Sri Lanka Sets Example with Efficient Debt Restructuring– CBSL Governor Explains

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?Ceylon Today 22 12 2024 Finnace Today section

By Ishara Gamage

The Government of Sri Lanka on Friday (20th) successfully concluded its two-year-long International Sovereign Bond (ISB) restructuring process by completing the bond exchange. The government is now expecting to finalise bilateral debt restructuring, and with the completion of this process, officials state that nearly 99% of the debt restructuring has been completed.

In addition, the government has appointed Lazard as Sri Lanka's financial adviser for the debt restructuring process, specifically to finalise the restructuring of SriLankan Airlines' debt, which remains the only outstanding external debt component after the completion of all domestic and external debt restructuring.

Against this backdrop, as Sri Lanka transitions from a temporarily defaulted nation to achieving more sustainable debt levels, Finance Today met this week with the Governor of the Central Bank of Sri Lanka, Dr Nandalal Weerasinghe, to discuss the country's economy in the post-debt restructuring scenario.

The following is the full text of the interview Finance Today conducted with the CBSL Governor following the conclusion of the bond exchange process.

Question: Sri Lanka is about to conclude its two-year-long debt restructuring journey. What progress has Sri Lanka made in its debt restructuring process?

In terms of debt restructuring, the first phase of domestic debt restructuring, completed last year, was carried out successfully. There has been a lot of talk about the Employees’ Provident Fund (EPF) being affected, but that is entirely a myth. The restructuring was executed in a manner that provided significant liquidity support to the government, enabling it to continue critical efforts without serious disruption. Moreover, the impact on the market and the EPF was minimal. There was no haircut applied to EPF balances—no member lost any part of their balance. In fact, members received a 13% return last year, compared to 9% or 7% in previous years. Moving forward, returns are expected to exceed 9%. In this domestic debt restructuring process, we, as the Central Bank, made the largest contribution of 0.9%, while the EPF contributed only 0.3%.

As for external debt restructuring, the second phase involving bilateral agreements has already been announced. Agreements in principle have been reached, and loan agreements are being drafted country by country. Once these are finalised, the government will resume normal, long-term payment schedules at an average interest rate of 2.1%—a significant achievement.

The final phase, involving commercial debt restructuring, became public information last month. The bond exchange was completed on the 20th, meaning that nearly 99% of the restructuring of government obligations was finalised.

Question: What does the remaining 1% represent?

The remaining 1% relates to SriLankan Airlines, which is still pending because of government-guaranteed obligations currently under discussion. That is the largest outstanding component. Additionally, there are some minor bilateral obligations involving countries like Iran, Kuwait, and Pakistan, with relatively small amounts. These are in the process of being finalised. The SriLankan Airlines restructuring is a separate process led by the government. They have appointed Lazard as the financial advisor, and the restructuring is being conducted in alignment with the existing commercial debt restructuring framework. There will be no deviation from this understanding.

Question: How will this post-restructuring shape Sri Lanka’s economic future?

If you consider the purpose of the restructuring, it is primarily to address the unsustainable state obligations compared to the limited foreign reserves we had. At the time, foreign reserves were almost non-existent, while annual obligations stood at USD 6–7 billion. This situation necessitated the temporary debt suspension, which was announced with the intention of achieving a sustainable national debt level.

The outcome of the restructuring is that, until 2027, the government will service only the interest component of external debt at low interest rates. This will create significant fiscal space, enabling the government to implement necessary reforms and allocate resources to other important priorities.

Furthermore, after 2027, based on the debt settlement schedule—which will be announced upon completion of the restructuring process—debt service obligations are expected to reduce to a maximum of 4% of GDP, compared to the 9.2% of GDP experienced prior to the restructuring. Over the next 15–20 years, this will result in a comfortable level of debt service obligations.

Sri Lanka should then be able to service its debt without significant difficulty, provided the programme is implemented properly, as debt service obligations will remain contained. During this period, necessary reforms will be introduced to enhance growth opportunities and address fiscal concerns. With these measures in place, a buffer has been created, allowing the government to focus on implementing critical reforms.

