In Placating the Demons: Ritual Practices among Sri Lankans, Prof Gananath Obeyesekere tries to explain how even urban Sri Lankans attribute various malaises to the malevolent spirit world. While rituals to dispel demons have a psychological effect, often the underlying causes remain when victims fail to receive medical attention. It appears the supernatural pervades our economy–after all, we have a 42-member State Astrologers’ Committee, more than our Cabinet of ministers. With elections around the corner, lawmakers are seldom focusing on fundamental economic issues, and this is a big problem.
Leading opposition lawmakers mean well, but recent statements about renegotiating the IMF programme and their demands for a seat at the negotiating table with international bondholders are disruptive, misguided and misleading. The rhetoric on corruption also falls egregiously short, with lawmakers failing to define the parameters of corruption and the hard reforms needed.
Race Against the Clock
Whatever its faults – and there are fundamental problems, beginning with a lack of a legitimate mandate, many perceive – the Ranil Wickramasinghe administration must complete the international debt restructuring process before the elections to avoid putting off investors or throwing investors into confusion and the country deeper into a prolonged crisis, despair and ruin.
We agree with Henrik Ibsen that considerations of expediency turn morality and justice upside down—and that they will end by making life here unbearable. But the experience in this case – concluding negotiations with bondholders soon is a matter of timeliness that will help make life here bearable.
The expediency we must avoid is fulfilling promises of reversing the uncomfortable adjustments and avoiding difficult reforms to win votes. We will not dwell on why we got into this economic abyss, the need for reforms or the IMF programme here but only say that pursuing these to a satisfactory conclusion will only help reduce the country’s indebtedness, stabilize the economy and improve investor sentiment, without which sustainable economic growth will be impossible; also imported goods like food, fuel and medicines – and capital goods that drive enterprises – will once again become dear and expensive.
Sri Lanka is not alone in defaulting, and there are plenty of precedents and experiences that we can draw from to avoid prolonging the economic crisis because we fail to engage investors.
Argentina’s Cautionary Tale
In two weeks between December 20, 2001 and January 3, 2002, Argentina had five Presidents, the fifth losing his seat in May 2003. In between this period, on the last day of 2001, Argentina defaulted on $81.3 billion worth of sovereign debt held by private creditors worldwide. Sri Lanka’s GDP was a little under $16 billion in 2001, according to Macrotrends.
According to various reports, in the run-up to the debt crisis, Argentina had borrowed heavily to fuel growth, and investors were only happy to oblige on the promises of economic expansion. Both the public and private sectors increased their leverage to unsustainable levels, and when the recession hit in 1999, the masses refused the austerity measures resulting in the unprecedented rapid succession of presidents.
The fractious and factious political climate did not help anybody. Argentina’s path through debt restructuring has been a tumultuous journey, intertwined with challenges and controversies. Beyond the technicalities of renegotiating its massive debt following the 2001 default, the process was steeped in debates over the nation’s strategy. Argentina aimed for a high level of debt relief, seeking to ensure sustainability and economic recovery. However, this approach faced stiff opposition from creditors and was complicated by lengthy legal disputes, particularly with “vulture funds.” These entities, which had acquired Argentine bonds at significantly reduced prices, aggressively pursued full repayment through U.S. courts and emerged victorious, setting a concerning precedent for future debt crises.
Moreover, Argentina’s restructuring strategy included the use of GDP-linked warrants, an innovative but initially underappreciated instrument that eventually yielded substantial payments due to the country’s economic growth. This aspect of the restructuring, while ultimately beneficial, highlighted the complexities of negotiating debt terms that align with a nation’s economic performance. It’s a case study worth reviewing. However, much has changed as a result.
A Recurrent Problem
Argentina has faced recurring defaults on its international sovereign debt: nine times with three of these within the last two decades. The most notable default was in 2001 discussed above. As of the end of 2019, Argentina’s federal sovereign debt stood at approximately $323 billion, and the following year, Argentina once again defaulted. The nation continues to grapple with challenges including volatile exchange rates, high inflation, and a deepening recession.
On the other hand, Sri Lanka’s Central Bank has earned praise for effectively managing inflation and stabilizing currency rates, fostering trust among bankers, industrialists, and investors regarding its ability to negotiate with external creditors. Despite the recent public and political backlash against collective salary increments, it’s crucial to recognize the Central Bank’s successful stabilization efforts thus far. Moreover, the implementation of salary increments has been postponed, indicating a commitment to fiscal prudence amidst economic challenges.
