Moving towards a more sustainable foreign debt
Achieving a more sustainable foreign debt profile is a national priority and economic imperat ive. Borrowing at high interest rates to repay debt will only worsen the country’s external financial vulnerability. International financial assistance from multilateral financial institutions and friendly countries is vital to lessen the severity of the problem, boost international confidence and prevent the escalation of interest rates for borrowing.
Longer run
While such immediate measures are needed to reduce the nation’s external financial vulnerability, a medium and long term strategy has to be implemented to ensure that the nation’s foreign debt is sustainable in the future.
Recognising the problem
Understanding and recognising the severity of our foreign debt problem is the first step towards finding a solution. The plain truth is that we are in a foreign debt trap as we have to borrow to meet our debt servicing obligations.
There is no room for complacency because we are able to meet our debt obligations this year and the next by further borrowing, various foreign currency swaps and depleting our foreign reserves to critical levels. We have to move towards a sustainable foreign debt soon.
Debt data
Foreign debt is about US$ 56 billion, which is 86 percent of GDP. Annual debt repayments in the next few years are around US$ four to 4.5 billion; the country is likely to have BOP deficits that erode the reserves and the costs of foreign borrowing is increasing.
Foreign reserves that were US$ 7.4 billion at the end of August this year, are currently about US$ 6.4 billion. Most of these reserves are borrowed funds rather than earned ones.
Recognising the severity of our foreign debt problem is vital to resolving it. We are in a foreign debt trap as we have to borrow to meet our debt servicing obligations. Our foreign debt is about US$ 56 billion or about 86 percent of GDP. Annual debt repayments in the next few years are around US$ four to 4.5 billion. As the country is likely to have BOP deficits, the reserves could be eroded to critical levels. Owing to the state of our debt dynamics the costs of foreign borrowing is high and increasing. Foreign reserves that are about US$ 6.4 billion are mostly borrowed rather than earned funds. As we have to borrow to repay our debt obligations, interest costs of new loans from commercial lenders are high owing to perceived risk.
Growth of debt
Foreign debt that was US$ nine billion in 2000, increased to US$ 11.3 billion in 2005, to US$ 21.2 billion in 2010, US$ 44.8 billion in 2015 and to US$ 56 billion in 2020.
There are many reasons for the exponential growth of foreign debt. The need to borrow at high interest rates to repay maturing debt, large defence expenditures, massive infrastructure projects that did not increase tradable goods and persistent large trade deficits are among the reasons for the escalation of foreign debt.
Debt reduction
Progressive reduction of the foreign debt in the next five years is imperative. Debates on how this debt escalated, who was responsible for it and the ability or inability to meet debt repayment obligations are futile now. There must be a national effort to reduce foreign debt.
Economic policies must be geared to reduction or at least not increasing the debt. Foreign borrowing must be on the most favourable terms and for investments that enhance tradable goods. The budget for 2021 must reduce the fiscal deficit and prioritise expenditure that enhances exports and reduces imports.
Domestic economic performance
A country’s external finances are largely a reflection of its domestic economic performance. Persistent trade deficits due to imports exceeding exports by far have been a root cause of this deterioration of external finances. This has been aptly described as the nation "living beyond its means."
Exports
Inadequate domestic production of traditional export crops, undiversified manufactured exports, high costs of production are among the reasons for inadequate export earnings. However export industries that were severely affected by the pandemic have shown an admirable resilience and adaptation to diversify into new products and new markets. In the last five months, export earnings have reached nearly pre-COVID levels of US$ one billion a month due to their diversification into personal protective equipment (PPEs) such as surgical gloves, rubber gloves and masks. It is vital that this same enterprise must continue to expand and diversify export produce and markets.
Strategies
A multifaceted strategy is needed to strengthen the external finances. Most important of these is to reduce the trade deficit. While decreasing non-essential imports and other imports by local production of these and their substitutes will help reduce import expenditure, the more pragmatic solution is to increase export earnings as import restrictions could also affect exports that have a high import content.
Restricting imports has not been successful in the past. Other countries like India that is better endowed with raw materials too abandoned this strategy to transform its economy to be more competitive. In fact freer and lower import costs could improve the country’s international competitiveness.
Solution
An export enhancing strategy is the viable solution to reducing the trade deficit. Exports are only about half the value of imports. For instance in 2019 before the COVID-19 pandemic struck the global economy, Sri Lanka’s exports were US$ 11 billion compared to imports of US$ 19 billion.
In recent years large trade deficits have been offset or reduced substantially by tourist earnings and workers’ remittances. Both these have reduced owing to the global pandemic. This makes the reduction of the debt more difficult.
Exports
The trade deficit must be improved by increasing the country’s exports. Manufactured exports such as apparel, tyres and ceramics were severely affected by the global shut down. However, export manufacturing diversified into rubber gloves, surgical gloves and personal protection equipment ( PPE) to increase exports. Consequently exports reached the previous levels of about US$ one billion a month since May this year.
It is this kind of resilience and enterprise that is needed to diversify exports and find new markets for new goods. This is the way forward. Opportunities must be seized when the global economy revives.
Imports
There has been a reduction of the trade deficit in the first seven months of this year by lesser imports. This has been due to both restriction of imports and autonomous factors. The dip in international oil prices reduced oil imports significantly. The slowing down of the economy also reduced imports of intermediate goods needed for construction. In addition, the government imposed import restrictions on gold and motor vehicles that reduced import expenditure. Owing to these reasons, import expenditure was reduced in the first eight months of 2020.
Restricting imports
This has led to advocating import restrictions to reduce the trade deficit. While restricting selected items of imports such as gold and motor vehicles may do no harm to the economy and would benefit the trade balance, broader import restrictions could affect our export manufactures as most manufactured exports have a high import content and reduce export competitiveness.
In conclusion
The severity of the country’s debt burden is such that it should get the assistance of the IMF to replenish the reserves and boost international confidence. Disagreeing with rating agencies will not bring any relief. The fact that the country could meet its debt obligations this year and the next should not lull us to complacency as the borrowing of new loans to repay loan repayment obligations are escalating the foreign debt. The time when this debt repayment cost is beyond our capacity is not too far away.
Foreign borrowing should be for investments that increase tradable goods or services that generate foreign earnings. Most of these loans should be at low interest costs and long periods of repayment. Essential infrastructure investments must be project loans that have a very long period of repayment and interest costs are very low as in the case of Japanese funding of projects and assistance given by multi-lateral agencies like the IMF, World Bank and the Asian Development Bank (ADB).
Fiscal, monetary and other government policies must focus on those that decrease import expenditure and increase merchandise exports and earnings from services. The fiscal deficit should be reduced by increasing government revenue and reducing unproductive expenditure. Fiscal monetary and other government policies have an important bearing on the trade balance and balance of payments.