Others are dipping into their Gold reserves to survive the current crisis

Gold has been the ultimate haven asset over recent years as economic and geopolitical uncertainties have intensified, helping drive gold prices to record highs. So much so, that the reduction in the price since the Iran conflict has been both surprising and substantial.

One explanation given is that some are selling down their gold assets to help pay for the sudden increase in costs from the Iran conflict, especially fuel prices. Central Banks were amongst the largest purchases of gold in the last few years, and now they might be selling some of their gold to help support their currencies and offset impact of their countries’ rising import bills.

But Sri Lanka’s reserves have little in terms of Gold assets

In contrast, Sri Lanka’s central bank has very little in terms of gold assets in its gross official reserves. By February 2026 it was reported to be about USD 200 million, recovering from lows below USD 30 million prior to mid-2023. But that is no where close to the gold assets of over USD 900 million in 2016, 2017/18, and 2019.

But looking at the gold assets in USD terms is not sufficient given changes in the volume of gold and the price of gold affects the value of the gold assets. Even as gold prices rose gradually from 2018 to 2022, Sri Lanka kept selling down its volume of gold. As a result, there was little gold remaining to benefit from the massive rise in gold prices from 2023 onwards. So what happened to Sri Lanka’s gold assets between 2018 and 2022?

Sri Lanka’s Gold reserves prior to 2018

CBSL’s reserves data reports the USD value of gold assets since November 2013 and the volume of gold in millions of troy ounces since June 2015. But I managed to back calculate the estimated volume going back to November 2013 using the market value of gold at the end of each month.

This shows that prior to June 2015 there was more volatility in the volume of gold around the 0.7 million ounces mark (about 22 tons), likely indicating active trading in gold during the period prior to 2015. But from mid-2015 onwards, the volume was much more stable at 0.72 million ounces until the first sale in March 2018.

The increase in Gold asset volume to around 22 tons was due to the purchase of 10 tons of gold from the IMF in November 2009 for USD 375 million. This was enabled by the USD 2.6 billion Stand-By Arrangement agreed with the IMF in July 2009, with about USD 660 million disbursed by November 2009. The jump in gross official reserves to over USD 5 billion, driven by a massive jump in foreign investments in rupee government securities, also created space to diversify reserves into more gold. According to data reported by EconomyNext in January 2022, the gold volume reduced during 2010-2012, but rose again in 2013 to above the levels in 2009.

A Series of Gold Sales from 2018 onwards

The volume of gold starts to reduce for the first time since mid-2015 in March and April 2018, with a total reduction of 0.08 million troy ounces or about 2.5 tons of gold (roughly 10% of the gold). This was a roughly USD 100 million reduction in gold, but coincided with a USD 2 billion increase in gross reserves, driven by a USD 2.5 billion ISB issuance.

The gold volume remain stable around 0.64 million troy ounces or about 19.9tons of gold until August 2019 when there was a 0.01 million troy ounce or 0.3 ton sale. This was followed by a significant 0.41 million troy ounce or 12.75 ton sale in January and February 2020 that reduced the gold volume by about 66%. This was done just before the COVID-19 pandemic and following the then government’s decision to cut taxes in December 2019. Gold prices rose about 25% across 2020, allowing for the remaining gold to gain in value by USD 67 million.

The remaining 0.22 million troy ounces or 6.8 tons remained until early 2022, when 6.2 tons were sold between December 2021 and March 2022, as the government scurried to utilize all remaining reserves to delay the inevitable sovereign default and pay for essential imports.

The remaining 0.015 million troy ounces or 0.47 tons of gold have remained so until September 2025. Purchases of about 0.16 tons in October 2025 and about 0.56 tons in February , raising the total to over 1 ton.

Sale of Gold assets, tons

What drove these gold sales?

While gold has been a long running reserve asset, it is not a very liquid reserve asset and its price can be volatile at times. A famous case of liquidating gold reserves was India’s 1991 liquidation of Reserve Bank of India’s gold to source foreign currency until an IMF program was negotiated. Some of them had to be airlifted to international financial centers.

Sri Lanka’s case was no different, especially in the run up to the 2022 crisis. Having a billion dollars in gold did not help when there were large regular foreign debt repayments to handle or when there was no foreign currency to pay for shipments of fuel. Even as early as 2018, 2019 and 2020, these liquidity concerns were increasing. But in 2018 and 2019 this was less of a dire concerns due to the ability to raise ISBs, term loans, and the lease proceeds from the Hambantota Port lease.

The reserve management policies of CBSL also changed over time, adapting to the changing context of Sri Lanka’s fiscal and balance of payments situation, and changing global financial conditions. By 2018 the return or yield on US Treasury securities, the ‘safest’ USD asset, was increasing from the record lows in the aftermath of the global financial crisis of 2007/08. As a result, it was relatively more attractive to hold a higher proportion of reserves in USD assets than in gold. Gold in itself has no regular yield or income to the central bank, and might even carry a cost to maintain in secure vaults.

It is easy to look at gold as a share of total reserves. But the actual usable reserves vary over time depending on the amount of swaps and other short term obligations of the central bank. And the illiquid nature of gold can reduce the usability of reserves even further. As a result, the amount of gold assets to be maintained would also need to adjust alongside changes in usable reserves.

CBSL’s explanation of its early 2020 sale of gold was based on these lines, citing the changes to its reserve management policy in 2016.

CBSL policy changes were also taking into account changes to the IMF’s reserve adequacy metrics. In the 2000s, the IMF Article IV consultations and programs focused more on the headline reserve amounts, months of imports coverage, and ratio of reserves to short term external debt. Gold assets in reserves were usually considered in their gross amounts, without accounting for their illiquidity.

But with the introduction of the Assessing Reserve Adequacy (ARA) framework in 2011, the IMF’s approach changed. IMF reports started showing reserves with and without gold, alongside an augmented ARA metric that applied a discount to gold assets to reflect their illiquid and price volatile nature.

Gold amidst Usable Reserves reality

During 2018, 2019, and early 2020, gross reserves were at relatively high levels, staying above USD 6-7 billion. But when adjusted for swaps and FX debt repayments due in the next 12 months, ‘usable’ or remaining reserves were much lower. Selling some gold to increase liquidity of the remaining reserves made since in such a context.

Gross Official Reserves adjusted for Swaps and FX debt outflows in 12-month forward pre-determined FX drains data

By late-2021, the price of gold had increase boosting the value of the remaining gold and the decline in reserves had increased the share of gold in reserves to above 15%. With the then government insistent on paying the USD 500 million ISB maturing in January 2022 and FX being desperately needed to pay for fuel shipments, liquidating the remaining gold would have been a no brainer. No central banker can refuse to liquidate some gold when payments for essential goods were at stake.

There was no law that prevented or limited such sales. The then government’s insistence of using up all possible space to avoid default till the last possible minute meant there was no option for the central bank.

The What if Scenarios

So, what if Sri Lanka still had the gold that was available prior to each major sale of gold assets from 2018 onwards?

Compared to the USD 200 million in gold at February 2026, retaining the volume of gold in 2018 and 2019 would have allowed for USD 3.3 to 3.8 billion in gold assets, driven by the massive increase in gold price.

But even if the gold assets remaining in November 2021 were retained, instead of paying the USD 500 million ISB in January 2022, the gold remaining would have been about USD 1.1 billion.

Actual vs. Hypothetical Gold Reserve Assets, USD million

At the Feb-2018 level of gold, the gross reserves would currently by about USD 3.6 billion higher by now.

