Does Sri Lanka have too much debt?
The primary problem Sri Lanka has is that everyone seems to agree the country has too much debt. Is that correct? The answer is not a simple yes or no.
The first thing to note is that there is internal debt denominated in Sri Lanka rupees (LKR) that is owed by the Government, businesses and consumers to the Sri Lankan banking system. Is there too much debt there? – probably yes as domestic inflation is high and that indicates too much LKR-denominated debt.
But as we all know the real crisis is Sri Lanka’s external debt. The government has a total external debt of about $50b USD which needs to be repaid over a period of time. About $6b of that has to be repaid in 2022.
Now we talked about how banks print money – so why do we not simply print that money? Well, the US banking system can print as many USD as they like – but our institutions cannot. We can only print LKR.The irony here is that when we borrow dollars, US institutions simply print that money and lend it to us. But we have to pay it back in USD we earn. Why do we have to pay it back? Because that is the deal when you borrow. You have to pay back the capital that you borrow plus the interest – unless you are the government controlling that currency.So here is an interesting thing to notice. If you are an ordinary person and you borrow money from your bank, you know of course that you must pay that money back with interest. Globally anyone that wished to borrow USD is in the same situation as an ordinary citizen of a country – you must pay back that loan. Similarly, if you borrow Euro, you must pay it back – unless you are in the European banking system. And the mirror image of that is true for Sri Lanka too – if a foreign institution (including the US government) wishes to borrow LKR – they have to pay it back to us! Unfortunately for us, nobody outside Sri Lanka is queuing up to borrow LKR.
Back then to my question at the beginning of this section. Does Sri Lanka have too much debt - especially external debt? I am going to delay answering that question, for a little longer, but consider this statistic. The following Table 1 is the external debt of four countries. Look very closely please as the numbers might surprise you:
Are you surprised? Notice the UK has 5-times as much debt as Sri Lanka has as a proportion of its GDP. This, by the way, is the external debt of each country. That means the debt is owed to those outside the country. In the Sri Lanka case you can be pretty sure that debt is not denominated in LKR. In the US case it is very likely to be in USD. In the UK case it is not clear, but some of that external debt will be in GBP, while the rest will be in a mixture of currencies including EUR and USD. How then can the UK possibly have an external debt that is 3.5 times bigger than its economy? I will leave you to ponder that for a bit – and will come back to it soon.
Well now is our external debt too high? Firstly, I want to give you one more way of looking at our debt, in the next section.
Sri Lanka has $51b of external debt. Is Sri Lanka already bankrupt?
Sri Lanka is not bankrupt. Let me explain.
One way of assessing whether Sri Lanka is bankrupt is to ask whether the country can pay its debt as it arises.Yes we know that Sri Lanka has trouble repaying its USD and other foreign-denominated debt “as it arises”. This test of paying debt “as it arises” is an important accounting test for insolvency and potential bankruptcy. On that test, we do not look too good.
Let’s ask a different question – can Sri Lanka pay its LKR debt as it arises? Absolutely yes. No country can ever actually be bankrupt in its own currency as governments have the sovereign right to print as much money as they wish and also have the sovereign right to tax its population as much as they can. So, it is impossible for Sri Lanka, or for that matter any other sovereign country, to be bankrupt in its own currency. Now printing lots of money is not a good idea – we know that may create inflation. But we also know from earlier in this article that money printing is not guaranteed to create inflation (if it was so, Japan would not be in permanent deflation).
So now, on the basis of those two tests so far, we have a -1 and +1 judgement. Yes, Sri Lanka is close to insolvency in forex terms, but certainly not when it comes to LKR and can never be. But there is another even more important test. And that is to look at Sri Lanka’s “balance sheet”. It is standard practice for accountants to look at the balance sheet of a company as well as its profit and loss statement when judging the health of that company. Funnily enough global economists never learned that lesson. No economist ever talks about the balance sheet of a country – they must have missed that class at Uni. Economists are always on about GDP and they measure everything as a proportion of GDP. That would be like judging a company by its revenue alone – ignoring the balance sheet and ignoring market value of that company. That is like looking at countries in 2D with one eye shut!