Love in the Time of Covid
In 2020, Ecuador held itself up as a luminary example of how to quickly engage with creditors, restructure its debt and get the economy back on track. The country reached out to investors holding 10 different series of debt securities, totalling approximately $17.4 billion in principal–nearly the same amount Sri Lanka proposes to restructure. These securities were scheduled for repayment in a range of years from 2022 to 2030.
The restructuring strategy involved adjusting the terms of these existing bonds to match the maturity dates and financial terms of a new set of bonds due in 2040, effectively reducing the total principal amount of the older securities. In a parallel move, Ecuador proposed a swap, offering holders of the old notes a chance to exchange them for new bonds maturing in 2030, 2035, and 2040.
This process also introduced new protections for bondholders, such as safeguards against the misuse of collective action clauses (CACs) and the right for the issuer to reclassify a series of notes within a dual-pronged voting mechanism designed for aggregated decisions.
The success of this restructuring was contingent upon the International Monetary Fund (IMF) reaching a staff-level agreement with Ecuador on a new financial assistance programme. This agreement was announced on August 28, 2020, clearing the way for Ecuador to finalize the restructuring deal. This move was a critical step towards stabilizing Ecuador’s financial situation and ensuring its ability to meet future obligations.
This landmark deal includes a $1.5 billion reduction in debt, a substantial decrease in interest rates from 9.3% to 5.2%, an extension of repayment terms by an additional 10 years, and a grace period of five years before the principal needs to be paid. President Moreno shared this news on social media, emphasizing the strategic importance of the renegotiation.
This restructuring effort is poised to alleviate financial pressures on Ecuador, as President Moreno pointed out that it would free up approximately $16 billion over the next decade for the country. The negotiations, which began on June 2, aimed at restructuring a total of $17.3 billion in sovereign debt. As a result of these negotiations, the total debt owed has been adjusted to $15.84 billion, including a reduction in the maximum interest rate to 6.9% and an extension of the average maturity period to 12.7 years, up from 6.1 years.
Better Debtor-Creditor Relations:
According to London-based Ashmore Investment Management, Ecuador’s experience demonstrates that the old antagonistic stance between issuers and bondholders seems to have had its time. “There appears to be a growing maturity among investors and borrowers alike, perhaps reflecting a greater understanding of their mutual dependence, which we expect will only increase in the post-COVID world. If so, the riskiness associated with sovereign distress situations will have declined meaningfully. This should be good not just for those owning bonds in distress, but also for the asset class as a whole,” the firm said in an August 2020 report.
While Sri Lanka got deeper into crisis, Ecuador’s success hinges on several factors from which Sri Lanka and other emerging countries can draw. According to Ashmore, these factors are as follows.
CACs work: Collective Action Clauses effectively prevent minority holdouts from blocking deals, streamlining resolutions and maintaining market access. Ongoing enhancements to CACs promise even greater efficiency in future negotiations. Almost all our bonds have CACs, except an older bond for $500 million. Sri Lanka has already benefitted from the incumbent attitude to debt restructuring. According to a Financial Times report over 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 US courts) seeking payment for defaulted Sri Lankan bonds worth $250 million.
Bondholder Cooperation:Demonstrating flexibility, bondholders have supported financial relief measures for distressed EMs, balancing their fiduciary duties with the needs of the issuers, and facilitating prompt and amicable agreements.
Rapid Private Sector Action: Private bondholders can offer relief more swiftly than the official sector, achieving meaningful restructuring agreements quickly and without the delays often encountered in official debt relief efforts.
IMF Engagement: The inclusion of the IMF provides critical reassurance and resources, bolstering the chances of achieving sustainable debt relief and ensuring the success of restructuring efforts.
Commitment to Reengagement: Success is underpinned by sovereign issuers’ genuine efforts to regain market access, engage in fair, transparent negotiations, and address structural challenges, thereby fostering trust and achieving high bondholder consent.
It is the last two points (IMF Engagement and Commitment to Reengagement) that Sri Lankan opposition lawmakers are trying to scuttle, suggesting investors–and the people of Sri Lanka–wait until they come to power to restructure debt, bring down the debt profile and improve our credit rating so we can access investments needed for economic growth.
Divisive or Decisive?
