FES writes to President AKD: Debt Restructuring and the Risk of a Long-term Failed State

27. 10. 24

Hon. President Anura Kumara Dissanayake,
Presidential Secretariat,
Colombo-01

Hon. President Dissanayake,

Debt Restructuring and the Risk of a Long-term Failed State

Through the results of the last presidential election, the people of Sri Lanka have led the corrupt political forces that existed so far to a crucial defeat and opened the country to a new political journey through a government of the National People’s Power. This is the result of the people’s struggle that unfolded throughout the recent past and a large propaganda intervention that influenced public opinion. The power of the defeated political forces was firstly brought down through the struggle. As a political party that has continuously clashed with these corrupt political forces, we think about this turn in Sri Lankan society from a generative political position. Therefore, with respect to the current political economic crisis, we see the need to deal with the current governance from a leftist political standpoint. It seems that the current economic and political crisis is very acute and widespread, and a long-term political effort involving policies is needed to respond to it and change it.

Several basic political dynamics can be identified in the new political chapter that has started after 2022. It can be subjected to a rough mapping as the protracted economic crisis, the intervention of the International Monetary Fund based on that economic crisis (as a strategic agent of the United States), Indian economic coercion, the unprecedented political behavior of the people (April 9 Uprising, July 9 Uprising, pushing back corrupt forces in this presidential election etc.,).

The economic crisis is the reason for the political crisis faced by Sri Lanka  associated with the year 2022.  Throughout the past, the public could listen to a number of conflicting analyses of the cause of the economic crisis, based on different economic and political insights. The idea presented about the economic crisis of 2022 in Sri Lanka by the Frontline Socialist Party through the People’s Struggle Alliance, which we represented in the last presidential election was that it was an issue that arose due to a handful of very wealthy business families illegally taking their profits out of the country (mis-invoicing during exports and imports). Similarly,  borrowing heavily without a plan was a result of a debt trap created by misuse of credit, and  the burden of the economic crisis has been placed entirely on the people of the lower class and lower middle class, and is a result of the excessive profits made by the above handful of richest business families who are increasing their profits even in the middle of this crisis, and who are excessively evading taxes, and that taken in the long run, it is the result of an economic policy that has not been industrialized, as well as a result of the consumerism of the new middle class that has emerged in the last few decades, and also a result of the neo-colonial debt model that hampers economic development that has trapped countries in the global south.

What was presented through the Global Economic Integrity report on the above-mentioned false invoicing was that illegal flows of 42 billion dollars had occurred in Sri Lanka during 2009-2018 alone. Through this, the loss of capital, the loss of taxes that are due to the government has occurred continuously. Although this fact is mentioned in the technical reports presented by the International Monetary Fund, it is surprising that no weight has been placed on this in their so-called economic reform recipe. A handful of Sri Lanka’s richest business families thus converting their profits into dollars and moving them out of the country, has led to losing reinvestment considered necessary in the current economic framework. As a result, economic growth rate is hampered, and the economy in the recent past had entered a cycle of Dollar deficit, Rupee depreciation, inflation, etc. There is no doubt that this layer has also achieved a great financial advantage through bringing money back into the country when the rupee is devalued.

The few richest business families in Sri Lanka are making huge profits through the high exploitation of labour in their companies, tax concessions from the government and tax evasion, market tender advantages obtained through relationships within the political regime up to the creation of monopolies.

They use the bureaucratic system, the political system, for favorable conditions from getting tenders to creating monopolies. When we look at this chain of corruption, at the end of it are the wealthiest business families in this country, and it is clearly seen that there are corrupt government officials and corrupt politicians as its first links.

Therefore, it should be noted that even the anti-corruption narrative is deeply intertwined with this system. However, we are focusing here on the fact that to save the Sri Lankan economy from this trap, the economic aspiration of the people (all lower and lower middle class economic strata) which is ending the stress in their economic life, cannot be done by addressing only the issue of fraud and corruption. It must be reiterated that dealing with the issue of fraud and corruption is a very complicated matter.

The agenda of the International Monetary Fund is one of the main dynamics of the aforementioned new political chapter that has started after 2022. While we do not intend to focus on the entire intervention of the International Monetary Fund in this letter, we do hope to focus here on the domestic and foreign debt restructuring that is being prepared to be implemented with their approval.

