On a wet Wednesday as public school teachers and principals marched in the rain demanding higher pay and got water cannoned for their troubles, the government was bracing to make a big announcement about the bilateral debt negotiations. A big win was how it was announced that evening.
In June 2024, in a significant move towards stabilizing its economy, Sri Lanka sealed an agreement with its bilateral creditors led by Japan, France, and India, and separately with China, covering $10.9 billion in debt, formalizing a provisional deal reached in November.
This agreement, crucial for the debt-ridden nation, comes amidst its ongoing efforts to recover from a severe economic crisis that saw it default on foreign debt in May 2022.
While the debt restructuring agreements with the Paris Club plus India and China mark a critical moment, Sri Lanka is only convulsing. It must continue to imbibe the bitter medicines to restructure the economy and reform the structures that hold up civilization.
What We Know: No Hair Cut
Usually, multilateral and bilateral creditors do not take haircuts because they grant loans at concessionary rates. Commercial creditors on the other hand do. According to the IMF, Sri Lanka can expect debt relief of about $10.5 billion from 2022-28.
The Official Creditor Committee (OCC) comprising the Paris Club (OECD bilateral creditors including Japan), India and Hungary, has taken a significant step by covering approximately $5.9 billion of Sri Lanka’s external debt. This move is complemented by the Export-Import Bank of China (EXIM), which manages about $4 billion of the nation’s outstanding debt. Overall, Sri Lanka’s total external debt stands at $37 billion. Of this amount, $10.9 billion is owed to multilateral banks, with the Asian Development Bank (ADB) accounting for $6.2 billion and the World Bank for $4.3 billion, as reported by Reuters.
In terms of debt restructuring, the bilateral loan payments have been deferred until 2028, with an extended repayment period stretching until 2043. The deferred payments and extended terms are expected to provide much-needed fiscal breathing room for the country.
Economically, this debt restructuring is a pivotal step for Sri Lanka to achieve a primary budget surplus of 2.3% by 2025, a key fiscal target set by the International Monetary Fund (IMF). President Ranil Wickremesinghe emphasized the significance of this restructuring, noting that foreign debt payments, which consumed 9.2% of GDP in 2022, are projected to decrease to less than 4.5% of GDP between 2027 and 2032. This reduction is expected to provide substantial relief to Sri Lanka’s economy, allowing for a more sustainable financial future.
Wickremesinghe Addresses the Nation:
President Wickremesinghe described the agreement as a historic milestone, reflecting the hard work and dedication of Sri Lanka’s government and citizens. He emphasized the importance of the deal in restoring international confidence and paving the way for economic recovery.
“In 2023, we completed the restructuring of domestic debt. Now, we have also successfully concluded the bilateral debt restructuring with foreign countries. Our next objective is to reach an agreement with commercial creditors, including International Sovereign Bond (ISB) holders,” said Wickremesinghe.
ISBs: The Last Piece of the Puzzle
Sri Lanka has to complete deals with private investors of ISBs (international sovereign bonds) for debt worth $12.5 billion, with expectations that this could be done in early July 2024. Investors had proposed a plan including a 28% debt reduction (haircut) and a 1.8% upfront fee, aligned with the IMF baseline and adjusted for economic performance. There are concerns over higher interest rates on later maturing bonds, and that haircuts will reduce sharply from 2028, down to 7.3%, if GDP exceeds IMF projections, with further adjustments based on economic output.
Negotiating favourable haircuts is necessary to reduce the debt burden.
The Paris Club and India, part of the Official Creditor Committee, issued a statement urging Sri Lanka to ensure comparable treatment with private bondholders, who hold over $12 billion in debt. The group emphasized the importance of achieving terms at least as favourable as those agreed with the OCC.
Sri Lanka’s Prime Minister is set to present the debt restructuring agreements to Parliament in a special session on July 2, 2024, seeking ratification to solidify the nation’s path to economic recovery.
Once the ISB deals are concluded, rating agencies are likely to remove Sri Lanka’s default status. The ISB negotiating process hit a snag early on when one U.S.-based investor threatened to hold out by demanding immediate payment. According to a Financial Times report from the first weekend of September 2023 (Sri Lanka Debt Twist), the United States government has intervened in a lawsuit filed by Hamilton Reserve Bank in U.S. courts, seeking payment for defaulted Sri Lankan bonds worth $250 million. That intervention has allowed Sri Lanka to negotiate with ISB holders collectively.