Most of the difficult reforms have already been undertaken, leaving little additional work required going forward. Once the restructuring is complete and properly utilised, Sri Lanka’s economy will essentially be on "autopilot." If all steps are followed effectively, this opportunity to stabilise and grow the economy will not be missed.

Question: How has Sri Lanka's process of regaining debt sustainability evolved during this transformative period?

Debt sustainability has already been restored to some extent. The debt-to-GDP ratio, was at 128%, is projected to decline over time to around 95% by 2032. Debt service payments and gross financing needs will be managed within sustainable limits during this period.

Multilateral agencies such as the Asian Development Bank (ADB), the World Bank, and other international organisations will continue to provide support through programme and project financing. Bilateral partners are also expected to resume some previously suspended projects, and the government can negotiate new agreements with them.

Domestically, with lower interest rates and the fiscal space created, the government will have the capacity to finance additional requirements through the domestic market.

Even with a 4.5% external financing gap, if the economy grows beyond the baseline scenario, it will generate additional fiscal space. In such a case, the government could borrow further if necessary. However, government borrowing is expected to stabilise, provided a 2.3% current account surplus is maintained and growth remains above the baseline. This approach will offer additional buffers and flexibility, if required, allowing for further domestic borrowing.

Under the baseline scenario, the expectation is that Sri Lanka may need to re-enter international markets around 2028. This will depend on whether foreign reserves can be built up to around USD 13.5 billion by that time. If reserves reach this level without external market borrowing, there may be no need to return to the markets.

The government aims to improve its credit ratings, which will naturally restore market access. Once this is achieved, the decision to raise funds will depend on necessity. Should there be a need, the government will have the ability to borrow internationally. However, prudent fiscal management and sufficient reserve accumulation could eliminate the need to rely on external markets.

Question: How do you see Moody’s recent approach to Sri Lanka’s sovereign rating amidst ongoing government obligations and domestic factors influencing assessments?

Some rating agencies suggest they will wait until all government obligations are met, but Moody’s has indicated they may act sooner once a significant percentage of obligations is addressed. Domestic factors will also influence these assessments. Moody’s made an announcement once the restructuring is completed. They will proceed.

We have never maintained a consistent investment-grade rating at this level before. Achieving a ‘B’ grade rating immediately after three years of sustained effort is a regular process. I believe that obtaining a ‘B’ grade rating is not a magical solution.

In order to attract non-debt-creating inflows, Sri Lanka must follow a strategy focused on export-led growth. Entering export markets and exploring potential services are essential. One part of this is maintaining a smaller current account deficit, which ensures sufficient inflows to finance that deficit. This, in turn, will help us build reserves and attract medium- to long-term investments, such as foreign direct investments, portfolio investments, and access to other treasury bills.

Confidence among investors is critical. While many steps need to be taken beyond the immediate mandate of government, such as implementing necessary reforms and addressing corruption, these are essential for creating a more conducive business environment. A stabilisation effort will provide a significant boost to ratings, which we expect to happen soon. This will instil confidence among investors, which must be maintained going forward.

Q: How about the other domestic obligations such as Ceylon Petroleum Corporation (CPC) and Ceylon Electricity Board (CEB) obligations?

That part has already been addressed by the government. The government has provided the necessary interest subsidies, and Parliament approved this last week. Additionally, the domestic portion of foreign currency debt for those institutions has been completed under the domestic loan category.

Q: How complex is Sri Lanka’s debt restructuring process so far, and how do we handle these different kinds of issues and different types of creditor groups?

It is a very complicated process, a highly complex one. Therefore, a better understanding of this unique, country-specific situation is essential. For example, in Sri Lanka, people ask why our situation is not similar to countries like Ghana, Suriname, Zambia, Argentina, or Greece. Each country has its own specific challenges.

Sri Lanka’s focus is on restoring its debt sustainability, not following the path of Ghana. To achieve this, we aim for a comparable basis where we cannot request more relief than what has been obtained from bilateral treatments. This approach has necessitated a large team effort, involving the Ministry of Finance, the Central Bank, the Attorney General’s Office, financial and legal advisers, and past and present administrations from Gotabaya Rajapaksa, Ranil Wickremesinghe to the current Anura Kumara Dissanayake era. The processes involve negotiations with different types of creditors to ensure fair outcomes.