Gross Official Reserves Actual vs. Hypothetical at Feb-2018 Gold asset levels, USD million

At the Nov-2021 level of gold, the gross reserves would currently by about USD 1 billion higher by now.

Gross Official Reserves Actual vs. Hypothetical at Nov-2021 Gold asset levels, USD million

Of course these are hypothetical what ifs, meant to illustrate the cost of the 2018-2022 crisis period in which desperate measures were taken to keep muddling through amidst multiple shocks. Reality is more complex. Priorities of central bank reserve management goes beyond holding large gold assets in hopes of a massive rally in gold prices. Immediate near term concerns take precedence. Which is why it is important that the political decision makers need to manage risks holistically and avoid seeing reserves as providing money and time they can use for policy gambles.

Note: This article is based on the personal analysis and opinions of the author. It is in no way a reflection of institutions that the author is affiliated with. Any errors or omissions are the author’s sole responsibility.

Switching back from Foreign Asset to Domestic Asset accumulation

Broad Money (M2b) expanded by 11.3% YoY or almost LKR 1.6 trillion for the 12 months to Nov 2025.

12 month rolling growth in M2b Broad Money, LKR billion

In the run up to and during Sri Lanka’s 2022 crisis, there was a massive increase in domestic asset creation as the banks and CBSL lent in significant amounts to the government in particular amidst high fiscal deficits. At the same time net foreign assets contracted, especially as CBSL foreign reserves were used up and swaps were obtained. But from mid-2022 onwards, the domestic banking system started to paydown its foreign liabilities and accumulate foreign assets using the current account surplus. As a result, net foreign asset improvement drove M2b expansion for much of 2023 and 2024. I’ve covered this shift more than a year ago.

From June 2025 onwards there has been a clear shift with the expansion in M2b being driven more by the expansion in Net Domestic Assets (NDA) than Net Foreign Asset (NFA) accumulation for the first time since early 2023. But the expansion in domestic credit expansion in 2025 is different to the expansion up to the 2022-2023 crisis years.

Contribution of NFA & NDA to 12-month rolling M2b expansion, %

Pre-crisis, the expansion in domestic credit saw significant contribution from licensed commercial banks (LCBs) lending to the government and SOEs, alongside some periods of CBSL lending to the government. But since late-2024, the expansion in domestic credit over rolling 12-month periods has been driven by the increase in LCBs lending to the private sector (firms and individuals resident in Sri Lanka).

SOEs have actually been paying down their borrowings from the banks and the government has taken over some of their debt and CBSL lending to the government was restructured in late-2023 and repaid gradually. While bank net lending to government has not contracted (other than during the height of the crisis in mid-2022), it has been largely stagnant as government borrowing needs have reduced amidst successful fiscal consolidation.

12 month rolling growth in Domestic Credit, LKR billion

Expansion in Bank Lending to the Private Sector

By November 2025, licensed commercial banks’ (LCBs) lending to the private sector (including individuals and households) had increased 26% year-on-year (YoY), the highest since September 2016. Since June 2025, the monthly expansion in lending to the private sector has been consistently over LKR 200 billion, for the first time since 1997 (excluding the one off increases during the mid-2022 crisis amidst rapid depreciation).

Monthly Change in Outstanding LCB’s credit to Private Sector, YoY %

Looking at 12-month trailing sum of expansion in banking lending to the private sector it is clear that the absolute growth of almost LKR 2.1 trillion by November 2025 is the highest on record for data going back to 1996.

12-month trailing sum of growth in bank lending to private sector, LKR billion

Is that really as high given the impact of significant depreciation of the currency during the crisis? Even in USD terms, the 12-month growth is the highest at USD 6.9 billion by Nov 2025, more than breaching the ~USD 6 billion peak in July 2016. Even as a share of GDP, the expansion in 2025 is likely to be around 7% of GDP, higher than the ~6% of GDP expansions in 2015-2016.

12-month trailing sum of growth in bank lending to private sector, USD billion

Where have the banks been lending to?

CBSL’s latest monthly sectoral breakdown of bank lending to private sector is available from April 2025 onwards. For the 6 months up to October there was about LKR 1.2 trillion in credit growth, with 18.1% of that being to financial and business services, 16.7% to construction (with 9.5% to personal housing including staff housing loans), 13.9% to manufacturing, 13.9% to wholesale and retail trade, and 12.1% to pawning. The financial and business services sector expansion might be partly due to bank lending to non-bank financial institutions (NBFIs).

Share of private credit expansion by sector for April to Oct 2025, %

Bank lending to private sector during 2016 to 2017, the last period in which there was sustained 20% plus YoY expansion, the sectors driving it were different. Construction was higher at 24% of the expansion, while personal loans - other than consumer durables and pawning - was the largest.

Share of private credit expansion by sector for 2016-2017, %

Licensed Finance Companies (LFCs) lending has also expanded significantly

Beyond the banks, the LFCs also lend substantially to the private sector in some categories such as consumer durables, especially vehicle leasing, and pawning. But their total outstanding lending was just under LKR 2 trillion at end-September 2025, compared to LKR 16.6 trillion by the banks. While the LFCs are smaller, their lending caters to a wider array of borrowers who might not have access to bank lending due to weaker financials and lack of sufficient collateral.

Similar to the banks, the expansion in LFC lending post crisis has been at the highest since quarterly data is available from late-2013. On a YoY basis the expansion was just under 50% and in LKR terms was just under LKR 650 billion by Sept 2025.

Quarterly Change in Outstanding LFC’s credit to Private Sector, YoY %

12-month trailing sum of growth in LFC lending, LKR billion

I would have liked to use M4 data which includes LFC and other FIs lending data. But an updated version of it is not available since late-2024.

A whole lot of balance sheet expansion

The quarterly expansion in lending by LCBs and LFCs to private sector (assuming all LFC lending is to private sector) was around LKR 900 billion in 3Q-2025. Across the period from 3Q-2023 to 3Q-2025, about 26% of the expansion in lending to private sector was driven by LFCs.

Quarterly expansion in LCB and LFC lending to private sector, LKR billion

All this lending by the LCBs and LFCs has expanded their balance sheets significantly since mid-2024. The rapid expansion of one of their major asset categories - loans to the private sector - requires financial institutions to either reduce other assets (such as investments in government securities) or expand their liabilities (deposits, borrowings or equity). The next article will take a look at how these balance sheet changes have happened over the last couple of years and whether it points to any major changes to how FIs function in an evolving economic context that is increasingly different to the past.

Note: This article is based on the personal analysis and opinions of the author. It is in no way a reflection of institutions that the author is affiliated with. Any errors or omissions are the author’s sole responsibility.

Now the question lies with how Sri Lanka will manage its fiscal position beyond 2025. Compared to 2024, the country needed to raise an additional LKR 734 billion in tax revenue in 2025 to meet the IMF’s tax revenue target. More than half of this increase; about LKR 450 billion, was expected to come from vehicle import taxes. By September 2025, the Ministry of Finance reported that revenue from motor vehicles had reached LKR 429 billion.[i] This shows that by the end of this year the given target will be overachieved and as a result of it our tax revenue will also be higher than our estimates. While pent-up demand for vehicle imports may allow the 2025 revenue target to be met, the challenge lies in sustaining such gains over the medium to long term.

