Why was the IMF Tranche Delayed?

Originally appeared on The Morning

By Dhananath Fernando

There is some uncertainty in the market regarding the reasons for the delay in the IMF's second tranche. The simple reason is that although we have made some progress, given the depth of the crisis, our speed of reforms is inadequate for a swift recovery, particularly in revenue collection.

A shortfall in revenue collection, expected to be about 15% compared to initial projections by the year end, has been cited as a key reason. Secondly, until we finalize debt restructuring, especially external debt restructuring, the risk factors remain high in achieving our desired debt-to-GDP ratio. Even after the expected debt restructuring, in 10 years, our debt-to-GDP ratio will still be above 90% according to estimates.

Thirdly, the Central Bank's reserve collection has slowed down. Consequently, with our macroeconomic indicators sending mixed signals, it can not be assured that the economic recovery is still on the right path. Furthermore, at the press briefing held on the 27th of September IMF officials reiterated that more work needs to be done to sustain the reform momentum.

It is crucial to identify the reasons for the delay in reforms. Our framework for driving reforms is not well-established. The current structure, where the President acts in the capacity of the Minister of Finance, appoints committees, and delegates tasks, is flawed. Some tasks are interconnected, and the entire drive must come from the Finance Minister alone.

Further, these two roles can have contradictory interests. The Finance Minister holds an unpopular job, requiring revenue increases through taxation and expenditure reduction. Conversely, when the President, a politician expecting re-election, occupies the role, there's a natural tendency to make popular decisions, deviating from essential reforms.

Our reform process is highly complicated, demanding direct involvement of the Finance Minister in debt negotiations with external creditors in several categories, namely multilateral, bilateral, and private creditors. This task alone is equivalent to a few full-time jobs. Additionally, structural reforms are expected to focus on State-Owned Enterprises, where considerable trade union influence will come into play with appointments made by fellow cabinet ministers. Thus, driving such unpopular yet critical reforms becomes nearly impossible, especially when the finance minister is also the President or vice versa. More importantly, for key appointments such as the Central Bank Monetary Board and Governance Board, the President nominates with the Minister of Finance's approval and the Constitutional Council's endorsement. When the President and the Finance Minister are the same, the objective of checks and balances significantly diminishes.

In the case of India's reforms in the 1990s, it was Dr. Manmohan Singh who spearheaded reforms. He had Dr. Montek Singh Alhuwalia as the Chairman of the National Planning Committee to drive reforms. With his experience working with the IMF and a keen understanding of the Indian perspective, the reforms initiated in the 1990s continue to fuel India's growth, making it one of the countries with the highest economic growth rate.

The IMF Governance Diagnosis report, subsequently released, provided numerous recommendations out of which approximately 16 recommendations have been prioritized, mainly focusing on governance and transparency.

One reason this column advocates moving beyond IMF reforms is that corruption cannot be curtailed solely through governance structures. The size of the government must be limited in conjunction with effective governance structures. Aligning governance structures with the vast expanse of the government is nearly impossible.

Furthermore, the IMF primarily brings stability; the responsibility for growth lies in our hands. We must unlock our growth potential through necessary reforms, extending beyond the IMF program. This underscores the urgency of accelerating comprehensive reforms and establishing a dedicated team to drive these changes. Regrettably, what we observe is mere enactment of legislation without robust mechanisms to execute and ensure continuity of the process, and this leading to delays in the IMF's second tranche.

Debt restructuring: A foreign language Sri Lanka needs to grasp very fast

Originally appeared on The Morning

By Dhananath Fernando

“Life is a foreign language and all men mispronounce it,” American journalist Christopher Morley said once. To Sri Lankan policymakers across all governments ‘economic policy’ has been similar to a foreign language that has been mispronounced, too many times too often. We have not only mispronounced but we have gone beyond, making conclusions and creating misperceptions and myths based on our misunderstanding of economic policy. 

Advocata and many economic experts raised the sustainability of Sri Lanka’s debt just after Covid and a Deep Dive Session was conducted providing an in-depth analysis on debt in September 2020 (1). Very early on, Advocata recommended that the economic reforms were a must to avoid any debt restructuring and we should do everything possible to solve the problem immediately. International rating agencies alerted on the same and many policymakers were in denial or silence about these alerts. In fact, CITI bank issued a report titled ‘Denial is not a strategy’ and credit rating was constantly downgraded. 

The moment of truth 

However, the moment of truth has arrived and the senior officials have indicated that the Government is expecting a sovereign debt restructuring. There is very little meaning in complaining and we all have to face the reality. 

Presently, debt restructuring is indeed a foreign language to us and this time we can’t make the mistake of mispronouncing it. This is because we haven’t done it before as a country and it is a very technical subject that needs specialised help. 

