Sri Lanka: Restructuring of Public Debt and Fiscal Policy – Field Note 1

The Monetary Board and the Governor of the Central Bank and the top management should be made responsible and accountable for the financial situation.

10 mins read
President Ranil Wickremesinghe leaves the ceremonial opening session of the Parliament in Colombo, Sri Lanka, on Wednesday, Aug. 3, 2022. [ Photo © Buddhika Weerasinghe/Bloomberg via Getty Images]

This series is based on the excerpts of the first report of the Sub-Committee in identifying short and medium term programmes related Economic Stabilization of the National Council tabled in the Parliament by Patali Champika Ranawaka as the Chair.  Composition of the Sub-Committee in identifying short and medium-term programmes related Economic Stabilization of the National Council,  Patali Champika Ranawaka (Chair), Naseer Ahamed, Tiran Alles, Sisira Jayakody, Sivanesathurai Santhirakanthan, Wajira Abeywardana, A. L. M. Athaullah, Rishad Bathiudeen, Palani Thigambaram,Mano Ganesan, M. Rameshwaran; all are members of the house representing various political parties – editors

It is a well-known fact that our country is currently facing an unprecedented economic crisis. The public debt is no longer sustainable owing to the absence of public financial discipline over a prolonged period and reliance on highly risky foreign commercial loans. The payment of loan installments without taking necessary steps to restructure the debt in spite of the understanding that the debt is not sustainable anymore had emptied the official reserves and the net foreign assets in the banking system. Due to the lack of foreign exchange reserves, the essential imports such as fuel, food, and medicine and import of raw materials required for the manufacturing process have to be restricted. The burden of cost of living has risen to an unprecedented level and real income and food security of people have deteriorated. According to the official data, total inflation in September 2022 stood at 69.8% whilst food inflation was recorded at 94.9%. The transport inflation was 150.4%. Furthermore, the World Bank has predicted that poverty, which was 13.1% in year 2021, will increase up to 25.6% by the end of year 2022. It has also been predicted that the economy, which contracted by 4.8% in the first half of 2022, will further be contracted by 9.2% in year 2022 and 4.2% in the year 2023.

According to the World Bank Report issued in October 2022, it has been emphasized that the cause of the economic crisis is not Covid-19. There had been shortcomings in the economic structure and economic management policies for a long time. It has been reported that the weaknesses in the competitiveness of the export market, Central Bank Monetary Policies that have been maintained without discipline from time to time and the exchange rates that have been forcefully maintained were fatal blows to the economy of the country. The decline of the government revenue is the main reason for the fiscal instability and the increasing indebtedness of the country. Owing to all these factors and the unnecessary tax concessions given in year 2019, the amount of public debt and government-guaranteed debt as a percentage of Gross Domestic Production which was 89% at the end of year 2019 has risen up to 110% at the end of year 2021.

The amount of public debt stood at 122% of the Gross National Production by the end of June 2022.

Debt Restructuring

  • The International Monetary Fund has declared that Sri Lanka’s debt is not sustainable. The fact that the International Monetary Fund has declared in March 2020 that the debt is unsustainable and urgent action is needed has now been revealed.
  • The Rating Agencies have declared that Sri Lanka is still in bankrupt state. (Downgrade from Selective Default (SD) to Restricted Default (RD))
  • After the Ministry of Finance declared the interim loan repayment arrangement (suspension of loan repayments) on 12th April 2022, assistance has been obtained from the International Monetary Fund.
  • Lazard Freres STS and Clifford Chance LLP have been appointed as financial advisor and contract law consultant respectively in order to have negotiations with creditors.
  • The negotiations were commenced in March 2022 with the International Monetary Fund and a staff-level understanding has been reached in September 2022. The Central Bank of Sri Lanka and the Ministry of Finance have expressed confidence that the approval to the understanding concerned will receive the approval of the Board of Directors of the International Monetary Fund in December 2022. If it is proved successful, the assistance of the International Monetary Fund will be available for the next four years (2023–2027) and funding amounting to US $ 2.9 billion is to be received in tranches based on progress.
  • During the final quarter of 2022, basic information is shared with all creditors (Under non-disclosure agreements) and discussions will be held with the International Monetary Fund with regard to obtaining their technical assistance (DSA – Debt Sustainability Analysis).
  • It is expected to conclude the negotiations and implement the agreements officially during the second quarter of year 2023.
  • The principles accepted during the negotiations with the creditors are Transparency, Good faith for a Collaborative Process, Fair and Comparable Treatment to all Creditors.
  • Furthermore, most of the Economic Analysts point out that the restructuring of domestic debt is mandatory to confirm the debt sustainability.
  • At the first glance this seems like a difficult task and, in light of the stance taken by the government not to restructure domestic debt, the target is more difficult to achieve.

New Economic Equilibrium

  • At present, the government has achieved a difficult, unstable, temporary and unsustainable financial equilibrium through strategies such as the imposing of strict restrictions on importation, foreign exchange conditions and controlled exchange rates.
  • The financial equilibrium has been achieved on the basis of the decision taken for non-repayment of debt and the debt concessionary package amounting to US $ 3.8 billion granted by India. This cannot be done in the long term. The importation of investment and intermediate goods including the fuel has also been restricted. (The fuel consumption has been decreased by 40 %.) This affects adversely to the industries and the services in mid-term, and, as a consequence, to the employment and economic growth. The restrictions have been imposed on imports in the western world and in Europe as a result of the economic recession, which affects the remittances in turn. On the other hand, higher fuel prices can be expected in short term in time to come (especially in the winter).
  • The policy on shrinking the foreign trade by the Ministry of Finance and the Central Bank could adversely affect the domestic trade, domestic job market and particularly the income level of the low-income earners in the mid and long term and also the period spent for the recovery of the economy would be prolonged.

Budget (as per Appropriation Act 2023)

  • The new taxes (direct and indirect) have been introduced with a view to increasing government revenue. However, no proper process has been introduced for the control of recurrent expenditure and capital expenditure of the Government. The purpose of increasing revenue is the meeting of expenses. As a result, in addition to the social strata already affected during the first round, the middle income earners are also subjected to tremendous pressure. This will lead to short-term social apprehension and loss of trust, accompanied by the risk of disruption of large-scale industries and services (due to increase in financial expenditure, tax expenditure, fuel expenditure and other expenses) in addition to the medium scale industries and services as well as a trend of poverty, unemployment and emigration. Therefore as to whether the expected incomes from them will be accrued is something which must be taken into consideration.
  • According to the proposed Appropriation Act (presented on 5th October 2022) the revenue is estimated at 3456 billion (11.4% of Gross Domestic production (GDP). Out of the expenditure of Rs. 5860 billion (19.4% of Gross Domestic Production), Rs. 2441 billion is for interest on loans while Rs. 1220 billion is for capital expenditure of the government. Similarly, the overall loan installment is Rs. 2025 billion, which brings the total expenditure to Rs. 7885 billion. When the revenue of the government for the preceding years, the new taxes and the present GDP contraction is taken into consideration, it is doubtful as to whether the expected revenue target can be met and unless a saving of 10% can be exerted on the recurrent expenditure of Rs. 2441 billion exclusive of interest payment together with a cut down of 60% on the capital expenditure of Rs. 1,220 billion the year 2023 will not see an approach leading to government fiscal stability even in a backdrop where debt repayments have been suspended.

Control of inflation, interest rates and businesses

  • A record inflation is reported to have resulted due to a rapid increase in the new money supply into the market (nearly three trillion in 2020 – 2022) and the slowdown in the production of goods and services. The interest rates have been increased by the Central bank to control the inflation and the treasury bills are sold in the primary market at increased rates over 30%. The high interest rates, new taxes (Value Added Tax (VAT) –, Social Security Levy and high personal and corporate taxes along with the inflation have almost destroyed the local businesses. As a result, there has been a situation of non-payment of loan installments, non-payment of lease installments, dismissal of employees, closure of companies and institutions. The high interest rates for deposits, non-issuance of new loans and the inability to recover loan installments have endangered the banking sector. The risk of defaulting of public debt is another threat faced by the banking sector.

Solutions and proposals

A change in the existing system

The need has arisen to change the legal and undeveloped systems, radically in every sector. It is a necessary condition for economic growth and a prime condition for building public confidence. Although financial stability is essential at this time, there is a danger of collapsing the economy in an attempt to establish strict financial stability. Therefore, a balance must be struck between financial and economic stability.

  • A collaboration of both the diplomats and the officials to accelerate the process of debt restructuring is essential.
  • The changing of the maturity periods of loans, the loan interest and the initial loan payments by paying attention to the factors such as the total debt amount compared to the GDP, the Gross Financial Need (GFN) rate to the GDP, foreign debt repayment to the GDP in keeping with the international standards on the debt and debt repayment ability of Sri Lanka at least during the next three years and the next decade is necessary in restructuring the debt.
  • The income and expenditure, foreign exchange earnings, control of balance of payments and a full financial and managerial restructuring of the public sector is mandatory to Sri Lanka in order to fulfill the difficult task of obtaining the concurrence of the creditors for the debt restructuring.
  • It has been reported that the government had taken a decision to restructure domestic debts. The liquidity of domestic debt had been contracted by over 60% due to the inflation. If the debt restructuring is continued in spite of the above situation, it is emphasized to reach a collective agreement among the depositors of the local banks and of the Employees’ Provident Fund and the

local investors after having formal negotiations whereby the trust will be built up among the foreign creditors on the restructuring of the foreign debt.

