Amidst the coronavirus pandemic in 2020, credit rating agencies downgraded Sri Lanka to junk status. In April 2021, Standard and Poor’s confirmed Sri Lanka’s CCC+ rating and highlighted several risks, particularly on the external debt front. “Sri Lanka’s external liquidity, as measured by gross external financing needs as a percentage of current account receipts plus usable reserves, is projected to average 122% over 2021-2024,” Standard and Poor’s (S&P) said. “We also forecast that Sri Lanka’s external debt net of official reserves and financial sector external assets will remain elevated at around 167% in 2021”. However, Sri Lanka not only has an external debt problem, it also often understates, miscounts, and misplaces big loans in its public reporting, a think tank has said. The regular reporting of debt in Sri Lanka is limited to a breakdown of external debt held directly by the central government, leaving out any external debt held by other government agencies suchas state-owned enterprises (SOEs). Verité Research said so in a research brief titled Navigating Sri Lanka’s Debt: Better Reporting Can Help – A Case Study on China Debt. The standard definition for the calculation for public sector debt includes the debt of the central government, the central bank, and public sector corporations (including state-owned banks and enterprises). However, in Sri Lanka, government financial reports do not give visibility of the composition of external public debt by the indebted institution or by the lender. The Central Bank only publishes a breakdown of the external debt of the central government. However, this is only a subset of the total public debt, excluding external loans to state-owned enterprises.
“This informational lacuna conceals the full extent of public external debt from the public. Such opacity on the actual debt position can undermine efforts towards understanding and improving the debt dynamics of the country,” Verite opines. “The weakness in reporting also creates a loophole that the government can exploit to actively conceal the actual debt obligations from the public and create misleading debt dynamics,” cautioned the think tank.
Sleight of Hand
To illustrate the debt reporting problem, Verité dives into the outstanding Chinese loans to the island to show how public financial reports significantly understate debt (See Graph 1). According to the Central Bank, debt owed by Sri Lanka to China totalled $3.4 billion (Rs615 billion), equivalent to 10% of the total external debt in 2019. However, these numbers exclude the $2 billion worth of loans Sri Lankan SOEs owe China. If included, the total debt owed to China increased by 60% to $5.4 billion. Verité also uncovers how a large quantum of external public sector debt lies outside the central government with SOEs. “The problems and concerns of servicing the (unreported) SOE debt are no different from those of servicing the (reported) central government debt. Therefore, reporting only central government debt provides a misleading picture of the Sri Lankan debt position and dynamics,” it contends. The $2 billion worth of Chinese debt to Sri Lanka SOEs – including an $828 million loan to develop the Puttalam Coal Power Plant, $952 million to build the Hambantota Port and $123 million for the international airport at Mattala – had earlier been in the books of the central government. However, the treasury transferred these loans to several state-owned enterprises in 2014. The Puttalam power plant loan was transferred to the power utility, the Ceylon Electricity Board (CEB). The Hambantota Port Development loan went to the Sri Lanka Ports Authority (SLPA). The loan for the airport went to the aviation SEO, the Airport and Aviation Services (Sri Lanka) Ltd. “This debt movement resulted in restating central government debt as a lower value, even though the actual amount of public debt was unchanged. It was an accounting sleight of hand that made it appear as if the debt had reduced,” Verité deduced. But that is not all! Verité has exposed how debt can get ‘misplaced’. For instance, the Chinese loan to develop the Hambantota Port was transferred backto the central treasury in 2017, according to the National Audit Office. However, the central bank lists the loan as a liability of the SLPA in its 2019 annual report. At present, this loan does not appear either in the books of the central government or the SLPA.
“The reports of the Auditor General in Sri Lanka also provide cause for concern, suggesting that the Ministry of Finance makes serious mistakes concerning counting and reporting debt correctly, even when that impacts statutory obligations,” Verite points out. This particular example shows that debt can also get miscounted simply by being misplaced as it is moved around from the books of the central government to that of SOEs and vice-versa, Verité notes. Sri Lanka is navigating the most challenging period the country has faced in terms of debt management. According to S&P, high fiscal deficits over an extended period will only worsen the government’s already extremely high debt stock.
“Sri Lanka’s debt profile is also vulnerable due to the high share of the total debt being denominated in foreign currency, although this has been reducing over the past year,” S&P said in its April 2021 rating review. “We expect the increase in net general government debt to average 10.3% over 2021-2024. Net general government debt has exceeded 100% of GDP in 2020 and will continue to increase over the next five years, in our view,” the rating agency said. President Gotabaya Rajakasa has said the country will not take on new foreign loans to develop infrastructure but will instead attempt to attract foreign direct investments. For instance, the controversial Port City Commission has a target to bring $3 billion worth of investments over the next few years. However, for Verité Research, fixing the debt reporting problem requires something else: improving the reporting for a better view of the actual debt position is a critical first step towards a solution, the think tank said.