A paper published by (2), Lee Buchheit, Guillaume Chabert, Chanda DeLong and Jeromin Zettelmeyer says: “All sovereign debt workouts are painful for the debtor country, its citizens, its creditors and its official sector sponsors. If mishandled, a sovereign debt workout can be incandescently painful. A mangled debt restructuring can perpetuate the sense of crisis for years, sometimes even for decades.”

Debt restructuring cannot be mishandled

Simply, Sri Lanka cannot allow debt restructuring to be mishandled. As this column has mentioned over and over again, without reforms based on the market system and restructuring the economy, mere debt restructuring won’t solve our chronic problems. Debt restructuring without making structural economic reforms can lead the way for another restructuring of debt if it is not done successfully. A failed restructuring can also cause a disorderly default. 

The consequences of this are that economic activity and growth will slow down and be delayed. Mishandled debt restructuring leads to instability in the financial system, leading to declining Foreign Direct Investments (FDIs) and many other chronic economic problems. There are instances of sovereign debt crises leading to political crises, banking crises, and even to the extent of humanitarian crises. So understanding the depth and gravity of managing the debt restructuring professionally and transparently is just the first leg to a very long journey. 

The first step is appointing financial and legal advisors for the restructuring process and it is very important to make the selection process transparent and get the assistance of financial sector experts and an established parliamentary committee of all parties. Simply, we have to have top-notch financial advisors and legal advisors on our side. Already, according to Reuters, the bondholders are in discussion with one of the top legal firms on the restructuring process. Same as debt repayments, after the restructuring process commences, future governments will also have to carry the burden and process forward. 

Sovereign debt restructuring 

Sovereign debt restructuring can fail in a few ways. If the restructuring process takes too long to execute, and if it fails to provide sufficient debt relief, or if the creditors perceive the process as excessive and confiscatory, then the markets will hold a grudge that can affect future market access to the sovereign. 

In any sovereign debt restructuring, the debtor is the central player. In a corporate or individual debt restructuring, there will be a bankruptcy code (in many countries) to be used in restructuring under the supervision of courts. But in a sovereign debt restructuring, there is no bankruptcy code and debt relief can only be obtained with the creditors’ consent. 

Role of the IMF

In sovereign debt restructuring, there is a role for the International Monetary Fund (IMF). It first conducts a Debt Sustainability Analysis (DSA). However, the decision whether the debt has to be restructured or not is a decision by the sovereign country and the IMF provides technical assistance. 

Funds can be provided by the IMF to overcome the balance of payment crisis with an agreeable reform programme based on the status of debt sustainability and access to financial markets. 

In Sri Lanka’s case, the debt sustainability report is still due but the indication of the Government on a debt restructuring programme indicates that our debt is not sustainable. This was one of the main discussion points at the recently-held All Party Conference between the former Prime Minister and the current Minister of Finance.

In the case of Sri Lanka, the debt restructuring adjustment can only be determined after a detailed analysis of our entire debt stock. This included the repayment clauses of recently-taken swaps from friendly nations and the payment postponements of the Asia Clearing Unit (ACU) and even the foreign-denominated debt taken by State-Owned Enterprises (SOEs). The tools available are either to extend the maturity, adjust the agreed interest rate (coupon clipping), reduce the debt stock or principal amount (haircut), or a mix and match of selected options of the above tools.

A zero-sum game 

Debt restructuring is a zero-sum game and any creditor class will first try to make their case as a special creditor category and avoid the restructuring. If it fails, the creditors will try to expand the net number of creditors as much as possible and share the pain with everybody. The pain of debt adjustment on one party is distributed. 

In the restructuring process, any country will try to avoid restructuring of local debt as it could cause stress on the local banking and financial system. In Sri Lanka’s case, some ISB holders are local banks so the restructuring will be a little complicated as even if the external debt is restructured, then there may be an impact on local banks with high exposure to sovereign bonds. 

Sri Lanka’s creditor profiles are slightly diverse. In the bilateral creditors class, we have Paris club member countries (Japan) and non-Paris club member countries (India, China) where the Paris club operates on six principles that guide its work. So it is important that we come to a consensus at the negotiation table with Paris club members and non-Paris club members. Commercial creditors and sovereign bondholders too have to negotiate similar restructuring agreements. International Sovereign Bonds are governed by London Law or New York State Law, which makes our debt restructuring case a ‘foreign language’ to us. 

We are already on the path for debt restructuring but it is vital that all parties and Sri Lankans understand to an extent the depth of the restructuring and professionalism, transparency, and maturity required during the restructuring process. We can’t let the restructuring be handled and treated with a kid’s glove mentality. We have to do structural economic reforms with debt restructuring. Life may be a foreign language where all men mispronounce it,  but if we mishandle the debt restructuring, the lives of many men and women will be at risk.

The opinions expressed are the author’s own views. They may not necessarily reflect the views of the Advocata Institute or anyone affiliated with the institute.