How does Sri Lanka want to approach debt talks with creditors?
Having opposition lawmakers at the negotiations is good. They can bring a level of transparency and accountability. However, it is not necessary because investors would want Sri Lanka to be stable to secure their investments, they would want to avoid prolonged and costly affairs like Argentina and Greece. That is why Ecuador’s example is illuminating.
Even if they get a seat at the negotiation table, it is unlikely the SJB or NPP will be on the same page with the Wickremasinghe administration. In effect, the opposition lawmakers are playing up the country’s political risk profile even further with no guarantees that they can bring it down. They also want to renegotiate with the IMF. We doubt it is to up the ante on reforms and adjustments. The rallying cry is to end corruption, but there is a danger of overstating its impact on the economic malaise and underestimating the effort needed to end corruption.
Talal Rafi, an economist, raises a pertinent point in a March 2024 interview in the Sunday Morning, a Sri Lankan broadsheet: While corruption is undeniably a problem in Sri Lanka, attributing the economic crisis solely to it overlooks other significant factors. Despite higher levels of corruption in Indonesia and Bangladesh, these countries have managed to grow economically, and South Korea’s economic ascent occurred alongside high-profile corruption cases. The focus on corruption, intensified by the IMF’s governance report, risks sidelining necessary reforms in fiscal and monetary policies, trade, state-owned enterprises, public sector efficiency, digital transformation, entrepreneurship support, labour law modernization, and land ownership. Addressing these structural issues is essential for economic recovery and should not be overshadowed by the singular narrative of corruption being the root of all economic woes, Rafi argues.
That is a critical point, which no one in the SJB or NPP is saying enough about. Instead, they are focusing on corruption and decreasing the burden of necessary reforms on the people. The front-running political alliance of the next election wants to tear down corruption’s edifice and reduce income taxes. That should gain middle-class votes. And that should concern us.
More than 230 years ago, the French Revolution began its journey for Liberté, Egalité, and Fraternité, dismantling the archaic, corrupt power structures and even electing a parliament with young people; older former parliamentarians barred. Soon, burdensome taxes fell, food price controls emerged, church properties seized, and limited land redistribution ensued. However it did not lead to economic stability, or growth and people assumed it was because their new leaders were corrupt, and indeed most of the system change advocates from the left and right ended their careers walking up the rickety steps to the guillotine!
Investors know that to recover their investments Sri Lanka’s economy needs to be on a firm footing and generate growth. That requires hard reforms, the ones the SJB and NPP are not talking about.
Political Risk Rising
As it is, the high tax rates are barely enough to cover loan repayments and interest payments, subsidies for deshiya businesses and the vulnerable, and salaries for an efficient public service. How to fix this problem without paying taxes and restructuring state-owned enterprises? What if negotiating with the IMF spooks investors and our sovereign rating never recovers, leading to draining reserves and limited access to imported essentials like food, medicines and fuel? Then what? Will impatience unleash Sri Lanka’s next Aragalaya, burning homes and lynching people outside the law because the law is corrupt?
The devil is in the details and the SJB and NPP are silent. It would be best to let this administration do as much as it can to stabilize the economy in the absence of a clear if not credible alternative from the opposition.
Where are We?
The government is proposing to restructure 68% of its foreign currency loans amounting to $30.8 billion, with $20.3 billion held by private creditors.
According to Verite Research’s Debt Update of December 2023, the 17-nation Official Creditor Committee (OCC) reached an “in principle” agreement last November to restructure Sri Lanka’s debt, following parameters set by the IMF. This agreement, similar to one made with China in October, aims to facilitate Sri Lanka in meeting requirements for receiving the second tranche of IMF funding.
Sri Lanka is obligated to ensure China’s cooperation in sharing necessary information with the OCC and to reach an agreement with private creditors promptly and on terms no less favourable than those with the OCC. However, the agreement does not provide a substantive resolution for expediting the debt restructuring process.
While Sri Lanka has already undergone several macroeconomic adjustments, improving governance will be crucial not only to convince investors but also to sustain the recovery and engineer growth.