The categorisation of creditors by type, such as domestic first, followed by external, bilateral, commercial (like CDB loans), ISB holdings, foreign currency denominated SLDBs, CEB loans, CPC debts, and government guarantees for institutions like Sri Lankan Airlines, requires different treatments that must be comparable. This creates a complicated process. Compared to countries like Zambia, Sri Lanka has done much better in terms of time taken to restore debt, although Ghana is slightly ahead in some respects.

Despite the complexity, Sri Lanka’s situation is unique, and it cannot be directly compared to other countries.

Question: What do you think about the IMF’s Debt Sustainability Analysis (DSA)? Some are criticizing its framework, questioning whether we are getting enough debt relief or concessions.

DSA is a product and responsibility of the IMF. They have their own framework, which has been developed and approved by the executive board of the IMF and is applicable globally, across all countries. Any revision to DSA falls within the remit of the IMF, not member countries. Therefore, the IMF has developed this DSA for two frameworks: one for low-income countries, and another for market-access countries, which applies to us. Under this framework, they analyse historical data alongside their projections. This results in a comprehensive assessment, which is essential for restoring debt sustainability. It is an independent analysis, and no one can influence the DSA, as it is the IMF's product applicable equally to all countries.

This is important because even creditors on the negotiating side view the DSA as an independent analysis conducted by experts with technical capacity. Thus, it serves as an impartial assessment, akin to an umpire, determining what is needed for a member country to achieve sustainability based on country-specific information and outlook.

Although administrations or governments can challenge the DSA if they feel it is too conservative, it is unlikely that the IMF would revise it significantly. Throughout the DSA discussions, there were numerous debates, particularly before the staff-level agreement, where we argued for a more optimistic outlook. Given our recent performance, we were able to show that we have outperformed the IMF’s projections in the past two years, creating buffers against their baseline scenario going forward.

Moreover, if managed properly, we have the potential to perform even better than the DSA parameters, which would provide greater space for the country. Having a conservative outlook is beneficial, as it allows for better performance and facilitates more substantial debt relief from creditors. The foundation of debt relief rests on the IMF DSA. A too-optimistic assessment would result in less relief, whereas a more conservative outlook could lead to greater relief. Therefore, maintaining a balance is crucial, and both parties—creditors and debtor countries—must accept and acknowledge the importance of the DSA. Negotiations are conducted on this basis.

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Question: Do you think we can achieve enough concessions to restructure within the DSA parameters? Is it sufficient to maintain sustainability?

I believe so. If you examine the DSA outlook and compare it to the actual progress so far, we have created sufficient space. We have performed better than expected, which means that sustainability has already been restored based on historical data. Going forward, if we continue to perform better than the baseline, we will ensure ongoing sustainability. There is no doubt about this.

Question: How confident are you that Sri Lanka won’t need to enter another IMF programme again? after completing these four years?

It largely depends on the policies implemented in the coming years. From the Central Bank’s perspective, we will ensure a proper monetary policy moving forward for sustainability, and we will maintain that. However, the Central Bank is not the sole player in this. Fiscal policies, sectoral strategies, and other policies need to be in place. I am confident that if we continue along this path, we won’t need to restructure again. This has been consistently emphasised. Regardless of the administration, moving in the right direction is essential. Fortunately, every administration has acknowledged and followed this approach, and we are steadily moving closer. There is a comfort factor knowing that discussions are heading in the right direction.

Question: What is your growth forecast for next year?

For next year, the baseline is around 3%, but I believe we will surpass that. It’s difficult to predict an exact figure, but based on recent data, 2024, Q3 was stronger than expected. In our last media conference, we projected a growth rate of 4.5% to 5% for this year, and it looks like we’ll hit around 5%. For 2025, with the right policies in place, I am confident we can easily exceed 3%.

Question: What is your forecast for next year’s forex inflow and outflow?

