelihoods.