Why the country went broke. How do we fix it? 

Friday, 24 June 2022 

Sri Lanka, until COVID, was mismanaged in late 2021 due to overconfident Government dignitaries under the illusions that they were on the right track. Tourism by late 2018 was booming and making headlines worldwide. Until a senseless attack on churches and hotels stopped the momentum in its tracks. Tourism however began to pick up once again by mid-2019, albeit dented by the pandemic. 

The economy began to tank by late 2021 due to poor policy options of the Government. The forex crisis aggravated the situation. Then to make matters worse, Sri Lanka defaulted in May on two interest payments on its sovereign bonds, becoming the first sovereign debt default country in South Asia. Today the country is insolvent and prices are skyrocketing. Sri Lanka’s foreign debt obligations for 2022 is around $ 7 billion. ISBs account for nearly half of the country’s total outstanding external debt. 

To make matters worse, Hamilton Reserve Bank that was optimistic in January about Sri Lanka, filed suit in a case against Sri Lanka in New York’s federal court seeking full payment of principal and interest. Action, according to media, involves 25 July-maturing bonds worth $ 250 million broadly held by US retirement systems including Fidelity Investments, BlackRock, T. Rowe Price, Lord Abbett, JPMorgan, PIMCO, Neuberger Berman and other US investors. Hamilton Reserve Bank Ltd. holds more than $ 250 million of Sri Lanka’s 5.875% ISBs. Hamilton Reserve claims Sri Lankan parties favoured and stand to be paid principal and interest in full. 

 

Debt restructuring 

Debt restructuring is a new task for CBSL and Treasury officials. We have happily borrowed over a period of time bilaterally, from multilaterals and from international private sector creditors at very high rates when banks with strong balance sheets were borrowing at half the price. Now we are burdened with those borrowings. 

To add to all our woes there is now controversy over the actual debt composition. Some argue that Sri Lanka’s debt obligations to China is around 20% of the total debt, whilst the official figures show it at 10%. The argument put forward is that some of the SOE borrowings are excluded from the 10%. Sri Lanka last week hired Lazard Ltd. and Clifford Chance LLP to serve as financial and legal advisors on debt restructuring as the country seeks a bailout from the International Monetary Fund. 

The IMF team is in Sri Lanka and the Government is hopeful of a technical level closure. The Government has the unenviable task of working out a debt relief structure agreed to by any one group that must in most forms comparable to that asked from the other groups. A Common Framework approach is therefore needed to win the support of the creditors who have varying interest. 

The other challenge Sri Lanka will face is the holdout creditor problem in sovereign debt workouts. As an expert pointed out recently, Sri Lanka is exposed to the potential cheap tactics of holdout creditors; where funds seek full repayment of their original investments through litigation, as opposed to participating in debt negotiations. Therefore, the more we delay in reaching out to our international private sector creditors with a viable plan, Sri Lanka could get caught up in a barrage of law suits delaying the process even further.

 

Way forward

According to FT, HNI Prem Watsa, Chairman and CEO of one of the largest general insurance groups in the world, recently expressed confidence in Sri Lanka’s ability to bounce back. However, he identified a few factors that are required for the recovery. A business-friendly environment for the private sector to do business, an environment that facilitates foreign direct investments, reforming State-owned enterprises along with privatisation and fast-tracking tourism recovery. 

The Government needs to manage the debt restructuring professionally and agree on terms that will help Sri Lanka move forward from this morass. Next, launch a massive private sector led effort to increase our export income, we need a minimum 30% growth to sustain ourselves. Finally, strengthen key institutions required for good governance by passing the 21st Amendment to the Constitution. That will pave the way to bring in competent people and more importantly, accountable people into the Government and policy making, to enable credible bilateral and multilateral economic support we desperately need.