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Shifting Tax Composition: From Income Tax to VAT Dominance

Looking ahead, the IMF program sets clear fiscal anchors: tax revenue must reach at least 14% of GDP (with overall revenue above 15% of GDP), primary expenditure must remain capped at 13% of GDP, and the government must maintain a primary surplus of 2.3%. These targets highlight two important shifts in Sri Lanka’s fiscal landscape. First, the country’s tax composition has changed significantly. With the VAT rates raised to 18% and most exemptions removed, VAT has now overtaken income tax as the largest single source of revenue.

Contribution of VAT, Excise and Income taxes to tax revenue (2010-2024)

Within the last 10 years, Sri Lanka’s single main source of revenue has changed between Excise, Income taxes and VAT. This also represent the unsustainable tax policies introduced by the government under different regimes. Current revenue generating patterns and IMF projections suggest VAT will remain the dominant contributor in the coming years. Second, moving from 2025 to 2026, tax revenue is expected to grow by at least 11% YoY, equivalent to about LKR 500 billion. Meeting this target will require careful planning, as reliance on vehicle imports as the main driver would not be sustainable.

The IMF’s decision to set fiscal targets as a percentage of GDP rather than fixed nominal amounts has both benefits and risks for Sri Lanka. On the positive side, it provides flexibility, as targets automatically scale with the size of the economy. When growth picks up, nominal GDP expands and so does the tax revenue base, making percentage targets more realistic compared to rigid rupee amounts. It also insulates performance criteria from short-term shocks, since revenues like VAT and excise naturally rise with inflation and higher prices. However, this can also create a false sense of progress, as inflation-driven nominal gains may hide the lack of genuine tax base expansion. For Sri Lanka, the challenge is clear: in the short term, percentage-based targets are achievable with VAT hikes, pent-up import demand, and inflationary effects boosting collections. But over the medium term, with growth expected to average only 3.0–3.5% according to IMF projections, meeting and maintaining sustained revenue increases will depend less on cyclical or price effects and more on structural reforms.

Tax Revenue Projection (2025-2030)

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Primary Surplus Over performance: Driven by Revenue and Capex Cuts

Over the past two years, Sri Lanka has consistently over performed in achieving a primary surplus. In 2024, the IMF set a quantitative performance target of LKR 300 billion, but the actual primary surplus reached LKR 650 billion. Similarly, in 2025, the target was approximately LKR 734 billion, yet by July the surplus had already climbed to LKR 974 billion. This over performance has been driven by two main factors: stronger-than-expected revenue collections and significantly lower capital expenditure.

A closer look at capital expenditure trends over the last decade highlights a sharp contraction in recent years. While budget allocations for capital expenditure have often exceeded LKR 1 trillion, actual utilization has been far lower. For instance, in 2024, the budget allocated LKR 1.2 trillion for capital expenditure, but only LKR 817 billion was actually spent. The underspending of capital expenditure is primarily driven by the stringent procedures and bureaucratic red tape surrounding government spending, rather than by officials’ reluctance to utilize the funds. This issue was also highlighted by the International Monetary Fund in its most recent review.

Capital Expenditure as a % of Primary Expenditure

This underutilization has contributed to the Treasury building a sizable cash buffer, now estimated at over LKR 1 trillion. The existence of this buffer has provided valuable flexibility for the Treasury in managing its borrowing costs more effectively. This also provide space for the government to pay down its domestic debt, which we have seen the treasury doing in the past couple of months, especially with short end government securities.

However, this strategy has also altered the structure of Sri Lanka’s economy. While reduced capital expenditure and strong fiscal buffers offer short- to medium-term stability in debt management, the long-term trade-off is weaker investment in infrastructure and growth-enhancing projects. Over time, this underinvestment risks constraining productivity, private sector competitiveness, and overall growth potential. In other words, fiscal over performance achieved through spending compression may stabilize the present but could undermine the foundation for future growth. Sri Lanka’s challenge, therefore, is to balance short-term fiscal prudence with the longer-term need to invest in development.

Disclaimer: The views expressed are solely those of the author and do not represent the opinions of any organization the author is currently or previously affiliated with. The author assumes full responsibility for any errors or omissions.

[i] https://www.themorning.lk/articles/wOD5sWCXGSd3tDkEqLOJ

Despite a gradual pickup in imports during 2024 and 2025, Sri Lanka has managed to sustain its current account surplus, which also helps to stabilise the dollar-rupee exchange rate. Remittances, in particular, have played a long-standing and vital role in the country’s foreign exchange market, dating back to the 1960s. Over the decade, the nature of labour migration and the composition of remittance flows have significantly evolved, providing deeper insights into their macroeconomic impact.

This analysis will examine migration and remittances through the lens of the Balance of Payments (BOP), highlighting their continued importance to Sri Lanka’s external and overall economic stability.

Remittance earning performance and BOP

Performance of Net Remittances (USD Mn)

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Worker remittances have played a crucial role in supporting Sri Lanka’s economy, particularly in managing the current account balance. This trend is especially evident in the monthly current account data for 2025. For instance, in April 2025, the trade deficit widened due to a surge in vehicle imports. However, the strong performance of service inflows and robust remittance earnings enabled the country to maintain a current account surplus despite the trade gap.

Historically, remittances peaked in 2016 and 2017, reaching USD 7.2 billion, the highest on record. However, this figure declined significantly during the COVID-19 pandemic and the subsequent economic crisis. In 2022, remittance inflows fell to USD 3.8 billion, partly due to an increase in the use of informal channels such as hawala, driven by the more favourable black-market exchange rate.

Since 2023, remittance earnings have shown a strong recovery. During the first five months of 2025 (January to May), Sri Lanka recorded USD 3.1 billion in remittances. If this upward trend continues without major external shocks, the country is on track to achieve USD 7.4 billion in remittance earnings for the year 2025, potentially the highest remittance earnings recorded in over a decade.

Rising Migration and Strong Inflows Position Sri Lanka for a New Remittance Peak

1Migration Trends and Remittances.

The above chart offers a comprehensive view of the performance of Sri Lanka’s labour migration and remittance inflows. The trend indicates that remittance earnings have rebounded to pre-COVID-19 and pre-economic crisis levels, suggesting a gradual return to economic normalcy. During the first five months of 2025 (January–May), remittance inflows grew by 18% compared to the same period in 2024 and by 32% compared to 2023. This strong recovery somewhat implies that remittances have reached a peak when looking at historical numbers. However, in 2024 total departures for foreign employment reached 314,786, the highest annual figure recorded in the past decade. This indicates the possibility for earnings from remittances to further grow beyond the historical levels. Furthermore, CBSL further states that workers’ remittances are expected to increase steadily in 2025 and beyond, helped by the momentum in foreign employment departures and increasing adoption of formal channels for money transfer by the migrant workers.2

As seen in the chart, end of Sri Lanka’s 30-year conflict and the post-war economic boom initially led to a slowdown in labour migration. However, the period between 2022 and 2024 saw a significant rise in migration, driven by economic and political instability. The sovereign default, soaring inflation which reached to 75%, and a series of tough but necessary economic reforms, including higher personal income taxes, increased VAT, and import restrictions severely impacted household living standards, prompting many to seek employment abroad.

By early 2025, there has been a decline in labour migration compared to the 2022–2024 (January–April) period. However, current migration levels still remain significantly higher than during the relatively stable 2015–2019 period. Given this backdrop, there remains potential for Sri Lanka to expand its remittance earnings beyond the current peak, although the extent of this growth will depend largely on future migration trends and global labour market dynamics.