It is our position that the IMF is clearly acting in accordance with the US strategy of keeping the country on the brink of a long-term failed state. Based on that, we emphasized very strongly in the last presidential election that the agenda of the International Monetary Fund is a trap and therefore, we should get out of it. However, the winning party of the Presidential election, National People’s Power, pledged to go for an Alternative Debt Sustainability Analysis, and then the IMF agreement could be revised in favor of the people. We very strongly believe that to minimize the destruction that is going to happen to the country and the people, at least an alternative debt sustainability plan and the revision of the IMF agreement be done in a way that is favorable to the people under the governance of Your Excellency.

From that basis, the purpose of this letter is to draw the attention of the government of the National People’s Power to the problem of debt restructuring in Sri Lanka and its future challenges. The country’s debt is mainly divided into domestic and foreign debt and the restructuring of domestic debt has been completed by now. But it is a clear fact that the local debt restructuring was done by the previous Ranil-Rajapaksa government in an arbitrary manner that lacked transparency. At that time, clearly opposing it, the trade union movement and opposition political parties raised two issues related to debt restructuring. The issues were the decision to completely sacrifice employee welfare funds including provident funds for this debt restructuring, and that through the debt restructuring unlimited profits would accrue to the private buyers including the primary buyers in the financial market.

Issues in Domestic Debt Restructuring

In this domestic debt restructuring, the point made by the Governor of the Central Bank was that a 30% reduction in foreign debt should be accompanied by a 30% reduction in domestic debt. But during that time itself, the trade union movement through a great struggle exposed that these cuts were made on a very unfair basis. Also, it appears that there is no such 30% reduction in foreign debt in the restructuring of foreign debt. What happened here should be highlighted once again, due to the fact that all the opposition forces at that time were against it and promised to correct the injustice done to the employee funds including the provident fund during their rule.

However, by changing the rate of return on loans given by the Employee Provident Fund to the government through treasury bonds (nearly 3500 billion Rupees) to 12% until 2025, and then to 9% thereafter, the fund will suffer a long-term erosion. In an affidavit submitted to the court in a case filed by the Federation of University Teacher Associations (FUTA) regarding this issue, it was emphasized that the fund would erode by 48% by the year 2037. Therefore, the working class that owns active provident fund accounts in this country, numbering 22 lakhs, will hope to correct this error and the unjust situation.

Similarly, the other side of the coin is the highly controversial issue of unfair profits being given to the above primary and private buyers. That is, the Central Bank, at that time, did not decide to change the return rates for any of the remaining bonds outside the provident fund and other employee welfare funds. During that time, there were only 12 recognized financial institutions in the primary market that provided loans to the government. Apart from a few employee welfare funds including the Employee Provident Fund (EPF), this did not affect the benefits of any of the remaining financial institutions.

Due to the economic crisis, the rate of return for bonds issued by the government in the period from 01 April 2022 (the symbolic onset of the economic crisis) to 15 September 2023 (the period when the domestic debt restructuring was completed) was between 20% and 33%. The total value of bonds issued by the government from 01 April 2022 to 15 September 2023 is about 1,825 billion Rupees. The benefit to be paid annually for that alone is as follows. This calculation has been done based on Central Bank data only for a few years. This paying of benefits will not end in 2025.

For the year 2023 –  394 billion Rupees

For the year 2024 – 453 billion Rupees

For the year 2025 – 453 billion Rupees

What was the need for a country immersed in such a huge economic crisis to pay such a high return to the above 12 financial institutions (financial institutions recognized in the primary market at that time, excluding Employee Provident Fund and other pension funds)? On the other hand, on what basis was that benefit deprived from only to the Employee Provident Fund?

These benefits can be seen through the Table below, which has been issued by two financial companies that are primary buyers of the bond market. According to the following Table, only in the year 2024 (ending March 31, 2024) the profit was more than double that of the financial institutions during the entire period of five years from 2019 to 2023. Obviously, this profit flowed in as a result of the above decision. As such, this can be seen as a kind of deliberate favoring of the handful of richest business families who should be responsible for Sri Lanka’s economic crisis.

