When Govt. revenue is not enough to meet debt servicing costsView(s):
The public debt has reached a magnitude when government revenue is inadequate to meet debt servicing costs. In 2012, debt servicing costs were 3 per cent more than government revenue. As much as 103 per cent of government revenue was needed to repay maturing debt and meet interest costs. Consequently government has to borrow to meet its other expenditure. Bringing down the public debt, is essential as the high debt serving cost affects long-term economic development adversely.
In 2012, the total outstanding public debt increased by 16.9 per cent to reach Rs. 6,000 billion — up from Rs. 5,133 billion in 2011. While the domestic debt increased by 15.3 per cent from Rs. 2,804 billion to Rs. 3,233 billion, the foreign debt increased by 13.8 per cent to US$ 28.4 billion last year. The domestic debt was 42.6 per cent of GDP while the foreign debt was 36.5 per cent of GDP. The share of the foreign debt in total debt increased to 46 per cent in 2012.
The increase in foreign debt was particularly sharp after 2008. In 2011 the foreign debt was Rs. 2,329 billion, which was 35.6 per cent of GDP. In 2012 it had risen to Rs. 2,767 billion that was 36.5 per cent of GDP. The foreign debt rose by 13.8 per cent to US$ 28.4 billion last year.
A 39.7 per cent increase in non-concessional borrowing resulted in the proportion of non-concessionary borrowings rising to 50.5 per cent of total foreign borrowing. It is not certain as to whether all foreign borrowings are included in these figures. Some contingent foreign liabilities may not be captured in this figure.
The foreign debt servicing costs absorbed 16.4 per cent of earnings from exports and services — up from 11.1 per cent in 2011. The burden of the debt servicing cost is reduced owing to the large component of worker remittances that amounted to nearly US$ 6 billion last year. When these remittances are excluded, the foreign debt servicing costs as a proportion of merchandise exports is about a third of export earnings. The use of a third of our merchandise export earnings for servicing the foreign debt is a strain on the balance of payments.
The Central Bank’s 2012 Annual Report says the exchange rate movements were primarily responsible for the increase in debt, as the depreciation of the rupee leads to an increase of the debt in rupees. However, there were significant increases in both domestic and foreign debt.
Less indebted nation
Although the debt to GDP ratio increased somewhat last year due to the depreciation of the currency and last year’s slower growth, this ratio is much lower than what it was earlier. It was as high as 86.2 per cent in 2009 and brought down to 78.5 per cent of GDP in 2011. However it increased to 79.1 per cent of GDP last year.
Despite these significant increases in debt, the Central Bank claims that the country is a less indebted nation compared to many others. Sri Lanka is classified as a “moderately indebted” country. This view is based on a comparison of the debt to GDP ratios of countries. Comparisons with other higher indebted countries should not lead to complacency and inaction to contain the debt, as debt servicing costs are high and an increasing burden on the public finances and external finances of the country.
For quite some time there has been complacency about the growing national debt owing to it declining as a proportion of the annual value of goods and services produced in the country (GDP). There has been a decrease in the public debt as a proportion of GDP since 2002, when the public debt was as much as 105 per cent of GDP. It was brought down as a proportion of GDP in the following years. In 2011 it was 78.5 per cent of GDP. However, there was a reversal of this trend in 2012 when the debt to GDP ratio increased to some extent to 79.1 per cent of GDP.
Nevertheless, it is much lower than in sometime past. The increase in the debt to GDP ratio to nearly 80 per cent last year was due to increased borrowing, the depreciation of the currency, and the slower economic growth of last year. The rate of increase in foreign debt was higher than the increase in GDP.
The debt to GDP ratio is an inadequate, even misleading, indicator of the country’s indebtedness. The decline in the debt to GDP ratio does not necessarily reflect the extent of the debt burden. If the GDP statistic is rising, the increasing debt does not increase this ratio. It could in fact decline. If the GDP statistic is exaggerated it could be more misleading.
The debt to GDP ratio declined in recent years owing to the GDP increasing and the appreciation of the rupee till 2012. This implies that the overvalued rupee till last year was a reason for the declining trend in the debt to GDP ratio. Although the debt to GDP ratio declined till last year, the public debt increased substantially.
Debt servicing costs
The debt servicing cost as a proportion of revenue is a better indicator of the crippling effect of the large public debt. In 2011 debt servicing payments absorbed 95.8 percent of revenue. In 2012, as much as 103 percent of government revenue was needed to repay maturing debt and pay interest costs. This means that the government has to borrow for its other expenditures. This in turn increases the public debt. Such a cyclic debt trap has serious economic consequences.
Since the large foreign debt is a continuing burden on the public finances and the balance of payments, it is important to take measures to reduce the foreign debt burden by generating a significant balance of payments surplus. Last year there was a small balance of payments surplus of US$ 151 million owing to the large inflow of workers’ remittances and increased tourist earnings.
The reduction of imports, especially intermediate and investment goods imports could reduce the deficit from last year’s US$ 9.3 billion to around 8 billion. If the trade deficit could be reduced by this amount, the expected increases in tourist earnings and worker remittances to about US$ 8.5 billion this year could generate a balance of payments surplus of about US$ 1.5 billion. This would enable a reduction in foreign debt.
The latest Fitch ratings have pointed out an impending crisis in external finances, if such a balance of payments outturn is not achieved. They have pointed out the heavy debt repayments in 2013-2014 could be a severe balance of payments strain. They said: “Sri Lanka’s external debt refinancing schedule, however, remains quite heavy as an average of US$ 1.9bn per annum in sovereign debt is projected to mature from 2013 to 2015 (versus US$ 1.3bn in 2012). This may not only limit Sri Lanka’s ability to rebuild foreign exchange reserves to a much higher level, but it also means that the country’s external finances will remain vulnerable to any spike in global risk aversion.”
The unbearable debt servicing burden makes it clear that the public debt should be brought down. The reduction of the fiscal deficit and the trade deficit is vital to achieve this. Both these objectives could be achieved by prudent public spending on the basis of priorities and consideration of import content of the public investment programme. A committed objective of policy must be to generate a balance of payments surplus to avert a debt trap.
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