Shift from Domestic Workers to Skilled Professions

Departures based on the skill breakdown

Since 2015, Sri Lanka’s labour migration has undergone a notable structural transformation. Prior to 2010 and even in the years that followed, approximately 40%–42% of migrant workers were employed as domestic workers, primarily in Middle Eastern countries. However, post-2015 data reveals a gradual but significant shift toward skilled migration.

By 2024, the share of domestic workers among total migrant departures had declined to around 30%, while skilled workers accounted for approximately 35%. This shift marks a structural change in the composition of Sri Lanka’s labour migration, indicating a growing preference for more specialised roles abroad.

Moreover, professional-level migration has shown a steady upward trend since 2018. In 2010, only about 1% of outbound labour was classified as professional. By 2024, this figure had increased to 7.1%, reflecting the increasing global demand for Sri Lankan professionals and a rising skill base among the workforce.

This shift has important yet negative implications for the domestic labour market. As highlighted in one of my previous articles, there has been a noticeable outflow and retirement of highly skilled professionals, particularly from the public sector, leading to a growing skills gap within the country. This trend can also be observed within the private sector. Addressing this vacuum should be a priority for policymakers. Ensuring the availability of an efficient and skilled labour force, alongside productive capital, is essential for sustaining long-term economic growth.

From Middle East Dependence to a 50/50 Remittance Base

3Remittance Earnings – Country-wise breakdown

The chart clearly illustrates the regions from which Sri Lanka derives the majority of its remittance inflows. An interesting observation between 2023 -2024 shows that remittance earnings, which came through North America, have increased approximately by 200%, which provides us an understanding that remittances that is coming from Canada and the USA are slowly increasing. Between 2012 and 2020, the country's external sector performance and foreign exchange earnings were heavily reliant on the Middle East, which accounted for approximately 45% to 50% of total remittance inflows. This high dependency also aligns with the labour migration profile during that period, where a significant share of remittances came from domestic workers employed in the Middle East. This correlation highlights how Sri Lanka's remittance-driven forex inflows were largely dependent on a specific skill group and region.

Middle East vs rest of the world performance

However, recent data suggests that this pattern is beginning to shift. The country is now witnessing a more diversified remittance base, both in terms of geographic sources and the skill levels of migrant workers. As the chart depicts, Middle Eastern countries and the rest of the world are now contributing 50%-50% for remittance earnings.4 The dip in the chart is mainly due to the calculation method revised by CBSL.5 This structural evolution reflects broader changes in labour migration trends and offers opportunities to build a more resilient and sustainable remittance inflow system.

As illustrated in the chart above, there has been a notable shift in the regional composition of Sri Lanka’s remittance earnings. By 2024, around 50% of remittances originated from countries outside the Middle East, indicating a growing diversification in source regions. Nevertheless, the Middle East still accounts for the other 50% share of total remittances, highlighting continued dependence on that region.

Middle Eastern Region: Highest Contributing Countries

Rest of the World: Highest Contributing Countries

The above analysis reveals a significant observation: Sri Lanka does not rely on any single country for remittance earnings. Instead, both Middle Eastern countries and other regions contribute almost equally to the overall inflow, indicating a well-diversified source of remittances.

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This reliance is particularly important in the current context of escalating geopolitical tensions between Iran and Israel. As of 2024 only 2% of our remittance earnings originated from Israel. However, any disruption in the Middle Eastern labour markets due to conflict or instability could pose risks to Sri Lanka’s remittance inflows. Given the critical role remittances play in supporting the country’s external sector and current account, this emerging risk underscores the need for proactive monitoring and policy preparedness.

Disclaimer: The views expressed are solely those of the author and do not represent the opinions of any organization the author is currently or previously affiliated with. The author assumes full responsibility for any errors or omissions.

Conversely, the other budget documents and fiscal estimates presented to Parliament indicate a completely different target: a public debt-to-GDP ratio of 95% by 2032, which aligns with the IMF’s Debt Sustainability Analysis. One would naturally ask: why such a large difference? The exact question that was posed by the COPF chair and members to the officials from Treasury and PDMO.

During the COPF session, PDMO officials attempted to clarify the discrepancy. They explained that the MTDS focuses on central government debt, while the IMF’s framework addresses public debt, which includes not only central government borrowings but also government-guaranteed debt and debt incurred by state-owned enterprises (SOEs). So yes, there is a definitional difference. Public debt has a broader scope and thus often is a higher debt-to-GDP ratio. However, it is not a massive difference as reflected by the data from the central bank and PDMO itself.

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Source : CBSL and Quarterly Debt Bulletin 2024
*IMF definition of Public Debt includes IMF loans provided to the Central Bank, so the number in IMF reports is slightly higher than this.

Historical data from the Central Bank supports this. For instance, public debt figures often exceed central government debt by 5–10 percentage points. However, given the IMF program’s recent restrictions on SOE borrowings, this gap has narrowed and is expected to narrow further. That makes the current divergence between the MTDS target and the Treasury’s projections harder to justify on definitional grounds alone.

In short, that’s not why numbers significantly differ. Numbers differ because MTDS seems to have been prepared without properly accommodating the DSA assumptions and other macroeconomic dynamics. MTDS is prepared based on World Bank and IMF's MTDS Analytical Tool (AT) while the DSA is prepared based on the Debt Sustainability Framework for Market Access Countries (MAC SRDSF). Although these are two different toolkits serving two different purposes, debt management strategy should be consistent with the DSA, and macroeconomic assumptions used in the DSA. In the case of Sri Lanka, this consistency seems to be lacking as implied by discrepancy of government debt estimates. PDMO also vaguely attempted to imply that assumptions differ. But as explained above, underlying assumptions of MTDS and DSA ought to be consistent.

“The MTDS is a more targeted debt management framework, focusing on the specifics of how the composition of debt should be managed over the medium-term. Determining an effective DMS requires that the performance of various financing strategies be evaluated under a given path for key macroeconomic variables, which should be consistent with that used in the DSA” Developing a medium-term debt management strategy framework (MTDS) – Updated guidance note for country authorities, 2019, World Bank and IMF

The issue at present could be driven by the PDMO being able to fully factor in the overall macroeconomic overperformance Sri Lanka has recorded in the past 2-3 years into its MTDS assumptions, while the IMF staff are not fully able to do that and update their forecasts for Sri Lanka’s debt to GDP ratio. The ongoing IMF program and the debt targets used in the debt restructuring were based on their initial DSA forecasts done in 2022/2023, which they institutionally cannot alter significantly within the ongoing program. It is possible that when the ongoing program ends, the debt-to-GDP forecasts of the PDMOs MTDS and IMF DSA are able to converge more closely.

It’s not merely a data discrepancy

This gap in figures and the official back-and-forth reveals several underlying problems regarding Sri Lanka’s public debt management and the PDMO.

1. Lack of coordination within the Treasury regarding the government’s debt targets. The budget estimates, annexures in the budget speech and MTDS seems to be prepared in silos.

2. Lack of agreement on how these targets are forecast. It is important to note that there are two distinct toolkits used for MTDS and DSA. While those serve different purposes, there has to be consistency in terms of the assumptions in using these toolkits to derive forecasts. Thus, PDMO and other departments of Ministry of Finance need to have common agreement about assumptions used.

3. Weak institutional capacity at the PDMO. It is crucial to point out that PDMO is a new institute which was set up only last year. A discrepancy in this nature is a consequence of lack of capacity and lack of clarity on technicalities involved in public debt management. Current PDMO officials needs more comprehensive training with the support of foreign experts to gain a detailed understanding about public debt management and tools used in it.