* As per the annual reports of those institutions, indicating profit after tax

Therefore, the task lies before the present government to rectify the injustice done to the employees’ funds including the provident fund during the restructuring of the domestic debt, and put an end the improper profit given to the remaining financial companies.

Foreign Debt Restructuring

Foreign loans consist of three major categories. They are multilateral loans (such as from the International Monetary Fund, World Bank, Asian Development Bank), bilateral loans (loans given by countries like China, Japan, India), and loans obtained from the commercial market. Currently, debt consolidation is done targeting commercial loans. But negotiations have been carried out at various levels with respect to all the rest of the loans. However, according to what has been reported currently, the consensus reached by the Ranil-Mahinda regime on last September 19 on commercial loans, the International Sovereign Bonds, is highly risky for the future of the country. The rest of the debt restructuring is also being done on the basis of international sovereign bond debt restructuring. Therefore, if this is not rectified now, it will place the country in an economic trap for decades.

Sri Lanka has not paid interest and maturity premiums on international sovereign bonds since 2022 and has now come up with a plan to repay them from 2028. There are many controversial points about this plan and these can be listed as below.

1. Linking the Dollar Value of Sri Lanka’s Nominal GDP as the Basis of International Sovereign Bond Restructuring

The International Monetary Fund has also agreed as suggested by creditors to link Sri Lanka’s nominal GDP with the dollar value as the basis for international sovereign bond restructuring. As has been reported, this measure is going to be tried for the first time in the world in Sri Lanka. As stated above, debt restructuring based on nominal GDP is highly unfavorable. When the dollar value of nominal GDP rises, real GDP may collapse at some point. Although Sri Lanka’s real GDP growth in 2023 was minus 2.3%, nominal GDP in 2022 had increased from $74.4 billion to $84.4 billion in 2023.

That is, the nominal GDP rises when an economy collapses in real terms. This is the index used as the basis for total debt restructuring. This is a cruel equation that loses credit cuts when the real economy collapses. Here they use the next three years 2025, 2026, 2027 as the base years. This loan repayment plan is set on the average of the sum of the nominal gross domestic production of those years.

In some way, if the nominal gross domestic product in the three years 2025-2027 rises above USD 88.6, which is the forecast value presented by the IMF, the amount of debt reduction indicated as 27% will decrease to 12% compared to those rising values. If the average dollar value of nominal GDP rises to $107 billion over the next three years, this debt reduction is to be reduced to 12%. Very clearly this has been arranged in a way that benefits the creditors. Therefore, we should get out of this trap set by the Ranil-Rajapaksa regime in the above debt negotiations.

2. The IMF Stating that the Debt Ratio as a Percentage of GDP being 95% is an Optimal Value

Another problem in this debt restructuring plan is the International Monetary Fund’s criterion that it is appropriate for the country’s debt to be 95% of the gross domestic product. The Economic Transformation Act is also designed based on the indicators arising from this standard. But this basis has serious problems.

In the early 1990s, when the World Bank issued a global debt sustainability assessment report, a country with a debt ratio exceeding 50% of its gross domestic product was designated as a highly indebted country. Based on this report, the United Nations has even passed a resolution at a session in 2006.

Even organizations such as the Jubilee Movement, which is working on the debt crisis in the Global South, indicate that a country’s Debt to GDP ratio should remain at 50%. Therefore, even institutions recognized by the Western powers regarding the debt burden of a country have from time to time expressed the above position (the debt burden of a country should be less than 50% of the Gross Domestic Product).

Yet, the International Monetary Fund, putting all of this aside, indicates that the figure being 95% is not a problem. The real benefit here is to the creditors. If the International Monetary Fund had brought the above figure below the value of 95%, Sri Lanka would have been able to obtain large concessions by increasing the debt reduction. The International Monetary Fund has clearly set this determinant as an advantage to creditors.