Looking at the overall macroeconomic situation, the current account of the balance of payments is expected to be in surplus, which is why the currency has remained stable. Next year, we anticipate a small current account deficit compared to previous surpluses. This is due to the economy’s growth, which will increase demand for imports, as well as debt service obligations returning to normal. We are projecting that debt service obligations will be managed with lower interest payments, which will help reduce the overall burden. We anticipate being able to manage payments effectively, with interest rates for debt service expected to remain manageable. Although this year’s total debt servicing was higher, including past due interest payments, next year, we expect slightly lower figures as payments are brought up to date and interest rates remain favourable.

Question: How is the CBSL relationship with the new government

It is very encouraging and highly supportive, and the new Act ensures sufficient independence for the Central Bank, which is a significant step forward. It provides a framework that maintains independence while ensuring accountability. This balance is crucial for the effective functioning of the Central Bank in supporting economic stability and growth. The relationship is being developed within this framework, focusing on mutual understanding and cooperation.

Question: How do we address vulnerable populations through government concessions, and how do these interact with government policies?

The government has the authority to provide concessions using taxpayers' money, within the framework of parliamentary approval. As long as revenues are collected and managed sustainably, the government can allocate resources to support social safety nets. This ensures that essential services and subsidies are provided where needed.

However, it is crucial to balance these concessions with maintaining overall macroeconomic stability. The government has the responsibility to manage the allocation of resources effectively, ensuring that social safety nets are preserved, especially in times of crisis. The erosion of income for vulnerable populations requires sustainable support.

Ultimately, the budget process will outline specific measures and initiatives, and it will be important to monitor how these are implemented, ensuring that debt sustainability is not compromised.

Question: How is inflation targeting working?

Inflation targeting is working very well. In the short term, we are experiencing a period of deflation, largely due to unexpected fluctuations in energy prices during the last two quarterly adjustments. Without these adjustments, we could have maintained a stable inflation target within the desired range.

That said, a temporary period of deflation is acceptable, especially after prices reached a high peak. The goal is to return to a normal inflation path. With the right framework and effective implementation of policies, including market operations, financing, and the independence to execute them, we are confident in maintaining a 5% inflation target.

Overall, the Central Bank’s performance in fulfilling its mandate has been commendable, and we believe that the foundation is solid for achieving sustainable inflation control.

Question: Do you think our monetary policy is at the appropriate level at the moment?

Our monetary policy is set at an appropriate level, and adjustments will be made as needed. We are flexible in maintaining, increasing, or decreasing rates depending on the prevailing economic conditions and requirements.

Regarding recent market interest rate expectations, we consider several factors when making decisions. Market conditions fluctuate, and we take a balanced approach based on various indicators.

Overall, with nearly 5% inflation management, we are confident that we can maintain stability while addressing short-term needs effectively.

Question: Are there any specific tools you are going to utilize to accelerate the recovery process, economic recovery?

Mainly, interest rates are the key instrument that we have for short-term control. It is a much clearer and more transparent process. We target short-term interest rates nationally. Additionally, we have some other tools, like changes in SRR (Statutory Reserve Ratio) and other regulations, which can be adjusted as needed.

The primary focus is on short-term interest rates. We aim to ensure a proper transition from short-term policy rates to longer-term market rates, making the transmission of interest rates more efficient within the market. This will help maintain inflation targeting and support overall economic recovery.

Question: How about credit growth so far?

The credit growth so far has been much better than expected. This is also reflected in the confirmation of Q3 growth. The growth is consistent with the trend we are seeing, with credit continuously increasing. I am confident that this growth will continue over the next several quarters.

Although there are tight fiscal conditions, the trend of credit expanding to the private sector will offset these conditions. As a result, the growth trend will persist through private sector recovery. I do not anticipate the government expanding its operations beyond this fiscal framework.

Question: What is your forecast for credit growth in this low interest rate environment?

I believe that credit growth should align with normal GDP growth rates. However, there isn’t a direct one-to-one relationship. Credit growth is not solely the outcome of specific policies. We do not target a specific level of credit growth. Instead, it is influenced by overall inflation, interest rates, and the distribution of credit across various sectors—dependent on demand, supply, and economic activity.