Add to that Sri Lanka does not have much experience in preparing Debt Management Strategies (DMS), particularly MTDS. Before this, there was only one MTDS prepared by Sri Lanka in 2019 by the Central Bank’s Public Debt Department. So, the current strategy is only the second attempt.

Why a Separate Debt Office?

The creation of the PDMO represents a structural shift. Its goal is to centralize debt management under one roof. Until recently, Sri Lanka’s public debt was managed by a patchwork of institutions:

• Issuance of domestic debt securities — like issuing Treasury bills and bonds—were handled by the Central Bank’s Public Debt Department. It was responsible for conducting auctions and

• Bilateral and multilateral foreign loans were managed by the External Resources Department (ERD) of the Finance Ministry. The ERD also maintained a comprehensive registry of foreign loans, outstanding debt and loan repayments. Prior the establishment of the PDMO, ERD published foreign loan disbursement reports monthly and different section of ERD dealt with different multilateral creditor and bilateral creditor.

• Commercial foreign loans, such as ISBs and foreign currency term facilities, were managed jointly by the Central Bank and Finance Ministry.

• Repayment of these debt securities and loans were handled by the Treasury Operations Department.

• SOE loans were managed by SOEs themselves, sometimes with input from the Finance Ministry. In some cases, debt was transferred to SOEs to paint a prettier picture of central government debt on the books—as in the cases of Hambantota Port, the Puttalam power plant, and the Mattala airport.

This fragmented structure lacked transparency and coordination. Now, the government, under the advice of the IMF, and the other two major multilateral lenders, is attempting to consolidate these functions under the PDMO. As revealed in COPF discussions, the issuance of Treasury securities will soon move from the Central Bank to the Treasury. Commercial foreign borrowing responsibilities will also shift away from the Central Bank—once the main actor in ISB issuances—and into the hands of the PDMO.

This is no minor administrative shuffle. It is a major institutional transformation. Such major transformation requires institutional capacity to match that transformation.

The PDMO has started training its staff through the Central Bank’s Public Debt Department to manage tasks like government securities auctions and bidding processes. But training alone won’t be enough.

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Why Capacity Matters More Than Ever

Managing public debt is not just a bureaucratic function—it’s a high-stakes, high-skill operation. In Sri Lanka, much of this complex work has so far been handled relatively smoothly with significant support of the Central Bank, even though, globally, debt management is no longer seen as a central bank’s core responsibility.

Managing public debt requires navigating both local and global financial markets. It demands a high level of technical expertise, operational efficiency, risk analysis, legal knowledge, and data security. These are not things that can be improvised. The Central Bank succeeded in large part because it had both the systems and the people to manage these operations. And let’s be honest—those people are paid much more than the rest of the public sector. This pay scale difference is a key factor.

The Central Bank offers significantly higher salaries than most other parts of the government. And for good reason. If you want technically competent professionals dealing with billions in public funds and dealing with complexities of the financial system, you need to pay them accordingly. That pay gap is one of the reasons Sri Lanka’s debt securities issuance and management —despite broader governance issues—has not been chaotic.

Now, as the PDMO takes over, it’s crucial to remember that this job involves daily interactions with financial markets. The institution responsible must stay two steps ahead, not one step behind. The debt must be managed transparently, but also smartly—always with the goal of minimizing long-term debt servicing costs.

Building a Real PDMO—Not Just on Paper

Establishing the PDMO was the right decision. But it was done without fully thinking through the technical and institutional foundations necessary to make it succeed.

Currently, PDMO officers are mostly drawn from the Sri Lanka Administrative Service and the Planning Service – from within the Ministry of Finance. While these officers are vital to general public administration, most of them do not have technical expertise in public debt management, debt related laws, and financial markets. This is not to downgrade them, but they were not recruited for the purpose of public debt management.

To bridge the gap temporarily, a few Central Bank officers have been seconded to the PDMO. But this is not sustainable. The Central Bank is meant to function independently, and lending its officers to a Finance Ministry department could compromise that independence in the long run.

In such context, what can be done about it? Solutions aren’t quite straightforward, but there are a few fundamental structural changes that can be done as a start.

• The PDMO should have a separate service structure, with its own salary scale—ideally aligned with the Central Bank. This essentially means a high salary levels.

• Recruitment should be based on technical competence, with specialized roles in economics, finance, law, and risk management.

• The government must be willing to pay for skill or risk a poorly run debt office that could create more problems than it solves.

• Obtain technical assistance from other countries debt offices, and multilateral agencies, research institutions at global level and universities

Public debt management isn’t just about numbers on a spreadsheet. It’s about navigating complex global and domestic forces while making sure the country stays solvent, credible, and stable. It requires people who not only understand financial markets but can also handle market-sensitive information with integrity and discretion.

That kind of skilled professionals don’t come cheap.

If the government tries to run the PDMO without having the adequate skilled team in place, it will have many adverse impacts on countries debt management. The success or failure of the PDMO heavily depends on its capacity, which in turn depends on government's willingness and ability to attract individually technical competency, experience and integrity to the PDMO.

Sri Lanka is now a middle-income country and if economic recovery continues, Sri Lanka will soon be an upper-middle-income country. Thus, Sri Lanka will have to constantly rely on international financial markets as a source of government financing. This means Sri Lanka will have to deal with global players in financial sector which has portfolios of USD billions and will require to handle large asset and liability books. This is a challenging exercise for any emerging market country. Not having the sufficient capacity to do it makes it harder.

Public debt management isn’t just about obtaining loans and repaying debt. It involves more complicated government cashflow management while minimizing the costs, risks and exposure. For these very reasons, PDMOs in other countries work closely with the Treasury cash management office. Thus, for smooth functioning, PDMO should be needs to be integrated well into the Treasury system. To put it in simple, PDMO cannot operate in a silo from the other institutions and departments.

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Don’t Repeat Past Mistakes

Sri Lanka has consistently neglected state capacity, even as it expanded its public sector. We now have a vast administrative machinery, but one that suffers from a shortage of skilled professionals—in large part due to uncompetitive salaries.

We’ve already seen how this played out in the country’s weak tax performance, and how poor supervision opens the door to corruption. Turning a blind eye to the capacity needs of the PDMO would be repeating the same mistake, but this time in a far more dangerous domain.

The good news? The PDMO has not yet become fully operational. It’s not too late to make the necessary course corrections. But doing so will require political will, bold decisions, and a real commitment to building a functional, professional institution.

If Sri Lanka is serious about getting its debt management right, it must build a PDMO with the right people, pay, and protection from political interference. Otherwise, we’re setting up another shell institution—big on paper, but hollow in practice.

This was first published in The Sunday Morning. The article reflects the author’s personal analysis, views and opinions.

Overview of the public sector

As of 2023, the Ministry of Finance reported that about 1.3 million individuals were employed in the public sector, including state-owned enterprises and the armed forces. During mid-2022 to 2024 the government essentially implemented a hiring freeze as part of its expenditure rationalization measures. Public sector services are structured into four hierarchical tiers, each with distinct roles and responsibilities. The (i) primary tier, comprising unskilled, semi-skilled, and skilled labor, accounts for approximately 32% of the total workforce. The (ii) secondary tier, which includes non-technical staff, makes up the largest share at 60%. In 2020, within this group, 244,000 were teachers, while 81,000 were health workers. The (iii) tertiary tier consists of professional staff, representing about 3% of the workforce, while the (iv)senior tier, composed of managerial and administrative personnel, makes up just 5% of public sector employment.

