Sri Lanka – Historic default, recovery underway despite local politics

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The recent few days have seen a flurry of positive statements about Sri Lanka in the midst of historic negative events locally. For the most part the positive statements come from overseas sources while one has local reference. In terms of action locally, apart from positive steps taken by the Central Bank of Sri Lanka (CBSL) and the Ministry of Finance (MoF), political focus to arrive at solutions look tardy and unfocused to say the least.

On Thursday 19 May, Reuters, referring to JP Morgan, the bulge-bracket US based global investment bank, pointed to recent political changes in Sri Lanka and action to appoint both financial and legal advisers to undertake the restructuring of debt, thereby facilitating discussions with the International Monetary Fund (IMF). Based on these events JPM opined that International Sovereign Bond (ISBs) issued by Sri Lanka currently trading at all times lows would move higher implying thereby the possible reversal of their steep discounts.

On the same day, Dr. Nandalal Weerasinghe, Governor of the Central Bank of Sri Lanka (CBSL), in response to questions raised on the statement made by JPM, explained that he has been saying the same and that JPM, uninvolved with the Government of Sri Lanka or CBSL, had endorsed his views. He went on to explain that given the stressed circumstances of Sri Lanka but also the action underway to engage with the IMF, investors will not only gain handsome returns but also transact on the basis of a favourable exchange rate.

Equally, in a draft communique issued the same day, the Group of Seven (G7) Finance Ministers comprising Canada, France, Germany, Italy, Japan, UK and the US, meeting in Bonn, Germany said they support efforts to provide debt relief for Sri Lanka. In their statement they committed to finding long-term solutions for the nation and urged it to “negotiate constructively” with the IMF on a potential loan programme.”The G7 stands ready to support the Paris Club’s efforts, in line with its principles, to address the need for a debt treatment for Sri Lanka,” they said.

The draft statement, which was to be finalised before the end of the meeting called on other large creditor nations not in the Paris Club to coordinate with the group and urged them to provide debt relief on comparable terms.The statement also singled out China, which has become a major creditor to low-income countries, to actively contribute to their debt relief.

Chad, Ethiopia and Zambia have sought debt relief under a new G20 common framework, but progress has so far been slow with some officials accusing China of dragging its feet.

China for their part, releasing a statement at a media briefing on Friday 20 May 2022, said it stands ready to work with relevant countries and international financial institutions and to continue to play a positive role in easing the debt burden of Sri Lanka and helping it to achieve sustainable development.

“China fully relates to the difficulties and challenges facing Sri Lanka and stands ready to play a constructive role in its steady economic and social development,” Chinese Foreign Ministry Spokesperson, Wang Wenbin said at the media briefing.

“In the meantime, we hope and believe that Sri Lanka will work in the same direction and make independent efforts to uphold the legitimate rights and interests of foreign investment and financing partners and maintain stability and credibility of its investment and financing environment, Wenbin said further in response to questions raised during the media briefing.

In this connection the efforts undertaken by India are also significant. Indian support came not only from visible action in the form of extending swap and credit lines for essentials such as fuel and medicine, but also in funding settlements undertaken by Sri Lanka within the ACU System.

As referred to in the G7 Statement, on 18 May 2022, Sri Lanka defaulted on its ISBs for the first time since entering the debt capital markets in 2007, a lapse of 15 years. The historic default occurred after failing to effect a coupon payment of $78M that was due on 18 April 2022 within the 30-day grace period.

Apart from the ignominity of such an event and the enormity of placing Sr Lanka among other recent defaulters such as Chad, Zambia, etc., experts say the event triggers cross-default clauses embedded in the ISB documentation that can accelerate and bring forth the repayment of other longer dated ISBs.

In mitigation, the debtholders as well as other market players would have expected such an outcome as the Government on 12 April 2022 had announced that it would suspend external debt-service payments from there onwards.

The announcement went on to say that it will pursue and undertake a comprehensive external debt restructuring process that would ultimately culminiate in an IMF funded programme.

Accordingly Sri Lanka issued RFPs for the recruitment of appropriate Financial  and Legal Advisers. Some 50 interested parties, that included among them some of the renowned firms specialising in such work, namely Lazard, Rothschild, Deutsche Bank, Barclays, to name but a few have expressed their interest. Committees within both the MoF as well as the CBSL have by now evaluated and shortlisted them awaiting final selection and appointment by the Cabinet.

The economic position of Sri Lanka is likely to remain under stress even with the suspension of servicing external debt. With government revenue at around 9% of GDP and domestic interest payments absorbing more than 70% of revenue, absence of fiscal reforms is unlikely to generate any uplift in the economy. Thus fiscal adjustments will be mandatory particularly in the context of escalating global energy and food prices. Not only will government revenue need to expand, expenses will also need curbing.

Next the role of multilateral partners in the short-term will take a dominant position. Relationships with such institutions will need to be taken to the next level particularly in unlocking US$ based financial accommodation. Already these multilateral agencies have agreed and announced that they will work in unison in supporting Sri Lanka. Such accommodation is also likely to stumulate private FDI.

As shown above, while many external institutions as well as countries are rallying to support Sri Lanka, in stark contrast, the effort by its own indegenous leaders look sparse and aimless. Much of the recent talking in Parliament had no focus on any type of solution to the crisis in the availability of dollars and rupees or even empathy with the masses labouring in queues for essentials.

In an interview with Sky News UK, the newly appointed PM offering wisecracks to local media was checked in his stride trying similar tactics. He was not only rebuffed but also lost an opportunity to promote tourist flows to Sri Lanka. 

Eventually given the lapse of say 6 – 9 months for reaching an agreed level of debt sustainability post the debt restructuring exercise, Sri Lanka is likely to reach an agreement with the IMF for a funded programme. Finalising such a programme will  take several months given the need for staff level agreement on both sides, followed by Parliamentary approval in Sri Lanka and  Executive Board approval by the IMF.

The ongoing political and social unrest in SriLanka will impact the pace of negotiations. The potential for changes in the political leadership or government with a 15-man Cabinet absent a Finance Minister, can also vary the time to reach an agreement with the IMF.

Whatever the vageries of the road, Sri Lanka has taken the first steps of recovery despite no efforts by local leaders except those of CBSL and MoF.

By Ishara Gamage