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Growth a Must for Debt Sustainability – Nishan De Mel

Published on Ceylon Today

Sri Lanka must reduce its foreign debt burden on a medium- to long-term basis, Verite Research Executive Director Nishan De Mel said yesterday.

‘Reducing foreign debt is vital to maintain debt sustainability; however it should be done in a timespan of 5-10 years, without drastically reducing reserves,’ he said.

Speaking at a Webinar organised by the Veemansa Initiative, Central Bank Governor W. D. Lakshman meanwhile was of the opinion that the government’s target was to maintain the foreign to domestic public debt ratio of 43:57 to 33:67.

The governor also said that the country’s reliance on foreign debt will require some austerity, as Sri Lanka attempts to shore up confidence in its faltering economy.

“This will no doubt require some austerity, in terms of mostly cutting down non-essential consumer imports (and) a systematic effort in enhancing all forms of foreign currency inflows,” he said.

According to him the country was committed to honouring its foreign debt obligations.

De Mel for his part pointed out that the cost of debt is more concerning than the amount of debt.

“Debt is manageable when the cost of debt is lower as in the case of Japan and United States of America,” he said.

“Two thirds of Sri Lanka’s earnings is spent paying interest for debt. There was a request from the Universities to increase funds allocated to education to 6% of GDP. Today, we spent 6% of GDP on interest cost on past debt alone,” he said.

Countries may be able to manage local debt by running zero or negative interest rates. With the COVID-19 pandemic, as the consumer demand and private sector credit fell, Central Bank was able to bring down interest rates. With zero real interest rates, local debt can be sustained by maintaining positive growth rates.

Problems arise on dollar or foreign currency denominated debt.  High inflation, could lead to depreciation of the rupee, affecting foreign debt.

Inflation, which is generally considered to affect local debt, adversely affects international debt.

If you can maintain the inflation and depreciation rate at a stable level, you can have sustainable foreign debt”, said De Mel.

Reducing the percentage of foreign debt and increasing average time to maturity on foreign debt are two ways of reducing roll over risks, which was also a part of the Central Bank plan for 2019.

However, De Mel cautioned that reducing foreign debt to local debt should be done over a period of time.

“If the Central Bank tries to reduce foreign debt to local debt too quickly, it would have to refinance from existing reserves. For this, Central Bank should maintain a Current Account surplus. At a time when tourists are not arriving, oil prices going up, credit demand picking up, 80% of imports being intermediate or capital goods, maintaining a surplus is not easy.

“If we deplete reserves too quickly, the market may lose confidence on the Rupee, leading to depreciation, which would also adversely affect the debt lead to servicing.”

With regards to reaching out to the IMF, De Mel said, “Governments may think the IMF will impose various conditions which would obstruct growth, but if we can get our appropriate policy mix, we can argue that we have a sustainable path for debt. In that way, it could help in managing a roll over risk. Additionally, some bridge financing to maintain the Current Account surplus can build confidence when reserves are high. Going to IMF shouldn’t be rejected on ideological terms but rather it should be seen as an opportunity to reduce cost of debt and enter a path of debt sustainability.”

De Mel further pointed out that it isn’t favourable to curtail imports to maintain reserves as it will lower growth, as 80% of imports being capital and intermediate growth. “It is not the optimal policy response. Growth is fundamental for debt sustainability, as faster growth rates could lower the debt burden as a percentage of GDP. There are other ways of controlling reserves related issues,” he said.

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Last modified: October 30, 2023