Distribution of Public Service Cadre (Approved cadre excluding Tri Forces and SOEs)

Source : MOF Annual Report - 2023

In the South Asian region, India and Pakistan have the largest public sectors, with government employment accounting for approximately 60% of formal jobs, according to a World Bank report.[1] In contrast, Nepal and Bangladesh have the smallest public sectors, comprising less than 5% of total employment. Sri Lanka falls between these two extremes, with its public sector representing about 15% of formal employment.[2] Comparatively, in Western countries, the public sector accounts for approximately 14.5%[3] of the total workforce in the United States and 18.1%[4] in the United Kingdom.

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Public sector has a higher share of female employees

Sri Lanka’s employed population[5] stands at 8 million, with 59% working in either the public or private sector.[6] The private sector accounts for 44% of total employment, with a gender composition of 69% males and 31% females. In contrast, the public sector employs 15% of the workforce, with a more balanced gender distribution of 52% males and 48% females. Female participation among professionals in the public sector stands at 61.5%, with many women working as teachers, nurses, and doctors. This also reinforces the fact that the secondary service level in Sri Lanka is predominantly composed of female employees, underscoring the gendered nature of tiers within the public sector.

Sri Lanka's female labour force participation rate remains low at 32%, a figure that has been stagnated for the past decade. The low rate reflects a limited number of women entering the workforce, with those who do often opting for public sector jobs rather than private sector employment. Notably, the proportion of women in the public sector is 16 percentage points higher than in the private sector, a trend that is driven by factors such as job security, different working hour aspects in roles such as nursing and teaching, and the provision of pension benefits, all of which can make public sector employment more appealing.

Downsizing the public sector

Public sector downsizing has become a key topic of discussion, particularly as the country entered an IMF program aimed at addressing the economic crisis. As of 2022, salaries and pensions for public sector employees amounted to 77% of government revenue. This significant fiscal burden has prompted the government to explore various measures to reduce public expenditure.

One such measure, introduced in mid-2022, involved a substantial reduction in new public sector recruitment. At the same time, Sri Lanka’s aging population has contributed to a decline in the number of active public sector employees, while simultaneously increasing pension-related expenses. Furthermore, professional skill migration exacerbates the existing problem.

1. Suspension of new recruitments

Public sector employment in 2023 saw a 2.9% decline compared to 2022, largely due to the suspension of new recruitments, the downsizing of cadre positions, and retirements. An interesting aspect of this shift is that while the approved cadre (the total number of positions allocated) remains higher than the actual number of employees, this reveals ongoing structural inefficiencies within the public sector workforce. As of 2023, the gap between the actual and approved cadre in Sri Lanka’s public sector stood at 395,000 positions. This means that while the government had approved about 1.75 million positions for public sector employment, only about 1.35 million were filled.

Public Sector Approved & Actual Cadre (Including SOEs & Armed Forces) in millions

Source : MOF Annual Report - 2023

The suspension of new recruits serves as a direct method of curbing the growth of the public sector, while highlighting the need for more effective management of existing resources. Historical trends show that 2023 saw the largest gap between the approved and actual workforce in the public sector. This raises an important question: What does this mean for sectors already facing labor shortages, such as education and healthcare, which is also the largest contributor to the public sector? These essential services rely heavily on a skilled workforce, and a further reduction in staff could worsen existing challenges, leading to decreased service quality, longer waiting times, and lower teacher-to-student ratios, ultimately affecting both the effectiveness and accessibility of these services.

2. Aging Population

Sri Lanka is currently in the final stages of its demographic dividend, which began in 1992 and is expected to end by 2037.[7] This demographic transition is causing a shift in the country’s population structure, with the population pyramid becoming more top-heavy as society ages. As a result, the current working-age population will gradually age, and without sufficient birth rates, there will not be enough young people to replenish the workforce in its current form.

The proportion of individuals aged 60 and above is projected to rise significantly, from 10.2% in 2001 to 29.2% in 2051.[8] This highlights the growing challenge of an aging population, with the number of individuals over 60 steadily increasing. The fiscal implications of this demographic shift are already becoming evident, putting pressure on the economy and public services.

Public & Semi government sector employees by Age group, 2016

Source : Census of Public & Semi government sector employees, 2016

Sri Lanka's employed age structure mirrors this trend, with a growing proportion of workers aged 45 and above. This is further evident by the increasing number of pensioners. As of 2023, Sri Lanka had 705,000 pensioners, representing a 25% increase from 2015. This rise in pensioners places additional pressure on government expenditure, emphasizing the need for sustainable pension reforms and effective fiscal planning to manage the long-term impact of an aging population.

The chart below illustrates the steady increase in the number of pensioners over time. With an estimated 35,000[9] public sector employees set to retire, the current budget has only allocated provisions for 17,000 vacancies. This means that more people are retiring than the number of new hires being made. Since public data on the breakdown of pensioners across different sectors is unavailable, it remains unclear how this will affect crucial sectors such as education and healthcare. This trend also poses a potential threat to public security, particularly if similar patterns emerge in critical sectors such as the police and the armed forces. For instance, in the police service, if the number of retirements consistently doubles the number of new recruits, the result over time would be a steadily shrinking police force. Should this trend continue for several years, it could significantly undermine the operational capacity and effectiveness of the police service.

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It is important to recognize that employment should not be based solely on political promises or the need to fill positions for the sake of it. Hiring should not be excessive but should focus on filling essential roles, particularly in sectors that are critical to the public's well-being. Therefore, cuts to the public sector or a freeze on recruitment should not be applied universally. Instead, these decisions should be based on a strategic approach that considers the specific needs of each sector, ensuring that vital positions are filled without unnecessary expansion.

Source : MOF Annual Report 2023
Note: While this number shows the majority of the public sector pensioners, not all in the public cadre get pensions. For example, SOEs and Central Bank of Sri Lanka doesn’t get pension from the pension department. This means that the actual number of pensioner are much higher than what is being reported here.

3. Professional Level migration

In 2022 the government decided to issue a circular granting a five-year no pay leave for public officers to pursue opportunities for employment abroad or within Sri Lanka. This resulted in emigration of highly skilled professionals, including doctors, engineers, and other technical specialists, which can cause issues in specific public sector roles.

Impacts of the old age dependency through pensions

This rise in pensioners places additional pressure on government expenditure, emphasizing the need for sustainable pension reforms and effective fiscal planning to manage the long-term impact of an aging population.

Pension Expenditure vs No. of pensioners

Source : MOF Annual Report 2023

When comparing the number of pensioners in 2022 and 2023, it is evident that a 4% increase in pensioners has resulted in a 20% increase in pension expenditure. The rise in pension expenditure could be becasue of the pension payments for new retirees is significantly higher than those for existing pensioners due to higher base salaries and a higher cost of living allowance, contributing to expenditure rising faster. However, as MoF points out, this is also due to returning the mandatory retirement age for government employees to 60 years in 2023.

Pensions as a share of Govt Expenditure excluding interest

Source : MOF Annual Report 2023

This growing disparity between new and existing pensioners’ payments is a crucial factor that must be carefully considered in future pension expenditure planning. As of 2023, pensions accounted for 13% of government expenditure, excluding interest payments. The Treasury expects this proportion to decrease to around 10%-11% by 2026-27. However, achieving this target will likely require pension reforms and additional fiscal adjustments to ensure the sustainability of public finances.

