Courtesy Finance Monthly

When a company’s foreseeable future earnings are not sufficient to repay debts, the company in question may choose to restructure its debt. And this applies to countries too. In years gone by, several countries have chosen to restructure their debt, with Sri Lanka potentially soon to join them.

How does debt restructuring work for countries?

Throughout history, there have been several cases of countries facing default on their external debt, including North Korea in 1987, Russia in 1998, and Argentina in 2002. Historically, some nations have chosen to restructure their debt with bondholders. This can involve moving the debt from the private sector to public sector institutions that may be capable of handling the weight of a country’s default. 

Sovereign bondholders may have to accept a reduced percentage of what they are owed. The maturity dates on bonds can also be extended, allowing the Government issuer more time to secure the funds required to pay back its bondholders. 

China’s role in Sri Lanka’s debt crisis

Over the past decade, China has lent Sri Lanka over £3.7 billion for projects including new roads, ports, and an airport. However, instead of praising China for its generosity, some critics have denounced the world’s second wealthiest nation for its lending practices to poorer countries, accusing China of leaving them struggling to pay off debt.

Typically, China lends at a higher rate of interest than western governments. At approximately 4%, these loans come close to commercial market rates and are around four times higher than that of a standard loan from the World Bank. Furthermore, the required repayment period for a Chinese loan is typically shorter. While other lenders’ concessional loans generally have a required repayment period of approximately 28 years, in China, it is less than 10. 

The case for Sri Lanka restructuring its external debt

Over the next couple of years, it is highly unlikely that Sri Lanka’s foreign revenues will be enough to meet foreign debt obligations. Cumulative foreign currency debt service amounts to approximately $26 billion from 2022 through to 2026. This year alone, Sri Lanka has foreign currency debt service payments of $6.9 billion. This figure is equivalent to almost 430% of official gross international reserves as of November 2021, according to Fitch Ratings. 

Furthermore, over the next 12-24 months, it is unlikely that foreign inflows will increase on the scale needed to service debt and finance imports necessary to meet basic needs and support the economy’s growth. This issue is further inflated by the downgrading of the country’s sovereign rating, which has resulted in Sri Lanka being excluded from international capital markets. 

Speaking to a visiting Chinese foreign minister at the beginning of January, Sri Lanka’s President, Gotabaya Rajapaksa, said it would be a great relief to the country if attention could be paid on restructuring the debt repayments as a solution to the economic crisis that has arisen in the face of the COVID-19 pandemic.”

Meanwhile, several business chambers, including Ceylon National Chamber of Industries and The International Chamber of Commerce Sri Lanka, amongst others,  have come together to issue a statement highlighting the serious issues faced by their members caused by the acute shortage of forex; the result of the loss of revenue from tourism as well as access to international capital markets. 

Combined, these business chambers make up nearly all sectors of the economy and their problems cannot be resolved while large amounts of forex are being sent from markets to the Central Bank of Sri Lanka to service foreign debt. 

The disadvantages of external debt restructuring for Sri Lanka

A major disadvantage of restructuring foreign debt is an immediate loss of access to international capital markets. However, since Sri Lanka has already lost access after being downgraded, this factor becomes irrelevant. 

A second disadvantage of restructuring foreign debt is the heightened risk premium Sri Lanka would be required to pay when it is eventually permitted to regain market access. However, to date, the country has demonstrated commitment to meeting its obligations. At the beginning of October 2019, Sri Lanka settled a $1 billion maturing international sovereign bond by reaching into its foreign reserves and settled another, also worth $1 billion, in July 2020. Sri Lanka’s demonstrated commitment will likely mean that this second disadvantage is at least somewhat abated.

Final thoughts

With the country’s president and major business chambers keen to see Sri Lanka restructure its foreign debt, it seems like the obvious next step on the path to economic recovery. But only time will tell if the world’s other nations are willing to facilitate it.