Praise from the U.S.
The United States Ambassador to Sri Lanka, Julie J. Chung, has expressed support for the debt restructuring agreement between Sri Lanka and its creditor nations, finalized at the Paris Forum 2024.
In a tweet, Ambassador Chung called it a positive step for Sri Lanka’s economic recovery and resilience, building confidence in its fiscal environment. “The U.S. encourages Sri Lanka to continue the reform process, adopting transparent and sustainable changes that foster long-term prosperity and growth,” Chung said.
Main Opposition Economist Responds
Main opposition party Samagi Jana Balawegaya (SJB) MP Dr Harsha de Silva expressed his views on X (formerly Twitter): “Thank you Japan, China, India. SJB appreciates your support to get Sri Lanka out of the hole they put us in. In our discussions, you told us it is not politics, but people. As the ‘people’s opposition’, we appreciate your kind gestures. Look forward to strengthening relationships”.
The SJB has been vocal about the need for cooperation from creditor countries to manage the debt crisis. “We hope the deal is a good one. Awaiting details. However, we are not in agreement with the ‘April ISB proposal’. Need a bigger haircut,” he added, showing cautious optimism.
His comments reflect the party’s scrutiny and constructive criticism of the Government’s debt restructuring strategies, particularly concerning the International Sovereign Bonds (ISB).
Where from Here? Uphill, Downhill?
Securing deals with creditors is significant, but only a small respite in the grand scheme. We have to pay the capital eventually, and Sri Lanka must be prepared for it.
Argentina’s history offers a sobering lesson. Argentina had five presidents between December 20, 2001, and January 3, 2002, with the fifth losing his seat by May 2003. On the last day of 2001, amid this political chaos, Argentina defaulted on $81.3 billion of sovereign debt held by private creditors worldwide. For comparison, Sri Lanka’s GDP was just under $16 billion in 2001, according to Macrotrends.
Leading up to the debt crisis, Argentina borrowed heavily to fuel growth, with eager investors backing promises of economic expansion. Both the public and private sectors increased their leverage to unsustainable levels. When a recession hit in 1999, widespread refusal of austerity measures led to rapid presidential turnovers.
The turbulent political climate compounded the crisis. Argentina’s path through debt restructuring was fraught with challenges and controversies. The nation sought significant debt relief to ensure economic sustainability, but faced strong opposition from creditors and lengthy legal disputes, especially with “vulture funds.” These entities, having bought Argentine bonds at low prices, aggressively pursued full repayment in U.S. courts and won, setting a troubling precedent for future debt crises.
Argentina’s restructuring strategy also included GDP-linked warrants, an innovative instrument that eventually yielded substantial payments due to economic growth. While ultimately beneficial, this highlighted the complexities of aligning debt terms with a nation’s economic performance. Argentina’s experience remains a crucial case study in debt renegotiation.
However, Argentina’s debt woes are recurrent. The country has defaulted on its international sovereign debt nine times, three of which occurred in the last two decades. The 2001 default remains the most notable. By the end of 2019, Argentina’s federal sovereign debt stood at approximately $323 billion, and the nation defaulted again in 2020. Argentina continues to struggle with volatile exchange rates, high inflation, and a deepening recession.
What will it take for Sri Lanka to avoid getting into this loop? We have a habit of going to the IMF, should we now form an addiction to something harder, like defaulting and restructuring?
Sri Lanka’s debt crisis is due to borrowing for both capital projects and the current account deficit because revenue is persistently too low, reflecting financial mismanagement and contributing to corruption.
For 2024, estimated tax revenue is Rs3.8 trillion, while recurrent expenditure is Rs5.3 trillion, including Rs1.1 trillion for public sector wages, Rs2.6 trillion for debt servicing, and Rs1.2 trillion for subsidies. Cutting any of these is challenging, and debt servicing cannot be stopped. Alternatives like reducing public services, laying off unproductive state-sector workers and selling or privatizing enterprises are challenging and eradicating corruption ingrained in our culture could take generations to fix, unless we decide to champ at the bit and pull our weight because the elusive benevolent driver may never show up. Sri Lanka has an opportunity and a challenge. The state school teachers and principals getting water cannoned in the rain is symptomatic of the problem and the choices we will have to make.