President Ranil Wickremesinghe spoke to IMF Managing Director Kristalina Georgieva about debt management at the COP27 climate summit recently
It is no understatement to say that there is much speculation about domestic debt restructuring today, after a Bloomberg report suggested that “Sri Lanka’s USD bondholders are likely to face heavier burdens Restructuring Costs as Domestic Lenders”. The report went on to say: “They may think they’re going to have a quick change of clothes. But that is not necessarily the case. The reason – Rupee lenders will suffer an additional implied inflationary discount. Bloomberg is right to say that a fair debt restructuring will take into account the inflationary impact borne by rupee lenders.”
The report goes on to say: “Our calculations suggest that parity between domestic and foreign lenders corresponds to an explicit haircut of 17% for domestic lenders and a haircut of 40% for external lenders in order to bring debt to sustainable levels.” bring.”
Sri Lanka has said many times that the country will ensure justice among its creditors. Very soon, due to unnecessary speculation, people/funds will stop investing in bills longer than three months. Sources say the government has not yet made a decision on the domestic debt structure. Ironically, market speculation has made it difficult for the government to raise funds domestically with repayment terms longer than three months, while yields have soared to over 30%.
Effects of haircuts
The EPF, ETF and insurance companies hold most of the bonds and will end up suffering the most damage – private sector workers, who have been the most productive all along, will be the ones who will suffer the full damage. You have already raised concerns. They can publicly resist through their unions, leading to litigation, and/or demanding a corresponding cut in public sector pensions. Therefore, selectively minimizing the impact on the vulnerable segments of government bond holders (GSec), i.e. EPF, ETF and insurance funds, which have historically been major investors in the GSec auctions, is crucial to ensure we don’t kill these captive group goes ahead.
First, long-term investors who invested for returns, not capital gains. The haircut for this group could be minimized. However, banks, FIs and others whose GSec holdings are held with the intent to trade for capital gains or are purchased in the secondary market must be prepared to take a discount to the coupon rate or face value. LKR’s total debt is 12.34 trillion, of which 3.78 trillion is in bills and 8.56 trillion in bonds. We need to assess the respective holdings and the NPV impact on these categories and subcategories based on the proposed action. This has to be quantified by the CBSL’s public debt department. Data must be taken from credible sources (CBSL Public Debt Department) and independently verified by the National Audit Office.
The initial view is that these actions will not result in a material reduction in outstanding debt and/or cash flows. The IMF is ultimately concerned with debt levels and how we reduce them to levels that are considered sustainable. Much like the IMF put the absolute annual sales targets through 2025 on the table, we (from the IMF) need to get the absolute annual debt limits through 2025. This would be a more complex calculation as it would need to take into account new borrowings (international and domestic), any principal repayments within that period, and similar to the annual absolute revenue targets set, the absolute debt perimeter targets would need to have the preliminary lowest impact on the most vulnerable GSec holders to be reached .
The starting point for this vulnerability assessment is the primary investment intent to direct returns to key vulnerable stakeholders such as retirees in pension funds. There is a possibility that this will not be sufficient, at least in the first few years, and that a slight deduction will also be necessary for these. The CBSL holds 2.44 trillion (about 20%) in Tbills and Bonds. The government needs to consider the implications (cash flow and notional public debt) when subjected to a haircut compared to the structure proposed in this table. In particular, the discounts to coupon values and face values of GSec in the CBSL debt stock.
The write-off of CBSL’s stake would need to be accompanied by some sort of backing/guarantee of CBSL from the multilaterals – possibly the World Bank, to ensure the central bank and dependent banking sector do not fall into crisis. The World Bank would have to invent such a backstop for the CBSL as pure central bank (not GOSL) support until the GOSL can replenish CBSL capital until at least 2025 – the year of the projected primary surplus. All this points to a professionally equipped Independent Debt Office (IDO) that will manage GSecs in the future.
This IDO would be appointed and accountable to Parliament and under the oversight of an appropriate Parliamentary Committee, leaving little room for GOSL requirements to be leveraged at the expense of Treasury debt service outflows and sovereign debt perimeters. Capital gains in the market would need to take a back seat in the current circumstances, at least until projected debt levels and debt service ratios are met and sustained.
All primary dealers and banks are currently using the 15.5% CBSL window to raise funds to buy GSecs with significant arbitrage evident, while GOSL debt service costs remain high and the money being printed to maintain the CBSL window , the CBSL earns at 15.5%. Banks are not using their FDs and primary dealers are not borrowing from banks at AWPR as both interest rates are well above the CBSL overnight window rate.
Rejected T-Bond auction bids are then offered in a secondary bid to the failed primary bidders in the winning bid path, ensuring the full bid amount is collected. Tbill auctions do not have this secondary bidding mechanism. If the next 2-3 Tbill auctions are bid and accepted at progressively lower yields (and the higher bids are rejected) and TBonds are offered instead, the current inverted yield curve may normalize from its current inversion. The signals to the markets could well cause T-Bond yields to fall at future auctions.
Wider capital haircut options
- General capital haircut on GSecs issued after 4/18/22 to holders under 6 months
- General capital haircut on all GSecs in debt holdings for the temporary holders under 8 months.
Keep it up
Sovereign debt restructuring is a very complex path that requires careful management, especially given Sri Lanka’s limited experience. Certainly, the starting point is to target the projected level of debt in the proposed Master Debt Sustainability Plan and work within that framework. This is an option worth considering when putting together a robust framework to address the haircuts. But surely there are other options that have been suggested. However, in order to develop a structure, we need qualified professionals with practical experience, firstly to give clear instructions to the advisors who negotiate on behalf of the government, and secondly, to give creditors (especially private ones) confidence in their obligations in this regard, we mean business .