3. The International Monetary Fund is in a Conflict of Interest

The International Monetary Fund, which is involved as an intermediary for debt restructuring, is also a creditor who has given loans to Sri Lanka. Therefore, they cannot be a mediator in such a discussion in its real sense. Anyone who looks at the issue without surrendering to the existing establishment understands that. Moreover, after the crisis, the International Monetary Fund has agreed to earn an interest of $1.9 billion on the $2.9 billion loan that Sri Lanka will receive in four installments through the International Monetary Fund. Here the interest rate is as high as 7%. Generally, lending at such interest is done when commercial loans are taken from the open market. Due to charging such a high interest, the country will have to pay back to the International Monetary Fund $4.7 billion over ten years for its $2.9 billion loan. Multilateral lenders such as the IMF, the Asian Development Bank, and World Bank do not offer any cuts to their loans using the argument that they borrow at interest rates between 1%-2%. But the amount of credit facility already extended to us, of 2.9 billion dollars, is given at a high interest rate of 7%, as mentioned above. If so, doesn’t the argument to be used to rule out the cut itself get expelled? All this shows that there is clearly a conflict of interest in the intervention of the International Monetary Fund.

4. Are high interest rates affordable for a country?

As per the International Sovereign Bond (ISB) restructuring plan that has been proposed at present, it has been proposed to pay a coupon rate of 8.75% to 9.75% (for the bonds maturing from 2033 to 2038 as relevant to that period). Further, according to the debt formulas that have been made connecting to the nominal value of the GDP, it has been proposed to pay a coupon rate of 3.35% to 5.1% for the bonds between 2028-32, and this coupon rate could further be increased by 0.25 % to 2% as against the value that the nominal GDP increases above the base value of the IMF. According to the proposed plan, its weighted interest may vary from around 5.5% to 8%.

The IMF itself predicts that the economic growth rate of Sri Lanka will remain below 3% for the next few years. In economics, there is general acceptance that interest rates on loans should remain in line with the rate of economic growth. The IMF has predicted within this debt plan itself that Sri Lanka’s overall growth in GDP will be 11.5% during the period from 2024 – 2027. Thus, according to IMF itself, the economic growth rate that the country can achieve in a year is 2.7%.

However, what is going to happen is that the country will get stuck in a big debt trap again by agreeing to weighted interest rates as high as 6% to 8.5% whereas the economic growth rate is predicted to be at 3%. Agreeing to high coupon rates in this manner will affect the interest rates on the loans that Sri Lanka will obtain in future as well: the interest rates on future loans will be determined taking these values as precedence.

5. Interest on Accrued Interest

According to the ISB restructuring plan that has been proposed at present, the unpaid coupon premiums on ISBs from 2022 to date amounts to US$1,678 million (after 27% haircut). Through this proposal, it has been proposed to convert this to another bond, and a plan to pay it off in installments from 2024 to 2028 with a 4% coupon interest has been submitted. The objective of this arrangement is to charge an interest on the accrued interest. This is a very unfair condition, and is an extortionate moneylending practice’. The penalty interest for this is US $ 64 million per year. It is noteworthy that, when Ghana completed the debt restructuring process a few weeks ago, it did not have to pay such a penalty interest. We should not agree to a penalty interest of this kind in a situation where one fourth of the country’s children are suffering from malnutrition and the poverty rate of the country has increased to 26% according to official reports.

6. Consent Fees

As stated in the ISB restructuring plan, a consent fee of 1.8%, i.e. USD 225 million, is payable for agreeing to this plan. What fairness is there in forcing a bankrupt country to pay another fee as a consent fee in addition to the penalty interest? All these expenses will be a burden on the taxpayers of this country, the general public. Shouldn’t the new government question the agreements of this nature that have been negotiated by the previous government? It should be further noted that Ghana, a lower-middle income earning country like Sri Lanka, as mentioned above, has paid only 1% as the said consent fee in its US$ 13-billion ISB restructuring. The Ranil-Rajapaksa government has prepared a debt restructuring plan with a penalty interest and a huge consent fee, and it is evident that there is a plan to get the rubber stamp of the National People’s Power government for this plan. Therefore, questions should be raised as to whether we should pay a consent fee for the restructuring plan that is presented by the bondholders themselves and whether we should, on the other hand, pay it at a rate as high as 1.8%.

7. The Danger in Increasing Interest Rates on ISBs

If this country agrees to a highly stressful debt restructuring plan of this nature, the debt sustainability of this country will come down at any moment. Thus, decline in debt sustainability may create the risk of an increase in interest rates on ISBs as well as on bilateral and multilateral loans in future.

