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Repay foreign debt or finance essential imports?

The country’s available foreign reserves can be used either to repay foreign creditors or to finance imports of essential goods and services required by its citizens. This is the dilemma Sri Lanka faces today.

Paying off the full value of the bond using the limited foreign exchange reserves available would be an exceptional gain for those who currently hold these bonds.1 But it will come at a heavy cost to the citizens of the country who will face shortages of essentials like food. , drugs, and fuel.

Under these circumstances, it is in the best interests of all its citizens that the government postpone the payment of the US $ 500 million in international sovereign bonds.

(ISB) maturing on January 18, 2022, until the economy can recover and fully rebuild.

Just as a person with co-morbidities is more likely to develop serious illness if infected with COVID-19 and more likely to require hospitalization and even treatment in an intensive care unit, Sri Lanka was vulnerable to economic shocks though. before COVID-19 hits. The country was already facing several macroeconomic challenges. Moderate economic growth. An untenable budgetary situation. Although a rigorous consolidation program was put in place to put public finances back on a more sustainable path, sweeping tax changes implemented at the end of 2019 reversed this process, with negative consequences for tax collection. Public revenue. Weakness of the external sector due to high repayments of external debt and insufficient foreign exchange reserves to service these debts.

COVID-19 has only exacerbated these macroeconomic challenges. And as a patient who gets over the worst of COVID-19 has a long road to recovery; Sri Lanka’s economy faces many challenges getting back on track.

The outbreak of COVID-19 in early 2020 has only worsened an already grim macroeconomic situation. The country has lost the confidence of international markets and the sovereign’s ability to renew its external debt has become difficult, if not impossible. Under these circumstances, there was a strong case for sovereign debt restructuring. But the response from the government and the Central Bank of Sri Lanka (CBSL) was a firm “no”.

The argument was that Sri Lanka had never defaulted on its debt and was not going to do so now. The official position was also that the government had a “plan” to repay its debt and therefore there was no reason to engage in a debt restructuring exercise. However, Sri Lanka faced high debt sustainability risks: the debt-to-GDP ratio at 110% was one of the highest in history and interest payments on government revenues at over 70%. % were one of the highest in the world.

Fast forward to 2022. The country’s foreign exchange reserves have declined to US $ 3.1 billion.2 Usable reserves are much lower. CBSL has sold more than $ 200 million of the country’s gold reserves to meet its debt obligations. In the first week of 2022, CBSL announced new swap facilities and its commitment to repay the US $ 500 million International Sovereign Bond (ISB) due in January.

According to Central Bank statistics, in addition to the BSI payment, there are predetermined outflows of foreign exchange reserves amounting to US $ 1.3 billion in the first two months of 2022. In addition, on the Based on trade data for the past 5 years, the country has on average a trade deficit of around US $ 2 billion to finance in the first quarter of the year (see Table 1). With expected tourism flows threatened by the appearance of the Omicron variant and the continuing decline in workers’ remittances, funding this external current account deficit will add further pressure on available foreign exchange reserves. India, which accounted for around 20% of recent tourist arrivals, is now forcing returnees to the country to self-quarantine. This will probably further curb tourist arrivals.

In this context, the country faces a trade-off between using its limited foreign reserves to repay its debt or using them to finance essential imports. US $ 500 million is enough to finance fuel imports for five months; or pharmaceuticals for one year; or dairy products for a year and a half; or fertilizer for two years.

See table 1: Summary of external sector performance Q1 – 2017 to 2021 (US $ millions)

Therefore, it is in the best interests of the country and its citizens that the government postpone paying its debt and use its limited foreign reserves to ensure an uninterrupted supply of essential imports. But it requires a plan. To minimize the cost to the economy, the government must immediately engage its creditors in a debt restructuring exercise. This will require a Debt Sustainability Analysis (DSA) by a credible agency to identify the resources needed for debt relief and the economic adjustment needed to put the country back on a sustainable path.3 This will be critical in bringing creditors at the negotiating table and assure them that the country is able and willing to repay its debts in the future.

The cost of not restructuring is much higher. A non-negotiated default (if and when the country runs out of options to service its debt) would result in a greater loss of production, loss of access to finance, or a high cost of future borrowing for the sovereign . It could even spill over into the national banking sector, triggering a banking or financial crisis.

The consequences are clear. What will we choose?

Dr Roshan Perera is Principal Investigator at the Advocata Institute and former Director of the Central Bank of Sri Lanka

Dr Sarath Rajapatirana is the Chair of the Academic Program of the Advocata Institute and the former Economic Advisor to the World Bank. He was the editor and principal author of the World Development Report 1987 on trade and industrialization.

The Advocata Institute is an independent public policy think tank. Learn more about Advocata’s work at www.advocata.org.