Sri Lanka ‘radio silence’ on domestic debt restructuring after IMF deal: BC governor

ECONOMYNEXT- Sri Lanka must maintain “radio silence” on the restructuring of national bonds as part of the process currently being followed by the International Monetary Fund to reduce debt to “sustainable” levels, the Governor of the Central Bank has said, Nandalal Weerasinghe.

Sri Lanka in April 2022 did not include domestic debt when the country defaulted after the biggest currency crisis in central bank history and two years of liquidity injections to suppress interest rates resulted in a loss of all its foreign exchange reserves and also of borrowed reserves.

Last week, Sri Lanka reached a staff-level agreement with the IMF involving macroeconomic adjustments that will increase tax revenue, temporarily reduce monetary instability until the next crisis under an intermediate monetary regime and structural adjustments.

“When we announced the debt freeze, we made it clear that our intention was to restructure the external debt because it was a balance of payments crisis,” Governor Weerasinghe said during a talk. -show hosted by Sri Lankan television Newsfirst.

“This is the position the government took in April. Going forward, because we started with the IMF staff agreement, because we officially started the debt restructuring process, we can’t talk about it.

“It’s called radio silence. This means that the authorities should not talk about the parameters of debt restructuring, whether it is restructured or not. Because it is unfortunately market sensitive. I cannot comment on this process.

It is not yet known what the IMF’s debt parameter is. According to information now in the public domain, the People’s Bank of China swap and the Bangladesh swap were included in an IMF debt sustainability analysis parameter.

Sri Lanka has not been allowed to blow up the trade with China on unsustainable imports and the money still remains in reserves.

Serious defect?

Uncertainty over whether or not domestic debt will be restructured, forcing a second haircut on top of depreciation and inflation, has discouraged investment flows into the domestic bond market, potentially exposing a serious loophole in the current permutation of a more or less elaborate debt resolution plan. by the US Treasury, IMF, Fed and Washington-based think tanks, analysts said.

The debt restructuring plans were drawn up in Washington in response to a series of sovereign defaults in the 1980s in Latin American countries with sterilizing (loosely pegged) central banks trying to conduct “countercyclical policy” with US Fed tightening cycles. which are pro-cyclical at the national level.

In the process, Argentina-style Latin American central banks with so-called soft pegs prolong the credit cycle and resist rate hikes by printing money to maintain a key rate followed by sterilizing interventions with new liquidity which then leads to loss of reserves, peg collapse and default.

Several plans have been concocted in Washington, including the “Baker Plan”, named after then-US Treasury Secretary James Baker, who is partly responsible for the “structural benchmarks” of current IMF programs.

Other debt resolution experiments in Latin America include Brady bonds, named after US Treasury Secretary Nicholas Brady, where bank loans were swapped for bonds as well as early permutations of what are known as now a haircut.

The principle was backed by deeply discounted 30-year U.S. “Brady bonds” purchased from bailout funds or remaining reserves.

The plans contained no serious attempt to restrain the loose policies of middle-regime central banks that led to currency shortages, sterilized interventions and defaults even when countries ran budget surpluses as in the case of Mexico.

Sri Lanka’s interest rates are now hovering around 30%, partly due to the loss of credibility of the peg which has yet to be restored – which is usually done through a float as a prior action in an agreement with the IMF, and also due to the lack of clarity on the treatment of rupee bonds, which created uncertainty.

Domestic debt restructuring leads to an effective default ending the gilt status of government bonds.

Sri Lanka’s position

Governor Weerasinghe has previously said Sri Lanka can achieve debt sustainability without restructuring rupee bonds.

Fitch Ratings said there was a high risk of default on local currency debt at its CCC rating.


Sri Lanka’s domestic debt restructuring could erode net benefits: Fitch

Large volumes of which were bought by the central bank to trigger the currency crisis and the rest are held by employee provident funds and commercial banks, insurance funds and private holders.

Sri Lankan authorities have said haircuts on domestic bonds will cause problems at banks, delaying recovery and the ability to repay foreign bondholders.

Sri Lankan banks have taken a direct hit on their equity and are facing higher rates on deposits anyway and they also have to budget for dollar bonds in their portfolios.

Holders of rupee bonds are at a real “haircut” anyway, with depreciation and domestic inflation tending to inflate the economy and generate higher nominal tax revenue, while the real value of the debt is “discounted” or inflated.

In the current debt restructuring, various creditors are treated unequally. IMF, World Bank, ADB and AIIB debt is not restructured. Bilateral debt is restructured and discounts are granted for corporate bonds which are sometimes purchased at significant discounts on the secondary market.

The current uncertainty came after President Ranil Wickremesinghe noted that Sri Lanka’s debt advisers were considering possible domestic debt restructuring as part of their analysis of debt sustainability scenarios. (Colombo/07/09/2022)

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