8. A Great Advantage for Banks and Financial Institutions in Sri Lanka that have Purchased ISBs

A number of Sri Lankan banks and financial institutions had purchased International Sovereign Bonds worth around $1.8 billion (by the end of 2023). However, as it has been reported, due to the economic instability that had prevailed in the country at that time, recently (from March 2020 to date), ISBs have been sold at a value that is less than their real value (face value) by 24% to 60% (market value). Therefore, it can be assumed that, although the government had issued to banks and financial institutions of Sri Lank ISBs with a value of 1.8 billion dollars by the end of 2023, they have paid less than this value at least for a part of those bonds.

The plan that has been presented to the banks and financial institutions of Sri Lanka under the ISB restructuring plan has been very beneficial to those institutions. After the financial crisis that occurred in 2022, the general discussion was that there would be a haircut of around 55% on ISBs. It is the common practice that, organizations that operate following international accounting principles be prepared for debts and losses by setting aside a portion of their profits in advance as an early preparation in such crises. The advice that had been given to the Sri Lankan financial institutions that had purchased these ISBs by the institutions involved in the audit of the financial institutions was to prepare for a 55% haircut. From year 2022 to date, allocations have been made for this by those banks and financial institutions, but it is said that the reduction of the haircut on these loans has been reduced to 35% – 39% under the proposed debt restructuring process. Accordingly, these banks and financial institutions will get a huge profit this year, and consequently, the share prices of those institutions have greatly increased, too. Accumulation of a large amount of profits among a few banks and financial institutes in this manner will result in the general public of this country having to bear a tax burden that they cannot afford to in future. Therefore, an arrangement such as the 55% haircut, which they are already prepared for, can be implemented while protecting the banking system without allowing them to make an undue profit.

9. The Face Value and the Market Value of ISBs

In the discussion on bonds issued by the Central Bank and on ISBs, matters can be discussed based on the difference between the face value and the market value. When  a bond issuance takes place in a certain country, the financial value of a bond issued is determined based on the existing economic ratings of that country and on other factors, and thereby a gap is created between the face value and the market value of a sovereign bond. By the beginning of 2020, the market value for a Sri Lankan bond was at 97%, but due to the economic instability that was caused by the COVID pandemic, it declined to the level of 24% – 60% by year 2020 – 2021. The market value given in the market at that time to a selected ISB issued by the government (ISIN- USY8137FAL23) is shown in the table below.

Accordingly, it is evident that the market value of ISBs in the secondary market has fallen to 24% by the end of 2022. Generally, as internationally recognized financial institutions have financial regulations that apply to them, their boards of directors decide to sell their ISBs in the open market in the event of such economic collapses. On such occasions, it is the disreputable companies that usually purchase these ISBs taking on some risk with the view to making high profits. Therefore, it is important to find out who really owns these bonds at present, as well as the market value at which they have been purchased. If the companies that originally purchased the bonds do not own them at present, profits should not be given to scandalous individuals who have purchased them with the intention of making huge profits, for they will not have to incur any loss through that.

10. Forensic Audit

The dialogue on Predatory Loans, i.e. loans given to countries with the view to preying on them, is a strong issue raised in the world’s dialogue on debt. Before Sri Lanka’s debt restructuring, in January 2023, the government of Sri Lanka was requested through a letter signed by 182 world scholars headed by the former Minister of Finance of Greece, Yanis Varoufakis, not to pay the Odious Debts. We have fallen into this horrible debt crisis through bilateral loans, ISBs, and multilateral loans obtained by Sri Lanka as a whole. It has been stated in a report issued by the Auditor General in 2022 that, out of the projects implemented with loans amounting to Rs. 8,200 billion during the period from 2006 to 2021, assets valued at Rs. 2,700 billion only remains as real assets. There is a strong opinion that a forensic audit should be carried out on Sri Lanka’s debt based on the content of this report. There is the real experience of how Ecuador, which once faced a similar debt crisis, included the issue of Odious Debt in the discussion on debt and laid the foundation for a debt write-off of 80%.

Therefore, there is the need to write off this Odious Debt, and this demand was strongly raised in the recent struggle named ‘Aragalaya for the removal of Gota’. Further, the mandate of the present government, too, includes a strong demand for anti-corruption, which cannot be excluded even by the IMF. In addition to that, as the National People’s Power has pledged during its election campaign that it will review the agreement with the IMF and present an alternative programme, even the IMF cannot rule out the fact that there is approval for it in this mandate as well.