“In contrast to the highly unstable macroeconomic conditions of 2022, characterized by soaring inflation and currency depreciation of approximately 60%, 2023 has seen significant stabilization, particularly in the monetary sector. Inflation and currency depreciation are projected to remain below 3% for the year. Also, Sri Lanka has proposed a budget for 2024, that is broadly in line with its IMF programme targets. It requires the treasury to increase revenue by 45% from the 2023 level. There is very heavy dependence on an increased value-added tax (VAT) — from 15% to 18%— with reduced exemptions, to achieve that target. However, Sri Lanka has never met a budgeted revenue target in the last 23 years,” Verite Research says. It says that achieving debt sustainability requires a focus on reducing its interest cost burden, which remains significantly higher than anticipated within the current IMF programme.
Sri Lanka’s economic recovery efforts may need to shift focus towards improving governance. The IMF’s Governance Diagnostic Assessment (IMF-GDA) for Sri Lanka, published in September 2023, reveals systematic and severe weaknesses in governance and corruption vulnerabilities across various state functions. The assessment identifies areas such as budget credibility, expenditure control, public investment management, procurement, oversight of State-Owned Enterprises (SOEs), revenue policy transparency, central bank governance, financial sector regulations, land ownership security, and judicial integrity as particularly impacted.
In September 2023, Sri Lanka implemented a restructuring of domestic debt targeting the retirement provident funds of formal sector workers, excluding other sectors such as banking and finance, private creditors, and most public sector workers. There are arguments for not including banks to maintain a fragile financial system stability. Excluding public sector workers was perhaps to avoid an explosion of trade union actions which could destabilize the economy and self-sabotage ongoing efforts to restructure public enterprises.
Successfully negotiating favourable terms requires us to present our case in good faith that we would adopt and persist with measures to fix the fundamental economic issues, which also requires dealing with matters of corruption as outlined by the IMF-GDA detailed above. This is why any rhetoric hinting at reversing reforms or renegotiating with the IMF just to win votes by assuring people that Sri Lanka would be returned to its post-COVID period is effectively proposing to carry out the very economic practices that got us here.
In March 2023, the IMF emphasized the crucial shift towards a positive economic cycle in Sri Lanka, cautioning against slipping back into a detrimental one. It said the economic situation is gradually improving, with growth turning positive after six consecutive quarters of contraction, recording 1.6% and 4.5% year-on-year growth in the third and fourth quarters of 2023, respectively. High-frequency economic indicators indicate a continued uptick in manufacturing, construction, and services. Inflation declined from a peak of 70% in September 2022 to 5.9% in February 2024. Gross official reserves increased to $4.5 billion at the end of February 2024, driven by substantial foreign exchange purchases by the central bank.
In its statement, the IMF pointed out the nexus between corruption and fundamental economic problems. Sustaining the reform momentum is crucial to steer the economy towards lasting recovery and stable, inclusive economic growth. The recently published Action Plan to implement key recommendations of the Governance Diagnostic Report is a positive development. Sustained efforts to enact these reforms are vital to address corruption risks, restore economic confidence, and enhance robust and inclusive growth. At least in this, the SJB and NPP must agree and make no qualms about the arduous journey ahead where painful adjustments will have to be made and difficult reforms executed to reboot the economy.
Our Choice
Protests and political blame games often follow IMF programmes, as governments fault the IMF for imposing harsh measures, while opposition parties capitalize on public anger. Unfortunately, this political theatre hampers necessary long-term reforms, trapping countries in a cycle of instability – Sri Lanka has gone to the IMF 17 times.
The ongoing IMF programme does focus on mitigating the impact of reforms on vulnerable groups, which include expanding social safety net programmes and improving targeting to ensure aid reaches those in need.
Ultimately, the responsibility for implementing social safety net reforms lies with the government, not the IMF, and this is something the opposition lawmakers can build consensus with the government – at least to get this one thing done. But no: the factious and fractious politicians must do what’s best for them.
If it pursues reforms, the next government will likely stamp out public descent or meet its demise before another aragalaya. The UNP, SLFP and JVP have track records of resorting to ruthless violence to defend what they believe is right. The only way to avoid this downward spiral is to run on a ticket of painful reforms – a system change precipitated by honest reflection on what needs to get done, not what is ideal.
IMF or no IMF, foreign debt or no foreign debt, our tax revenue cannot sustain the bloated public sector, fill the loss-making chasm of state-owned enterprises, pay subsidies and transfers, and service debt. Denying past presidents their pensions and tracing wealth in safe havens for repatriation will not solve the fundamental economic problems. Growth cannot come without building infrastructure, expanding our productive and skilled workforce and compelling our businesses to be enterprising and competitive.