Sri Lanka should consider an IMF deal, pre-emptive debt re-profiling: Pathfinder

ECONOMYNEXT – Sri Lanka should consider an agreement with the International Monetary Fund and pre-emptive extensions of capital and interest maturities on debt, to stabilize the economy, Pathfinder, a Colombo-based think tank has said.

“Sri Lanka’s external debt dynamics are extremely challenging over the next six months and urgent action is needed to address them and mitigate collateral damage which can have wide-ranging social and political ramifications,” the think tank said.

“…[T]here is a strong possibility that reserves will fall to extremely dangerous levels within the next six months (by July 2021).

“Unless there are significant inflows in the meantime, there will have to be severe compression of domestic absorption (consumption and investment), i.e., very painful austerity.”

Sri Lanka’s gross foreign reserves were 5.7 billion US dollars by December 2020. Key repayments from February to July 2021 included a billion US dollar bond payment, 980 million dollars of Sri Lanka Development Bonds and interest payments of 482 million US dollars.

Sri Lanka had also been having difficulties in rolling over Sri Lanka Development Bonds, due to money printing pushing rupee interest rates below dollar yields and yields on sovereign bonds rising and banks unable to extend credit lines.

Sri Lanka also had to repay a 400 million dollar swap with the Reserve Bank of India in February, which India said needed an IMF program to roll-over.

Sri Lanka has about 1.7 billion dollars in bi-lateral and mutli-lateral project and program lending expected this years, Pathfinder said.

A 700 million US dollar loan was expected from China Development Bank and a billion US dollar swap was being discussed with India.

However it was tied to Colombo Port Development and removing import restrictions.





A 10 billion Yuan swap was also expected from China, however it could have conditions limiting its capacity to boost reserves, Pathfinder said.

“The delay in the completion of these transactions seems to indicate that there are challenges in each of these negotiations,” the think tank observed.

“The second option is to seek the support of the IMF. This will also serve to leverage a number of other sources of external financing.”

Sri Lanka was eligible to get up to 830 million US dollars from a Rapid Financing Facility.

“An arrangement with the IMF can also trigger direct budgetary support from the ADB (USD 500 million) and the World Bank (about USD 300 million),” Pathfinder said.

“It can also pave the way for a rating upgrade and eventually regaining access to international capital markets.

“Anchoring policies to an IMF arrangement would also provide foreign investors with greater confidence to invest in the country.

On the present global and domestic climate, it is unrealistic to expect that foreign direct investment will play a major role in filling the external financing gap, particularly in the short term, Pathfinder said.

Analysts point out that FDIs are not owned by the government, neither are remittances or export proceeds, which create their own demand for foreign exchange when spent by the recipients.

To capture any foreign exchange flowing to third parties, the government either has to raise rupee debt and crowd out domestic consumption and investment at a market rate, or the central bank has to sell sterilization securities (its bill holdings) to curtail domestic credit or both.

At the moment however there is excess liquidity in money markets, the central bank is purchasing bills to inject liquidity, through failed bond auctions.

In 2018 Sri Lanka printed most money through a wide range of open market operations and only one bond auction in April was re-financed by the banking system in an elaborately roundabout way (buffer strategy).

The 2018 injections also led to import controls, reserve losses and currency depreciation.

All this was done despite the existence of an IMF programe which required consistent pegging to collect forex reserves, but left room for liquidity injections to torpedo the program with a high inflation target which went counter to the forex target.

Inflation was generally kept down by near depression conditions, in consumption collapses that came after the currency collapse and credit contractions.

In 2015 a currency collapse and foreign exchange shortages were triggered first by unwinding term repo deals with the central bank and then by outright purchases of bills to sterilize forex sales. (Colombo/Feb09/2021)

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