11. Changing the Legal Basis of Debt Restructuring

If any legal issue arises regarding the loans that have been obtained by Sri Lanka at present, the New York legal framework will apply, but in this debt restructuring, the approach is to change this legal framework to the London legal framework. Under the New York law, there is the option of writing off the debt in the event the country suffers a debt crisis, but if it is changed to the London legal framework, there is no such option. On the other hand, as we are still caught up in the debt trap, the reasonable question that arises under these circumstances is whether the creditors included such matters in the conditions for debt restructuring as an early preparation in case the country goes into bankruptcy once again.

12. Alternative Debt Sustainability Analysis

People’s Struggle Alliance, which we represented in the presidential election platform, emphasized the fact that we should withdraw from the IMF agenda, but the National People’s Power stated that the plan of the IMF will be revised in a way that is favourable to the people. They further said that they would submit an ‘Alternative Debt Sustainability Plan’ to the IMF once they come into power. You had also stated at various press conferences that this process may take a year and a half. It seems that the Ranil-Mahinda regime, which has made all the plans to put Sri Lanka in a debt trap, waiting for the newly elected government to get stuck in the trap they have set.

We would earnestly say to this government that, as the agendas of the international and national conspiratorial forces are so strongly aligned, the country will fall into a sharp debt trap by the end of 2027 unless this debt restructuring process is not revised at least through the ‘Alternative Debt Sustainability Analysis’ as you announced during the presidential election campaign.

The summary of this explanation about the debt restructuring process can be summarized as follows: correcting the damage that has been caused to the private sector employees’ fund by the country’s debt restructuring and putting an end to the undue profit that the primary buyers are gaining, completely discarding the index known as the dollar value of the nominal gross domestic product, which is considered as the base index of international debt restructuring, challenging the position of the IMF that it is not a problem that the country’s debt amounts to 95% using the reports of the other institutions of the West themselves, taking a considerable time further for the repayment of loans and interest instead of commencing the repayment in 2028, taking an approach through a forensic audit to avoid the repayment of these Odious and Predatory Loans, bringing down the excessively high coupon rates that are higher than  the country’s economic growth rate, stopping the changing of the legal framework that is applicable for these loans from the US legal framework to that of the UK, opposing to the consent fee of US$223 million (at least bringing it down to the fee that Ghana had paid), stopping the payment of a penalty for the unpaid interest (coupon payments) and writing off the outstanding interest, taking into consideration the information of the current owners of ISBs and adopting a principle of paying profits based on the value at which they have purchased the bonds, and preventing the payment huge profits that are to be paid to banks and financial institutions in Sri Lanka and presenting them with the option of 55% debt haircut that they have been preparing for since 2022.

However, the opportunity for all of these will open up once an alternative debt sustainability plan is presented to the negotiating table.

The risk of Re-explosion of the Debt Trap in 2028, and Keeping the Country on the Brink of a Prolonged Economic Instability

After the restructuring of ISBs, bilateral debts and multilateral debts, Sri Lanka will have to pay a huge installment of about US$ 4 – 5 billion from 2028 onwards. According to the existing exchange rates, the government should have additional revenue of around Rs. 1200 – 1500 billion for this purpose. Apart from that, the dollar reserve, too, should be further expanded as adequate. However, it seems that this will be a hard challenge. At least, if the debt restructuring plan is not revised in a way that is favourable for Sri Lanka, the country will have to suffer bankruptcy again and again as evident from the experiences of some of the other countries on debt restructuring. Apart from that, there also is the danger that Sri Lanka will have to suffer the same experience of such a failed state and also of the agenda of the regional powers. Therefore, it is the responsibility of the National People’s Power Government to carry out a deep study and analysis of this issue and to present an ‘Alternative Debt Sustainability’ plan as pledged during the presidential election campaign, and to get conditions that are unfavourable to the people of this country removed from the IMF agenda, which will be a progressive and historic approach to saving the people from the US-IMF agenda of keeping this country on the brink of failed state over a long time.

Thank you.

Central Committee
Front Line Socialist Party