Wednesday, September 28, 2022

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SL Domestic debt restructuring raises fiscal sustainability issues

The Government is now considering the domestic debt restructuring as a part of a broader policy package to address massive debt vulnerability running up to trillions of rupees, finance ministry sources said.

Total outstanding domestic debt was Rs. 12 trillion as at the end of March 2022 while the gross domestic borrowings of the Government surpassed Rs 1.6 trillion in the first four months of 2022, ministry data shows.

Around 60 percent of the domestic borrowing (over Rs. 1 trillion) was raised from Treasury bonds, 31 percent (Rs. 518.2 billion) from Treasury bills, and 4.4 percent (Rs 73.8 billion) through provisional advances from the Central Bank, and Rs 65.6 billion was raised from Sri Lanka development bonds.

In this context, President Ranil Wickremasinghe shocked the local debt market by saying domestic debt may have to be included in restructuring.

However domestic debt has already received upfront hair cut via over 60 percent inflation and inclusion debt restructure could cause financial instability, debt market sources warned.

According to Central Bank sources the restructuring of domestic debt would exert an adverse impact on domestic bank balance sheets.

In order to avoid the impact on the domestic financial system, measures should be taken to recapitalise some banks or replenish superannuation funds such as Employees Provident Fund (EPF) and Employees Trust Fund( ETF),CB sources said

A country’s debt is sustainable if it can repay it by borrowing from the market; this is known as ability to refinance, former Central Bank Deputy Governor and eminent economist Dr.W.A.Wijewardena claimed.

In the case of forex debt, if repayment has to be made by using reserves or borrowing from friendly countries it’s not sustainable and the domestic debt can be repaid by borrowing from Central Bank, then, it’s also not sustainable, he explained.

The Central Bank Governor tries hard to avoid this by increasing rates and borrowing everything from the market. But, there’s a liquidity crunch in the domestic financial system and so, he might one day run into problems, he claimed.

If this happens, it’s outside the control of local monetary authority and terms will be dictated by outside creditors and prospective lenders like International Monetary Fund (IMF) he said adding that in the case of IMF, it cannot lend to a member whose debt, either foreign or domestic, is not sustainable.

According to an IMF report, restructuring of heavy domestic debts could play a vital role in the resolution of future debt crisis by countries like Sri Lanka.

The government is now compelled to present a debt sustainability analysis (DSA), to the IMF and the country’s foreign creditors, finance ministry sources disclosed.

Therefore it has to consider potential restructuring of domestic debt in order to achieve debt sustainability, a senior finance ministry official said.

The authorities need to put in place measures that mitigate losses for banks, non-bank institutional investors, and that minimise spillovers, IMF report suggested.

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