For example, sectors like tourism, which are more substantial, will absorb more credit, while other sectors may absorb less. Currently, credit levels are still relatively low.

Moreover, real wages have not kept pace with the rise in inflation, creating a gap between income and purchasing power. It will take time for incomes to gradually adjust in order to compensate for the increased prices. Thus, there is a transition period required where incomes rise progressively, balancing the effects of inflation.

Ultimately, we anticipate that credit growth will gradually align with economic recovery, ensuring a balanced and sustainable approach.

Question: How is the controversial Parate issue being addressed, especially given its impact on various sectors?

The government has extended the debt moratorium period up to March, after which we will assess the situation.

In the banking sector, we are considering business revival options via related banking units for those who are currently unable to meet their repayment obligations. This will include specific guidelines to assist individuals and businesses willing to restructure their loans and resume servicing their debts. These adjustments, such as interest rate modifications, will be addressed within the coming year. Once these changes are implemented, the process will return to normal.

Currently, the banking sector indicators are showing positive signs. Non-Performing Loans (NPLs) have been steadily decreasing—from a peak of 13.8% to below 12.5%. This decline is primarily due to low interest rates and natural credit growth, leading to a higher ability for individuals and businesses to meet their repayment obligations.

Sectors such as tourism and construction have been the hardest hit due to the ongoing crisis, but they are gradually recovering. We have seen sector-wise data indicating improvement, with a more balanced recovery across various industries.

Question: So, how is the financial system stability status after the restructuring?

The financial sector is now much safer and more stable compared to the challenges faced in recent years. Earlier concerns about liquidity and capital adequacy, particularly during the crisis, have been addressed. Banks have been recapitalised, and their ability to support the economy has improved.

Sri Lankan banks are now in a better position to attract external funding, especially as foreign counterparties relax their limits following potential rating upgrades. Banks have opportunities to lend in foreign currency, particularly as the export and tourism sectors recover. These developments will enhance the banking sector’s competitiveness and support overall economic growth.

On the other hand, this improvement is evident in the balance sheets banks publish, and by the end of this year, their performance is expected to be historic. One reason is their over-provisioning for ISB holdings; once restructuring is completed, this will benefit them, allowing some of the provisions to be recouped back to the balance sheet. This will reflect higher capital buffers. I expect high profits for the banking sector now that restructuring is completed. I do not believe even the two state banks will require significant additional funding. The banking sector is now much more stable and ready to support growth going forward.

Additionally, Parate execution must be an integral part of the credit delivery process. I believe what we would like to see from the government is the introduction of bankruptcy laws. Once that is in place, bankruptcy laws will serve as a solution instead of Parate. It is essential for businesses to continue operations while transitioning from an insolvent shareholder to a solvent one. We need to protect the enterprise, not the entrepreneur. Entrepreneurs may come and go, but enterprises should be safeguarded under insolvency law. This natural service will support banks, businesses, SMEs, and corporates across the banking framework, assisting those with large exposures.

Question: What type of assistance are you providing in creating insolvency laws?

I understand the draft insolvency laws have already been finalised and are likely to be presented to the Cabinet soon. These laws aim to address two key areas: the credit process and the challenges faced by enterprises.

The proposed framework allows enterprises to declare a form of bankruptcy, enabling another party to take over the business and continue its operations. This is crucial for protecting employment and ensuring viable enterprises are not forced to shut down due to managerial issues or inefficiencies. Investors can step in, management can transition, and businesses can continue to operate without unnecessary disruption.

Currently, Parate execution bypasses this process, with banks repossessing and selling off assets. This approach often results in significant losses in the value of the company, as the process is time-consuming and disrupts operations. Maintaining continuity is essential, as prolonged inactivity diminishes the operational business and makes recovery difficult. Parate execution without an efficient resolution mechanism can also lead to job losses.

The proposed insolvency laws aim to address these issues, providing a faster, more efficient process that allows businesses to recover or transition ownership within three to four months. This approach minimises losses and ensures a quicker resolution. Any revisions to existing acts must incorporate these strong mechanisms for recovery, enabling a more sustainable and balanced approach to handling business insolvencies.

