Sunil malli – one of my relatives – called me early morning on the New Year day, to greet me. Our phone conversation was, however, not limited to greeting each other, but to discuss many more things. As usual, we continued a long conversation. He too, whenever he calls me, usually brings interesting news and stories from around his different social circles to discuss and ponder.
This time he brought a really interesting story, circulating through social media: “The government is hurriedly planning to pass a new PTA, because now we are getting ready for domestic debt restructuring”. I knew that by PTA he referred to the proposed Prevention of Terrorism Act or the “Anti-Terrorism Act”.
Puzzled by his news, I told him: It’s like serving “konda-kewum (oil cake) with coconut sambol” at the New Year table!
“No, no!” He clarified: “As they say, when domestic debt is restructured, people will lose even their EPF (Employees’ Provident Fund). There will be massive protests in the country, which can be controlled with a new PTA.”
I replied: “I don’t know the truth in this connection between PTA and EPF. Neither did I hear that EPF is subject to domestic debt-restructuring. But, of course, if somebody likes, for political taste, there is no issue of enjoying konda-kewum with coconut sambol”.
As many are still puzzled with the debt-restructuring episode, and particularly its domestic component, I thought of addressing the issue today so that we may be able to understand it better.
Sri Lanka’s total debt is about Rs. 25,000 billion, while its domestic and foreign components are roughly about half and half. As Sri Lanka is not in a position to meet its debt repayment obligations to both foreign and domestic lenders, debt must be re-structured. In doing so, the country can once again achieve “debt sustainability” and establish its “financial stability”. Debt is sustainable, when the country can start repaying it comfortably. The country is financially stable, when it can maintain a sound budgetary and monetary policy position.
Sri Lanka has a unenviable history of borrowing more to keep repaying the previous borrowings and, getting caught up in a debt trap, whether it’s foreign borrowing or domestic borrowing. There must be a breakthrough in this vicious cycle to achieve debt sustainability and financial stability.
If the country is bankrupt, then lenders too face the risk of losing what they have lent. For this reason, lenders may come to the negotiating table to minimise the losses although they may not get everything back as they wish. By agreeing to some concessions with the lenders, the debtor may also be able to avoid total bankruptcy and improve debt sustainability and financial stability.
A country carries out its foreign borrowings from multilateral and bilateral sources as well as from international financial markets. A foreign debt instrument, which is commonly known as a “sovereign bond” is sold to borrow from private lenders in financial markets. During the period of maturity, the issuing government pays periodic coupon (interest) payments to the bond holder, and while at maturity the total value of the bond (face value).
The lender, who purchased the bond from the primary issue can also trade it in the secondary market, which is usually the case for financial market borrowings. The market price of a bond depends on the demand for bonds. When the country has a poor credit rating or has already declared default, the bond price must be very low. For instance, a US$1 worth Sri Lankan sovereign bond with 7 per cent coupon rate and 5-year maturity period is now priced in the market around 40 dollar-cents, while those with 10-year maturity period around 35 dollar-cents.
Generally, debt-restructuring involves (a) re-scheduling of the maturity period of bonds and (b) cutting down part of interest or principal of the bonds. The first is concerned with extending the period of maturity. It is easier to negotiate this option because it does not cause much losses to the lenders, while the debtor also gets an extended time period to find enough money to repay debt.
The second option which is known as the “haircut” is the hardest, because it involves lender’s consensus to forgo part of the debt. In some cases, however, it may be the “second best” option for the lenders who would, otherwise, be faced with the risk of losing all what has been lent.
Here is an example: If the bond-issuing country is unable to pay back the bond’s face value of $1 on maturity, and the bond is priced now in the market at only for 40 dollar-cents, the lender is at the risk of losing the entire investment. Instead of allowing that, the lender can agree with the bond-issuing party to take a 25 per cent “haircut”. This means, the lender agrees to receive only the balance 75 per cent of the money that was lent.
Public debt consists of both foreign and domestic borrowings so that debt-restructuring is concerned with both sides in order to make it a complete effort. The bitter truth is that even if domestic debt-restructuring happens or not, the public must pay in order to achieve debt sustainability. Accordingly, an alternative to domestic debt-restructuring may be a further increase in taxes!
The Sri Lankan government’s domestic borrowings were based on selling government securities (Treasury Bills and Bonds). The holders of the government securities are (a) the Central Bank which lent to the government by printing money, (b) government banks such as Bank of Ceylon, People’s Bank, and National Savings Bank, which lent to the government out of their deposits (c) government funds such as EPF which are invested in government securities and (d) other, which include private banks, other institutions and other public entities including individuals.
I separated some of the “government institutions” in the first three points to show how important they are as lenders to the government. Where debt-restructuring is concerned with either rescheduling public debt or applying a haircut, it affects these institutions differently. As of now, what has been clearly stated by the government is the rescheduling of public debt held by the Central Bank only.
Rescheduling domestic debt can be implemented by converting Treasury Bills to Treasury Bonds. By definition, Treasury Bills are short-term debt instruments with maturity period less than a year, while Treasury Bonds are long-term debt instruments with a maturity period of more than a year. When Treasury Bills are converted to Treasury Bonds, automatically debt is restructured by extending the maturity period.
It may be the Central Bank out of all lenders to the government, which can absorb the impact of domestic debt restructuring, as it has already been announced. Other lenders, depending on the impact of debt-restructuring on the financial position and the cash flow, can choose it differently. The more critical area of debt-restructuring implications may fall upon the banking sector, depending upon their exposure to the government debt.
The largest pension fund of the country, EPF amounts to about Rs. 2800 billion, while about 94 per cent of this money remains invested in Treasury Bills and Bonds. Debt restructuring with rescheduling can extend the maturity period of outstanding government securities held by any party. A haircut can reduce either the interest income or the principal value of investment.
There are 2.61 million private sector and semi-government employees contributing to the EPF annually, while a small number of people reach the retirement age every year. Moreover, the annual addition to the EPF is much bigger than its reduction due to the payment of retirement benefits. All these facts mean that, even if debt-restructuring on EPF investment can affect the overall fund, its negative impact on the individual EPF beneficiaries can still be avoided.
(The writer is a Professor of Economics at the University of Colombo and can be reached at
email@example.com and follow on Twitter @SirimalAshoka).