Assess domestic debt stock before restructuring
The government is in a rush to implement the recommended austerity measures by the International Monetary Fund (IMF) to get its bailout leading to a discussion on domestic debt restructuring, putting pressure on the local banking sector, analysts say.
However, it is important to get a proper analysis done on the debt stock the sector holds.
Dr. Priyanga Dunusinghe, Economist, University of Colombo told the Business Times that despite the banking sector being the primary dealer, the extent of how much they hold in domestic debt stock is not clear. “We need to do a comprehensive study on the domestic debt. Also, it is important to note that now the impact of the macroeconomy crisis and the pandemic-related relief given to businesses have impacted the capital position of banks.” He also pointed out that foreign debt structuring will impact the domestic banking sector as 12 per cent of the international sovereign bonds are held by them.
Debt sustainability is the ability to repay maturing debt by borrowing from the market without exceptional arrangements such as money printing.
At the initial discussions with the IMF, the issue of restructuring domestic debt didn’t crop up. However, the domestic debt is unsustainable as the Central Bank must print money to meet the demand for repaying this debt, a senior economist said. The banking regulator since the beginning of discussions with the donor agency is taking a hard stance, saying that local debt cannot be touched. However, independent analysts observe that restructuring should not only be for foreign bondholders, as they will be playing hardball for the local debt should also be restructured.
“To repay the domestic component of the debt, the Central Bank must borrow money at 30 per cent plus. This is also why the local debt restructuring has gathered steam, as it has become progressively unsustainable,” a second economist told the Business Times.
The IMF recommendations want the country to bring the primary balance to a surplus, but despite 50 per cent haircuts on international sovereign bonds, the domestic debt stock is still not below 100 per cent of GDP.
A senior banker pointed out that firstly, the t-ills and bonds held by large corporates along with the Employees Provident Fund and the Employees Trust Fund have to be assessed. “The banks hold about 25 to 30 per cent of the domestic debt stock. This stock has to be assessed without looking at things in isolation,” he said.
If the government decides to restructure domestic debt, it will place extreme stress on the domestic banking system, Dr. Ahilan Kadirgamar, political economist and senior lecturer at the University of Jaffna told the Business Times. The banks are already under tremendous pressure and restructuring domestic debt, which amounts to either not repaying loans in full or taking a long time to repay them, either undermines the assets or create a liquidity crisis that will lead to acute problems for the sector, he said.
“During an economic depression like this, the government should be expanding domestic debt to provide relief to the people.”
Right now, the economy is in a freefall he said, noting that the Central Bank has predicted a negative growth of 8.7 per cent for this year, he pointed out. “This is not a time to balance the budget. It is the time to stimulate the economy and make sure that it gets into a growth path. The government should encourage production and give relief to the people.”
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