Salaries & Pensions as a share of Government Revenue, %

Source : MOF Annual Reports

As the graph illustrates, public sector salaries & pensions on average as a percentage of total revenue stood around 45%, excluding the period of 2020-2022. However, the period from 2020 to 2022 saw a notable increase to over 75%, driven by the loss in revenue due to tax cuts and the increased hiring into the public sector.

In conclusion, Sri Lanka is at a critical juncture in its demographic transition, with an aging population that poses significant challenges for economic growth and fiscal sustainability. The country is witnessing a shift towards an ageing population, which is already evident in the rising dependency ratio and the increasing number of pensioners. The increase in pensioners and the growing fiscal burden of pension expenditures are key issues that demand immediate attention. With the government's current efforts to manage public sector employment and pension liabilities, the need for comprehensive reforms becomes even more urgent.

This includes decisions on public sector hiring and compensation. The government cannot hire required skilled employs if it does not pay competitively. But higher pay is hard to deliver across a large public sector, especially one that has a large share of unskilled or semi-skilled employees. The implementation and success of digitization would also weigh in heavily on the future of the public sector and it ability to deliver effective, efficient services with a smaller workforce.

Disclaimer: The views expressed are solely those of the author and do not represent the opinions of any organization the author is currently or previously affiliated with. The author assumes full responsibility for any errors or omissions.

[1] https://documents.worldbank.org/en/publication/documents-reports/documentdetail/099062623201039265

[2] Labour Force Survey 2023

[3] United States Public Sector Employment

Strategic Choices in Reforming Public Service Employment, 2001

ISBN : 978-1-349-42491-7

Jonathan Brock

[4]https://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/publicsectorpersonnel/datasets/publicsectoremploymentreferencetable

[5] During the reference period, persons who worked as paid employees, employers, own account workers or contributing family workers are said to be employed. This also includes persons with a job but not at work during the reference period

[6] LFS Annual Report 2023

[7] https://srilanka.unfpa.org/sites/default/files/pub-pdf/IPS-and-UNFPA-Report-May-2014.pdf

[8] https://srilanka.unfpa.org/sites/default/files/pub-pdf/IPS-and-UNFPA-Report-May-2014.pdf

[9] 2023 number +additional 5% (assumption based on historical trend of growth)

I was expecting the Treasury to make a few changes to the “Drafted Budget Estimates” that were published alongside the second reading. One major change was the provisional capital expenditure amount for 2024. While the Draft Budget Estimates indicated this amount to be Rs.1,525 billion, Budget Speech Annexure 1 indicated Public Investment for 2024 as Rs.817 billion (a Rs. 700bn difference!). The line item ‘Public Investment’ in Budget Speech Annexure usually refers to capital expenditure. Line item “Capital Expenditure” estimated for 2025 in the Budget Estimates and “Public Investment” in Budget Speech Annexure both have the number Rs.1,315 billion, indicating that it refers to the same. However, two documents contradict the numbers for 2024.

Figure 1 : Approved Budget Estimates 2025

Figure 2 : Budget Speech 2025 - Annexure 1

Although the discrepancy is huge (more than Rs.700 billion), such differences can be there between Draft Budget Estimates and Budget Speech Annexure as the speech is prepared later (Ideally such big differences should not exist). However, these discrepancies can be corrected in the “Approved Budget Estimates” as these documents are debated in detail during the committee stages. I seems like this discrepancy went unnoticed.

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This then raises the question, which is the correct number? The answer can be found in the Report on Financial Performance of the Government 2024 published by the Treasury which indicates that actual capital expenditure for 2024 was Rs.815 billion.

So if one looks at the Budget Estimates, it would imply that the capital expenditure of the government is expected to reduce by Rs.210 billion (to Rs.1,315 billion in 2025 from Rs.1,525 billion in 2024) whereas the reality is that it is expected to increase by approximately Rs.500 billion from Rs. 817bn in 2024. This increase is due to the recommencing of infrastructure projects such as Central Expressway, which were halted due to the sovereign default. The previous year's estimate for capex was high due to the expectation of finalizing debt restructuring sooner, thereby commencing these projects, and a Rs. 450 billion allocation for state-bank recapitalization measures. However, debt restructuring was finalized at the end of the year and foreign-funded projects did not recommence, resulting in the government spending less capital expenditure than estimated. And only Rs. 130 billion was utilized to support state banks, that too through a transfer under recurrent expenditure, rather than under capital expenditure.

These discrepancies have been frequent in different budget documents. While it has decreased over the last few years, this case shows that big discrepancies that could be rectified easily continue to exist. In fact, even in the 2024 budget documents these discrepancies were present for the 2022 and 2023 numbers.

Figure 4 : Approved Budget Estimates 2024

Figure 5 : Budget Speech Annexure 2024

As the extracts above show, there were significant discrepancies in the revised capital expenditure amount indicated in the Budget Speech and Approved Budget Estimates in 2024. The question is why were these discrepancies not fixed during the budget debates so that big discrepancies or incorrect numbers will not appear in the “Approved Budget Estimates”?

In fact this discrepancy was highlighted in the Report prepared by the Committee on Public Finance on Appropriation Bill for the Financial Year 2025. The said report highlights that discrepancies exist between draft estimates and budget speech numbers. The report was presented on 25 February and there was time to fix discrepancies in the committee stage. But Approved Budget Estimates suggest that discrepancies were not fixed.

Figure 6: COPF report extract on capital expenditure discrepancy

These discrepancies could often result in misleading information and confusion, particularly given that approved budget estimates are an official document that received parliament approval. In the eyes of a journalist or researcher, it is an official and a legal document. The budget process in Sri Lanka has gotten better over the last few years, and the hope is that these discrepancies will also be fixed in the future.

Disclaimer: The analysis and opinions expressed in this article are solely those of the author. Any errors and omissions are the authors sole responsibility.

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Notes of everyday political economy

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By Umesh Moramudali

The historical analysis showed that before 2020, the introduction of the Advanced Personal Income Tax (APIT), there were two separate personal income tax structures. One structure applied to salaried income earners in both the government and private sectors. This was known as the Employment Income Tax, commonly called Pay-As-You-Earn (PAYE). Under this system, taxes were deducted directly from employees' salaries by their employers before the income was paid to them. The other structure was the Individual Income Tax (IIT), which applied to self-employed individuals and other non-salaried earners. Unlike PAYE, where tax was automatically deducted, individuals under this system had to declare their earnings and calculate their tax liabilities voluntarily. The introduction of Advanced Personal Income TAX (APIT) in 2020 replaced these two systems with a more standardized approach to income taxation.

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Summary of the Political Economy of Personal Income Tax Changes for the Last 25 Years

In 2005, Sri Lanka underwent significant political and economic changes. This period followed the devastation of the tsunami and saw a political transition with Mahinda Rajapaksa serving as Prime Minister before being elected as President later that year. As part of the tax reforms introduced in 2005 to stimulate economic growth, tax slabs were widened, and the lowest tax rate was reduced from 10% to 5%. Under the revised tax structure, the first Rs. 25,000 of an individual’s monthly income was tax-free. The next Rs 25,000 was taxed at 5%, while subsequent income of Rs 16,667 was taxed progressively at rates of 10%, 15%, 20%, and 25%, with a maximum cap of 30%. Additionally, the PAYE system was introduced for public servants, with their income initially assumed to be half of their gross salary.

