Tuesday, February 11, 2025

The debt restructuring process and its implications

by malinga
January 5, 2025 1:03 am 0 comment 247 views

By D.M. Dinithi Sandamali-Lecturer/Faculty of Management Studies/The Open University of Sri Lanka
Dinithi Sandamali

One of the most significant phases in Sri Lanka’s economic history is the restructuring of its debt. This follows a serious economic crisis in which the nation struggled to pay off its obligations, had little foreign reserves, and had significant inflation. Sri Lanka is currently working to stabilize its economy and pave the way for sustained expansion. The fundamental aspects of the debt restructuring process, the obstacles it presents, and its possible long-term implications for Sri Lanka’s economy are explored here.

The debt restructuring

A 48-month plan to assist Sri Lanka in recovering from its economic crisis has been authorized by the International Monetary Fund (IMF) under its Extended Fund Facility (EFF). A total of SDR 2.286 billion, almost US$3 billion, is provided by this initiative to promote economic policies and reforms.

The first review of the EFF was completed by the Executive Board with disbursements of SDR 254 million, about US$337 million on December 12, 2023. The second review completed by the Executive Board of the International Monetary Fund (IMF) under the 48-month Extended Fund Facility (EFF) arrangement, allowing the authorities to draw SDR 254 million, about US$336 million.

The program’s three primary objectives are to promote growth, safeguard the financial system, and restore stability. Enhancing governance and safeguarding vulnerable populations are also top priorities in the plan.

To obtain EFF funding, Sri Lanka must first prove that its debt is manageable, according to the IMF. Sri Lanka must bargain with its creditors to restructure its debt to satisfy this criterion. This entails lowering the debt load or extending repayment periods to make it more affordable. Moreover, Sri Lanka was given some debt sustainability analysis targets. Debt stock target – 95% of GDP by 2032, Gross Financing Needs (GFN) target – average 13% of GDP during the period 2027-2032, and foreignexchange debt service target – maximum 4.5% of GDP during the period 2027-2032.

The Sri Lankan government and the International Monetary Fund (IMF) as part of a larger plan for economic recovery started debt restructuring. Sri Lanka’s external debt restructuring plan should provide a sizable portion of the required relief, although it is not enough to reach all debt sustainability analysis (DSA) goals.

Even if it greatly raises Sri Lanka’s DSA, the planned external debt-restructuring plan, under reasonable treatment assumptions for external creditors, prevents Sri Lanka from meeting the IMF’s GFN objective. To reduce the government’s demand for refinances, local creditors must participate through domestic debt optimization. To fulfil the GFN target, lower rollover risks, and guarantee that all creditors contribute fairly to the resolution of Sri Lanka’s debt issue, the domestic debt must be treated. As an example, Sri Lanka and the China Development Bank (CDB) have reached a definitive agreement in principle regarding the main financial conditions of restructuring over US$ 3.3 billion in sovereign debt.

Key challenges

Several significant challenges stand in the way of Sri Lanka’s debt restructuring process, making it more difficult to stabilize the country’s economy and attain sustainable growth. Coordination of creditors is one of them. A wide range of creditors, each with distinct objectives and interests, are owed money by Sri Lanka. China and India, two of Sri Lanka’s biggest bilateral lenders, might have different approaches to managing the debt.

For example, other creditors could insist on explicit debt reductions or haircuts, while China has generally favoured debt rescheduling, which extends payback terms. It takes time to reconcile these divergent viewpoints, which makes coming to a consensus more difficult. Since they own a sizable amount of Sri Lanka’s foreign sovereign bonds, private investors frequently insist on equal treatment to prevent them from suffering excessive losses in comparison to other creditors. These equity expectations complicate discussions since it becomes difficult to balance repayment terms and haircuts across various creditor groups.

Sri Lanka had to impose fiscal tightening to be eligible for international financial aid and restructure its debt.Taxes must be raised to increase government revenue, but doing so burdens citizens more, especially middle- and low-income households. Higher indirect taxes like VAT or income taxes, for instance, can raise living expenses and cause general dissatisfaction. Another popular adjustment is lowering or eliminating subsidies for necessities like food, energy, and fuel.

Although these cuts save the government money, they also result in higher costs for basic needs, which affect poor populations that depend on these subsidies to survive. Public protests, strikes, and political pressure resulting from the combination of higher taxes and reduced subsidies have made it difficult for the administration to implement these necessary but unpopular reforms. In addition, it creates uncertainty in the economy.

The unpredictability and length of the debt restructuring process have an impact on the overall economy. It takes time to reach agreements with all creditors, particularly when their interests diverge. Businesses and individuals find it more difficult to make long-term plans because of these delays, which prolong economic volatility. Foreign investors find Sri Lanka to be a less attractive destination due to the uncertainties surrounding the debt restructuring process. Until they have faith in the nation’s economic stability and debt sustainability, investors are reluctant to make financial commitments. Sri Lanka will have trouble expanding its economy and obtaining fresh funding if the debt situation is not resolved. Recovery attempts are slowed down by a lack of investment and consumer confidence, which maintains high unemployment and slow growth.

Steps towards progress

To successfully manage the debt crisis and come out stronger, Sri Lanka needs to add a clear and inclusive plan to its debt restructuring efforts. The government ought to be transparent about the rationale behind debt restructuring, the difficulties encountered, and the anticipated results. Media campaigns, public forums, and frequent updates can all help achieve this. The public and creditors can be reassured that resources are being managed properly by disclosing information about debt talks, fiscal changes, and fund utilization.

Promoting feedback from interested parties, such as corporations and civil society, can aid in the creation of just and efficient reforms. And Sri Lanka needs to concentrate on measures that boost economic expansion, provide employment, and increase public resources. Shifting the focus away from traditional exports like clothing and tea and toward sectors like high-value agriculture, IT services, and tourism. This will strengthen the nation’s resilience and lower its trade imbalance. For Sri Lanka, tourism is a significant source of foreign exchange earnings.

Revenues will increase if this industry is revived by focused marketing, enhanced infrastructure, and safety measures. This will draw tourists from abroad. Sri Lanka can become a centre for IT services, e-commerce, and digital startups by investing in innovation and technology, which will attract both domestic and international investment. Protecting the most vulnerable populations is also necessary to ensure that budget cuts do not worsen inequality or result in widespread suffering.

Supporting low-income households by boosting initiatives like free healthcare, food aid, and direct cash transfers. Tax rises and reductions in subsidies may be reduced by these actions. The government must ensure that reforms consider the concerns of women, rural communities, and other marginalized groups to promote fair development. And investing in educational and vocational programs to help people adapt to a changing economy and improve their chances of finding work.

Conclusion

The process of debt restructuring offers Sri Lanka a vital chance to change its economic course, even though it also comes with many difficulties. The country can pave the way for sustainable and fair growth by addressing the root causes of the crisis and implementing transformative reforms. Debt restructuring not only offers a means of escaping a fiscal crisis, but it also presents a chance to reorganize the economy and promote resilience over the long run.

Sri Lanka can build a more robust and inclusive economy by increasing tourism, diversifying its exports, investing in human capital, and embracing digital innovation. Innovations that focus on protecting the weak benefit of all aspects of society by reducing inequality and fostering social cohesion. Sri Lanka can transform this catastrophe into a springboard for a better future by combining sensible policies, immediate action, and inclusive growth methods.

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