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Loosening the debt trap and resolving the

foreign debt crisis
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The Sunday Times, 30 April 2017

Resolving the foreign debt trap discussed last Sunday is a mammoth task as the annual debt
servicing costs are very heavy in the next few years. Meeting the impending debt repayments for
this year and next year are immensely difficult. The debt repayment of as much as US$4 billion
in 2019 is unthinkable at present. The severity of the problem is such that further foreign
borrowing is likely to be needed to meet this year’s debt servicing obligations.

Mitigating the crisis

Three vital steps towards mitigating the impending debt repayment crisis are recognition of the
problem and the need for strong measures to cope with it, monetary, fiscal and exchange rate
policies geared to improve the balance of payments by reducing the trade deficit and professional
management of the debt at this critical juncture that requires a judicious use of financial
instruments in a manner that minimises debt servicing costs in the future. The prudent
management of the foreign debt also requires clear cut bold economic decisions.
Debt repayments
Foreign debt and repayments have been increasing since the unity government took office in
2015. According to the Treasury, debt repayments increased to US$2 billion in 2015 from
US$1.4 billion in 2014. In 2016 debt repayments reached US$1.6 billion.

These figures are much less than those of the Central Bank as the Treasury figures only contain
project loans and loans taken by the government. The Central Bank figures are higher as they
contain all foreign loan liabilities. However the lower figures of the Treasury are adequate to
demonstrate the severity of the problem.

Next three years

The impending debt repayments in the next three years are onerous. Debt repayments are
increasing this year to US$2.4 and to US$2.5 billion in 2018. Then it balloons to as much as
US$4 billion in 2019. Debt repayments in the last two years were a serious burden and resulted
in further foreign borrowing.

Trade deficit
A significant balance of payments (BOP) surplus would ease the repayment of debt. To achieve
this, the trade deficit must be contained at a much lower amount than currently. Recent balance
of payments outcomes have been woefully unsatisfactory primarily owing to the large trade
deficits. In 2015 the trade deficit reached a massive US$8.4 billion only to be surpassed in 2016
to US$9.1 billion. Consequently, there were balance of payments deficits.
The overall balance of payments had a deficit of US$1.5 billion in 2015 and US$0.5 billion in
2016. This was despite the trade deficits being offset by remittances from abroad, earnings from
tourism and other service receipts. Had the trade deficit been contained to about US$ 7.5 billion,
there would have been overall BOP surpluses.
BOP surplus
In the current crisis situation a BOP surplus of about US$2.5 billion is needed to make a dent in
the debt profile. The containment of the trade deficit to below US$8 billion is vital to enable a
significant contribution to the external reserves to assist in the containment of the debt servicing
burden. Fiscal, monetary and exchange rate policies must ensure that the trade deficit is
contained at about US$7.5 billion.

Debt management
The magnitude of the debt repayment problem is too high to be resolved by improvements in the
balance of payments alone. It is therefore essential that a professional management of the foreign
debt that enables repayment obligations be put in place. Astute use of financial instruments
would be needed to achieve this. Overcoming the foreign debt repayment problem would require
the use of several financial instruments including currency swaps, renegotiation of debt
repayments over a longer period and redeeming high interest loans with lower cost borrowing.

The possibility of getting these arrangements are a serious challenge in a context when the
country’s external finances are at a low ebb and the country risk is high. Nevertheless it is
important to attempt such means of easing the debt repayment.

Economic reforms
Economic reforms are a vital part of the strategy to improve the external finances immediately
and in the long run. Divesting of loss making state enterprises would strengthen the public
finances. Sales to foreign investors would bring in foreign funds that would help redeem foreign
debt. However there is doubt about these being implemented owing to public protests.
Despite the government’s undertaking to reform loss making state enterprises, the current
political context and incessant protests make it difficult to implement significant reforms. This
could also jeopardise receiving the remaining tranches of the IMF Extended Fund Facility (EFF)
that would aggravate the debt repayment.

The proposed Chinese investments in Hambantota of about US$2 billion would have made a
significant contribution towards debt repayment.

Way Forward
The magnitude of foreign debt repayment is such that a multi-pronged strategy is needed to
ensure that the country does not default in its repayments. In as far as this year’s challenge is
concerned, it is important to generate a balance of payments surplus of about US$3 billion to
ease loan repayments. This can be achieved only if the trade deficit is reduced from last year’s
US$9.1 billion to about US$8 billion or less. A drastic reduction in imports is essential to achieve
this as exports can be expected to increase only moderately.

Realistically the debt repayment obligations of this year would be difficult even with these
improvements. Therefore prudent debt management through currency swaps, renegotiations of
loan repayments, easing of interest costs by redeeming high cost borrowings with lesser cost
loans and longer maturity periods and debt equity swaps are vital.

The strengthening of the economy by economic reforms and appropriate macro economic
policies is vital to resolve the long term weaknesses in the external finances. Hard policy
decisions to introduce economic reforms that propel the economy to a higher growth trajectory
are essential. The fundamental weakness in the polity is that it shuns such decision making to
aggravate economic problems.
The fundamental lesson that must be learnt is that foreign borrowings must be used for projects
that are productive and bring returns above the costs of the borrowing. Even productive foreign
loans with a long gestation period and short maturity create foreign debt liquidity problems.
Foreign loans should be used for investments that increase tradable goods.