Sri Lanka: Progress in public debt restructuring

Event  

On 1 July, Sri Lanka’s Parliament made a step forward by approving a domestic public debt restructuring plan. Among several options, the aim is notably to apply a 30% haircut, which will mostly affect the central bank and the country’s superannuation funds (retirement funds), but spare the banking sector – at least directly.

Impact 

The announcement may lack ambition, but is all in all quite positive as Sri Lanka’s government has to reduce its huge public debt (117.7% of GDP in 2022) to restore long-term debt sustainability, exit the protracted economic crisis and receive much-needed support from the IMF and other multilateral creditors. The latest deal on domestic public debt could have a moderate impact on public debt, but should principally pave the way to a new IMF disbursement in September – within Sri Lanka’s 4-year Extended Fund Facility (EFF) programme approved in March – and allow access to other multilateral loans. These will support the country’s liquidity in the near term. Still, the economy remains in recession and the outlook is challenging amid the global economic slowdown. As the domestic debt deal will affect retirement funds, it could also fuel protests by further eroding private savings.

A lasting economic and fiscal improvement will require not only structural fiscal consolidation, but also a bold debt restructuring with external creditors. Negotiations are underway but take time as the dominant weight of private creditors and diverging views between China and other official creditors, notably the Paris Club and India, are slowing the process. The latest deal on domestic debt could be proposed to external creditors as well and the government has notably asked them for a 30% principal haircut. However, as China would favour a long grace period and much extended debt maturities rather than a partial debt cancellation, these options are more likely to accelerate the debt restructuring process. At this stage, a conclusion of debt talks still looks months away and a significant debt reduction appears doubtful.

Meanwhile, Credendo’s highest short-term risk ratings for Sri Lanka are stable. This said, the short-term political risk could nevertheless see its outlook improve in the coming months thanks to external financial support.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com