So let me add the third dimension to the view of Sri Lanka’s economy. Credit Suisse and McKinsey Global Institute publish a global wealth report for countries each year. You can find a quick summary of the Credit Suisse numbers for countries on Wikipedia here. Sri Lanka’s net wealth as a country is $ 351b USD. Yes, that is the net wealth after the US$ 50b of external debt is deducted. So, our gross wealth is US$ 400b if you add back the debt, which creates a balance sheet for Sri Lanka of US$ 400b of assets and US$ 50b of debt. Now I am sure most of you reading this article did not know that. Have you ever seen a newspaper quote that figure? Have you ever heard an economist quote that figure?
As you can see, Sri Lanka is far from bankrupt on that measure. An organisation that has US$400b of assets and $50b of debt is not bankrupt. Sri Lanka is in fact quite a wealthy country by that measure and is #58 in the world league of countries by wealth.
This view also answers the question about the United Kingdom’s external debt. Did you notice from the previous section how the UK has an external debt of 345%of GDP totalling $9.3trillion? Surely, they must be bankrupt right? But not so because you need to check out their net wealth. The UK’s net wealth according to Credit Suisse is US$15T which means its net assets are US$24T once you add back the debt. That is why the UK is not bankrupt – they have US$24T of assets and $9T of debt. Any accountant knows that that is more than good enough.
So, let’s then focus on the obvious next question. If Sri Lanka has so little debt compared with the UK, and our “country balance sheet” is so healthy, why do we get so much grief from the financial markets? Let’s look closely at the numbers again for the UK compared with Sri Lanka: See Table 2
Sri Lanka’s debt to assets ratio is 13% compared with the UK at 62%. How is it that the UK is not in even hotter water than us? The answer is that much of the UK’s debt is seen by the markets as “secured debt” while our SL debt is primarily seen as “unsecured debt”. Let me explain.
The UK as you all know has an open economy, it has a currency that is freely exchangeable, and a body of law (English Law) and courts that are trusted by people around the world. (Full disclosure – I live in Edinburgh, UK).
It means that when external parties in other countries lend to UK’s institutions that debt is secured on assets owned by the UK institution that is doing the borrowing. If the UK borrower is unable to repay the debt, the lender will seize that asset, sell it and recover the debt. This is the way loans work globally. Most importantly if there is a dispute between the borrower and the lender, the UK Courts would resolve the matter and if necessary, the ruling could go all the way to the Supreme Court where a final ruling would be made. The important thing to know is that this process is totally independent of politics, democracy, and government. It does not matter what the people of the UK think about the matter, the courts will rule in favour of the foreign lender if that lender is deemed to be in the right - no more questions asked. Property rights in the UK are guaranteed by law and by the independence of the courts. Even more importantly all foreigners trust that system of law and the independence of the UK’s Courts when it comes to matters of property.
I do not need to tell you that this is not true for Sri Lanka. The problem at heart is our perception of national sovereignty. We do not of course have a freely exchangeable currency (which means that LKR cannot be used to repay a foreign debt – unlike GBP can), and we do not have a system of property rights for foreigners, because we think Sri Lanka is for Sri Lankans. That at the end of the day is a political judgement for the Sri Lankan people and the Sri Lankan Government. We seem to think that foreigners owning land in Sri Lanka is unacceptable (contrast that with the UK and US where large swathes of the country are owned by foreigners, including by Chinese and Russian investors whom the West do not like that much). Do we really value our national sovereignty so much more than the US does? And do we understand the down side of that choice we have made? Did we ask the people of Sri Lanka in an educated debate about the choice the establishment has made for them? Guess what - you cannot eat sovereignty. Sri Lanka really must rethink this in an open and clear manner.
Back then to the problem Sri Lanka had with its debts. As foreign lenders cannot be sure that we will not default on our debt (and all those people urging the government to default are making matters worse), Sri Lanka cannot borrow and secure that borrowing against our assets in the way that a country like the UK can. Please have no doubt that this is a mess of our own making. Sri Lanka can change the situation overnight by changing our laws to guarantee foreigner’s ownership of Sri Lankan assets, and by guaranteeing that foreign debt will always be serviced and repaid – by law.
(Aravinda Korala is the Founder and CEO of KAL. KAL is the leading ATM software company globally and is headquartered in the UK. Aravinda obtained his BSC in Electrical Engineering from Kings College London and Ph.D. from the University of Edinburgh in Artificial Intelligence.)
To be continued
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