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Sri Lanka's debt sustainability: Steering the economy through choppy waters  

11 Apr 2021

 

  • World Bank notes risk faced by Sri Lanka 

  • Aware of risks and no risk of default: Govt.  

        The World Bank recently released a report based on the economic rebound in South Asia, following the historic negative low the region faced in 2020, after the outbreak of the Covid-19 pandemic. The report, which was titled “South Asia Economic Focus: South Asia Vaccinates”, released on 31 March, deemed Sri Lanka's debt sustainability at risk due to the country's depleted fiscal buffers, high indebtedness, and constricted market access.   Sri Lanka was named as one of three countries whose debt sustainability is facing the greatest risk due to the country being more vulnerable to external shocks; the other two countries named were Afghanistan and the Maldives.   The report stated that the credit to the Government from the banking sector has been rising fast, in order to take care of large deficit financing needs; and with more debt amortisation due, Sri Lanka is facing a challenging situation.  “On a year-on-year (y-o-y) basis, credit offered to the Government by banks in Sri Lanka increased by 63% in January 2021. Included is credit to the Government from the Central Bank (CBSL), which increased by 176%, y-o-y. The treasury bills stock held by the Central Bank, which partially reflects monetisation of deficits, rose to a record high of Rs. 810 billion by 28 February,” the report stated.   The report also stated that the situation in Sri Lanka is problematic, with the widening fiscal deficit, which was 12.6% of the GDP (Gross Domestic Product) in 2020, after including arrears payments. It went on to state that the country's fiscal sustainability was challenging even before the Covid-19 pandemic and has been leading to significant foreign exchange shortages amid high debt service due. Public and publicly guaranteed debt is expected to reach 109.7% of GDP, exacerbating debt sustainability concerns.  Moreover, the World Bank estimated Sri Lanka’s real GDP to grow by 3.4% in 2021, and 2% in 2022.      Looking at accuracy  Speaking to The Sunday Morning, economist Prof. Sirimal Abeyratne stated that he does not think that the rise in credit given to the Government from the banking sector is a proper indication of Sri Lanka's debt sustainability being at risk. He explained that it is a practice which is being adopted around the world due to the current situation.   However, he agreed with the report when it stated that the country has been heading along a problematic route even before the pandemic. He stated that better indicators of this is the slowdown of the country's economic growth, stagnant export earnings, the Government's finances not being reformed, and the debt that is piling up.  Similarly, former CBSL Deputy Governor Dr. W.A. Wijewardena stated that Sri Lanka's debt sustainability being at risk is nothing new, as the country’s debt-to-GDP ratio is above 100%. He explained that another reason the country is in a dire situation is due to the contrasting estimations released by both the World Bank and the CBSL.  He stated that the CBSL has overestimated Sri Lanka's economic growth in their reports, underestimated the inflation rate, and overestimated economic recovery, which the World Bank has given a very low estimation on, alongside highlighting the country’s high debt-to-GDP ratio.  “The CBSL is trying to please the Government by creating a ‘rosy’ picture of the Sri Lankan economy. This is also because the data the CBSL gets is from government institutions, while the World Bank gets its data from more reliable sources that give a more accurate picture. At the end of the day, the international community is going to believe the World Bank and we are going to be deceived by our inaccurate estimations.”  Dr. Wijewardena explained that the CBSL has estimated Sri Lanka's economic growth to be 6% for 2021, while the World Bank has only estimated it to be 3.4%. Then again, the CBSL has estimated the economic growth from 2022 to 2025 to be around 6-7%, while the World Bank’s estimation is only around 2%.  Economist and MP Dr. Harsha de Silva added to these examples and stated that last November, the Government estimated growth in 2020 to be 1.4% while the World Bank estimated it to be -3% or more, with the final reports showed that it was actually -3.6%.   “It is not their job to paint a rosy picture; it is their job to be honest and accurate. There are very good professionals at the CBSL, but if the Monetary Board and Governor want them to pull a political line, there are going to be medium-term repercussions for the entire country.”    Govt. responds  Speaking on the warnings from the report, State Minister for Money and Capital Markets Ajith Nivard Cabraal stated that in any debt management, there are always some risks. He explained that the CBSL and the Government is well aware of these risks, more than any other organisation.  “Both the Government and CBSL have acted proactively and sensibly. This has led to us having an impeccable debt servicing record,” said Cabraal.   He went on to state that all the present risks have been addressed and that there will no longer be a possibility of any default.  As for the contrasting figures presented by both the CBSL and the World Bank, Cabraal stated that the CBSL's data is more accurate than any of the figures presented by any other foreign agency.    Inflation woes  The report also stated that South Asia's inflation was higher than average, and stated that in 2020, food price inflation became the main driver of overall price inflation for the large South Asian countries, with an emphasis on Pakistan and Sri Lanka.  Speaking on the matter, Dr. de Silva stated that Sri Lanka is facing some decisive challenges due to the Government politicising monetary policy and exchange rate policy. He explained that while the Government can politicise fiscal policy, which is what they tax and spend, making it their prerogative, monetary policy and exchange rate policy should not be politicised.   “What is happening now is what we call fiscal dominance of monetary policy. The monetary policy has been dominated by fiscal policy, meaning that we will spend as much as we want and the banking sector has to print the money and give it to us if and when it is needed. And to a certain extent, this is okay.”  He explained that many countries all over the world have done this during the pandemic, resorting to an accommodative monetary policy, where the central banks in these countries accommodate the expenditure of the governments by printing money. However, he stated that there's a limit to this action and that it is a temporary measure which also depends on how much excess capacity is there in the economy and what the potential GDP growth is versus what it is now. Once these limitations are exceeded, the local currency will lose its value due to too much money tracing with too few goods.    Dr. de Silva stated that when the currency loses its value domestically, it causes inflation, leading to the prices of things such as coconuts, rent, and bus fees going up.  “We see this (depreciation) happening in Sri Lanka now, where the rupee, which the Government stated will remain at Rs. 185 to a dollar, has gone down and now the Bank of Ceylon is selling it at Rs. 205 to the dollar. It is crashing and in a couple of months, I expect it to be selling at Rs. 210 to the dollar. This is an inevitable truth, because economics is at the end of the day, a science."  He stated that if Sri Lanka continues to increase money supply without any limitations, sooner or later, inflation will eat everything up, which has happened in several other countries in the past.   “In economics, there is an equilibrium, so we cannot disturb that equilibrium, and we cannot expect everything to be good just because our politicians who know next to nothing about economics, want it to be.”    PHOTO ©️ UNCTAD


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