  • It is necessary to amend existing laws and bring new laws to establish responsibility and accountability in the financial sector to prevent the recurrence of the economic bankruptcy that occurred.
  • A new Public Finance Management Law must be adopted immediately, which binds the responsibility and accountability of the Ministry of Finance and its authorities for the stability of income, expenditure and debt, and the provision for debt management and Fiscal Management (Responsibility) Act (2003)) should be updated. .
  • A new Financial Regulation Act (Monetary Law Act 1950) which ensures accountability of inflation and financial supply should be prepared in line with the old Act and thus the independence of the Central Bank should be assured.

The Monetary Board and the Governor of the Central Bank and the top management should be made responsible and accountable for the financial situation.

  • A new independent agency should be set up for public debt management. The Central Bank and the Treasury can work together in its front office and back office functions and the debt management strategy should be managed by the middle office.
  • A new strong Act should be introduced to prevent corruption and it should ensure:
  • Professionalism for investigations.
  • The confidentiality of the complainant.
  • Efficiency and impartiality of investigations and litigation.
  • Independence, impartiality, and non- partisanship in litigation.
  • Active relationships with international parallel organizations.
  • The assets and liabilities of politicians and higher-ranking officials in Ministries should be declared to the public.
  • An independent, impartial, and efficient National Procurement Commission should be appointed for regulation and appeal with regard to procurement. It should consist of professionals who have experience in every field.
  • The Department of Census and Statistics should conduct a formal census on the social impact of economic reforms (closure of industries and services, foreclosure of property, losing employment, losing income, poverty, malnutrition) in every three months and economic reforms should be changed as necessary based on that data.
  • There should be an independent Bureau to identify civil groups, families and persons subject to social pressure, based on census data, and to direct local and international donors to projects aimed at them.
  • The prices of all food items, essential services, medicine and health care should be brought to a digital platform and any service supplier and consumer should be given the facility to access it. The consumer will receive the best service for the lowest cost and market competition.
  • The public entities should be restructured to gain the public’s confidence.
  • 2200 number of public entities audited by the Auditor General should be subjected to a proper management audit.
  • The nominal institutions should be closed.
  • The public entities should be amalgamated and separated under the theme
  • “one institution for one task.” Separate institutions should be amalgamated. (Eg:- Research institutions to universities)
  • To conduct a Work Audit in the institutions, and non-essential workers should be allowed to go abroad, self-retire, take no-pay leave or resign from the service after obtaining an allowance.
  • The public sector recruitment should be done only for the essential service category and should be done only on a competitive basis.
  • The professionals with proven capabilities should be appointed to the Chairmanship and the Board of Directors of strategically important public institutions after an open call.
  • Every state institution should be given annual, monthly, technical, and financial targets in the supply of their services. The work efficiency and financial efficiency of the public sector (recurrent expenditure savings) can be improved through that.
  • The Key Performance Indicators (KPIs) should be introduced to all public entities including Ministries.
  • The promotions and salary increments for the higher- ranking officials should be based on their performance evaluations as well as seniority.
  • Those who violate procurement procedures and are connected to corruption should be deprived of their right to hold a post again.
  • A new system should be introduced to pay dividends for commercially successful enterprises.
  • After a proper Assessment of Needs and Finances:
  • Public enterprises that should be alienated;
  • Public enterprises that should be made into joint ventures with the private sector;
  • Public enterprises that should be subject to private sector management with the state owning the enterprise;
  • Public enterprises in which public management should be restructured

Such Public Enterprises should be identified, and the necessary strategies should be implemented after an open discussion with the employees.

  • The Department of Inland Revenue, Excise Department and the Sri Lanka Customs which are the main institutions of collection of public revenue, should be digitalized and restructured.
  • All professionals who provide their services on cash basis should conduct their transactions on an open internet platform and they should be open for public revenue institutions of the government.
  • No large-scale project should be commenced outside of the National Physical Plan. Moreover, no capital expenditure should be made without the approval of the National Planning Department.
  • As there is no war situation in the country, the following things should be done by a Special Public Security Management Committee;
  • Preparation of strategies on public security
  • Preparation of basic criteria on the number of soldiers, equipment and training,
  • Introduction of new economic activities for the soldiers, who are not essential for the service,
  • Preparation of an expeditious Programme for manufacturing military equipment and accessories locally and for finding foreign markets for trained soldiers and equipment.

Source: Sri Lanka Parliament

SLG Syndication

SLG Syndication is committed to aggregating excerpts from news published by international news agencies and key insights on contemporary issues published by think tanks. Our aim is to facilitate the expansion of its reach while giving due credit to the original source.

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