Question: How is the financial sector consolidation process being implemented?

Currently, we are progressing through the consolidation process in the non-bank financial sector. Phase one has been completed, and phase two will launch soon. We are working towards reducing the number of companies in the non-bank sector from 55 to around 25-30. This will result in a mix of stronger, larger companies and smaller ones, with some level of consolidation likely to occur. Most companies now meet regulatory requirements, except for a few that are still below the minimum capital threshold. However, liquidity and capital adequacy have improved significantly.

During the crisis, deadlines for meeting minimum capital requirements were extended to give institutions time to stabilise. While some non-bank institutions continue to lend at high rates, interest rates across the sector are gradually decreasing. Overall, the non-bank financial sector is much more stable and better prepared to serve the economy.

In the banking sector, I see opportunities for synergy between smaller and larger banks. Some consolidation may happen here as well, although it remains voluntary. Smaller banks, however, may face challenges, particularly with the need to bring in more capital. They might explore various avenues, such as raising capital through partnerships, issuing debentures, or other methods.

The regulatory framework for the banking sector is robust. We have already set up systemic importance buffers to protect the sector during stress periods. These buffers have been instrumental in ensuring that banks continue to operate effectively, even in challenging times. Without these buffers, we could have faced bankruptcies, but instead, we maintained stability throughout the financial crisis.

As interest rates stabilise, banks will have the opportunity to reduce their cost of capital, particularly through the issuance of new instruments to replace higher-cost capital raised earlier. While some banks had to raise capital at very high rates, around 20–25%, during difficult times, this can now be adjusted.

Private banks are already well-capitalised, and I do not foresee significant issues with their capital adequacy. State banks, following restructuring, are also adequately capitalised.

Sri Lanka's minimum regulatory capital requirement under Basel is 8%, but banks currently maintain much higher buffers. On average, capital adequacy is at 14% and is expected to rise to close to 18%. This strong buffer allows banks to deploy capital effectively, support economic expansion, and drive growth going forward.

Question: Why are you encouraging consolidation in smaller banks?

Consolidation among smaller banks is more efficient because these banks often struggle to compete unless they invest heavily in technology and digitalisation. Technology is essential for their survival. Without it, smaller banks may remain weak, potentially affecting their ability to serve customers effectively.

There are instances where smaller government-owned banks, such as the Sri Lanka Savings Bank or Regional Development Bank, are not well-managed and lag in technological adoption. On the other hand, some small private banks are already advancing through technology. Encouraging consolidation can strengthen the sector, ensuring smaller banks either innovate or merge to create more robust institutions.

Question: Will the government establish a new Development Bank?

Discussions about creating a new Development Bank have been ongoing, but no concrete proposals have been made. In principle, existing banks could handle development banking functions if they have adequate medium- to long-term funding sources. However, the key to a successful Development Bank lies in its ability to raise medium- and long-term finance to support development activities.

A single development bank with limited resources may not be as efficient as encouraging the existing banking sector to raise long-term capital, such as Tier 1 or Tier 2 capital, and attract external development financing. This would allow the sector to better support small and medium-sized enterprises (SMEs) and long-term projects.

Question: How is the ongoing human resource restructuring process at the Central Bank?

It’s part of an internal strategy. We have a chartered strategy that has been in place for some time, which includes a structured resource strategy. However, I prefer not to discuss internal matters further.

Question: What is your message regarding the stability of the economy and the future?

The key message is that there’s a very narrow path forward for the economy, and it’s essential not to deviate from this path. We’ve come a long way in stabilising the economy, but achieving sustainable growth and improving living standards still requires commitment to this disciplined approach.

As we stay on this path and achieve economic recovery, more opportunities will arise for greater policy flexibility. However, until we return to pre-crisis levels, maintaining this course is crucial. The administration has accepted this approach, which is a positive step for the country.

Question: How does this disciplined approach benefit the country?

?By staying focused on this narrow path, we ensure economic stability and lay the foundation for future growth. This strategy, which has now been confirmed and accepted by the administration, is vital for the country’s long-term progress.

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