The next major change in Sri Lanka’s personal income tax system occurred in 2011, following the end of the 30-year civil war and the beginning of Mahinda Rajapaksa’s second term as President. At the time, the government prioritized rapid economic expansion despite the country’s high fiscal expenditure, particularly driven by expenses on defense. To support economic growth, the individual tax-free threshold was raised to Rs 41,667 monthly. Income beyond this threshold was taxed at progressive rates. Every additional Rs 41,667 was taxed at 4%, 8%, 12%, and 16%, while the next Rs 83,333 was taxed at 20%, with the maximum rate capped at 24%. Additionally, the government fully incorporated public sector salaries into the PAYE system, applying similar tax rates and brackets, with a monthly tax-free threshold of Rs 50,000. However, under the PAYE system, numerous exemptions were introduced for allowances. For example, monthly motor vehicle allowances of up to Rs 50,000 were exempt from PAYE. This indicates that, although the tax brackets were smaller compared to current rates, many allowances were not taxed. This tax structure remained in effect until 2018.

In 2015, the Yahapalanaya government, led by President Maithripala Sirisena in coalition with Prime Minister Ranil Wickremesinghe, came into power. By 2016, Sri Lanka was struggling with fiscal imbalances, particularly twin deficits, leading the government to enter an International Monetary Fund (IMF) program. As part of revenue consolidation efforts, a new tax structure was introduced on April 1, 2018. The individual income tax was slightly altered, with tax brackets raised from Rs.41,667 to Rs.50,000 per month while maintaining the same tax rates and tax-free threshold as the previous IIT structure. However, the PAYE structure was overhauled. The tax-free threshold was raised to Rs. 100,000, and every subsequent Rs 50,000 was taxed progressively at rates of 4%, 8%, 12%, 16%, 20%, and capped at 24%. While the changes appeared to increase the brackets and tax-free threshold, the 2018 IRD Act amendment included all allowances under the PAYE tax system, with no exemptions. This led to a significant increase in overall income tax revenue.

In 2019, a new government led by President Gotabaya Rajapaksa was elected. As part of an election promise, the administration significantly reduced personal income taxes in its first cabinet meeting. The monthly tax-free threshold was raised from Rs 100,000 to Rs 250,000, and subsequent income was taxed at just two rates: 6% on the next Rs 250,000 and 12% thereafter, with a cap at 18%. Additionally, the government introduced the Advanced Personal Income Tax (APIT), which merged the Individual Income Tax and PAYE systems. While the APIT system made tax collection more efficient and simpler, the broadened tax brackets and increased tax-free threshold contributed to poor fiscal performance. This, in turn, played a role in the country’s worst economic crisis.

However, by 2023, Sri Lanka had defaulted on its debt due to weak fiscal management. The economic crisis and mass protests (Aragalaya) led to Gotabaya Rajapaksa’s resignation, and Ranil Wickremesinghe was sworn in as President. To restore fiscal discipline under the country’s new IMF program, the government introduced a revised personal income tax structure. The monthly tax-free threshold was set at LKR 100,000, with subsequent income taxed progressively at 6%, 12%, 18%, 24%, 30% and a maximum rate of 36%. The accompanying graph illustrates that this system effectively imposed higher taxes on high-income earners.

In 2025, following Anura Kumara Dissanayake’s election as President, another tax reform was implemented, fulfilling a key campaign promise. The new structure increased the monthly tax-free threshold to Rs 150,000. The next Rs 83,333 was taxed at 6%, while every additional Rs 41,667 was taxed at 18%,20%,24%, and 30%, with the maximum rate capped at 36%.

Tax Payables as a % of Monthly Income

While these changes affected only one component of tax revenue, their spillover effects were substantial. Among the five different tax regimes introduced over the years, the 2023 tax structure stands out as the most progressive as it places a greater tax burden on high-income earners compared to previous systems. The chart above clearly illustrates the vast difference between these four tax policy changes that happened over 8 years (2018-2025). These shifts in tax burdens suggest that certain tax policy changes were strategically designed to target specific income groups, providing insight into the political and economic motivations behind these reforms.

The chart below illustrates the tax-free income threshold as a percentage of the nominal GDP per capita (in LKR terms) over time. This ratio offers valuable insight into the relationship between the income individuals are allowed to earn before being taxed and the overall economic output per person within the country. Notably, the tax policy changes introduced in 2020 led to a significant spike in this ratio, reaching a historic high of 420%. Such a high ratio typically indicates that a large portion of the population is exempt from paying personal income taxes. The most recent tax changes have brought the ratio back down to around 121%, aligning closely with the levels seen during the historic period of 2012-2013. The fluctuation of this ratio over time highlights the government’s changing approach to taxation

Annual Tax-free threshold (PAYE) as % of GDP per capita

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Looking at the overall tax structure, income tax plays a crucial role, contributing approximately 30% of the total tax revenue, as illustrated in the chart below. Frequent policy changes in income taxation not only impact individual taxpayers but also have broader fiscal implications, influencing government revenue stability and economic planning.

Income Tax as % of total tax revenue

The chart illustrates PAYE’s contribution to income tax revenue: By 2024, it accounted for approximately 19% of total tax revenue. This highlights the critical role PAYE plays in the overall tax system. Therefore, it is essential to establish and maintain a sustainable income tax policy rather than frequently altering tax structures based on electoral promises. A stable and well-planned tax framework ensures predictability for both taxpayers and administrators, ultimately strengthening revenue collection and economic stability.

PAYE generated revenue as a % of Income Tax revenue

Looking at the big picture, PAYE is one of the easiest forms of income tax for a government to collect. This is because it primarily targets the formal sector, where individuals' income and employment details are well-documented. However, while governments tend to focus on taxing the formal sector, they must also consider how to extend taxation to the informal sector to create a more equitable tax system.

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A key challenge in Sri Lanka’s tax system has been the frequent changes in tax policy: six different tax regimes in the last 20 years. These constant shifts create significant difficulties for tax administration. Since 2018/19, the government has attempted to improve tax collection efficiency by digitalizing the system through RAMIS (Revenue Administration Management Information System). However, frequent policy changes require continuous updates to this system, adding administrative burdens. Moreover, individuals who were once within the tax bracket may fall outside it under new regimes, complicating efforts to expand the tax base. Instead of focusing on broadening the tax net, tax administrators are often preoccupied with adapting to the latest policy shifts.

Another issue is the narrow scope of PAYE taxation. Since it primarily applies to the formal sector, mainly salaried professionals in the urban middle class, there is growing frustration among these taxpayers who feel they bear an unfair share of the tax burden while individuals in the informal sector remain largely untaxed. While this concern is partially valid, it should be addressed through comprehensive income tax reform rather than frequent, short-term policy changes. A well-structured reform should aim to expand the tax base, ensuring a fairer distribution of the tax burden across all economic sectors. Additionally, the formal sector, being highly unionized and politically influential, often lobbies for policies that serve its interests, further complicating efforts to implement sustainable tax reforms. This influence was evident in the 2019 and 2024 presidential and parliamentary elections, where the voting patterns of the salaried urban middle class played a crucial role in election outcomes. This has led to a concerning trend where politicians use personal income tax policies as a political tool to attract votes rather than as a mechanism for sustainable economic management.

Ultimately, a country’s tax policy should not be dictated by politicians or powerful lobbying groups. Instead, it should be designed by professionals and economic experts who can develop a long-term, strategic plan for national fiscal stability. Taxation should be a simple, sustainable, and transparent instrument for economic governance rather than a short-term political tool used to sway elections.

Disclaimer: The views expressed are solely those of the author and do not represent the opinions of any organization the author is currently or previously affiliated with. The author assumes full responsibility for any errors or omissions.

Given all this, there ought to be a good understanding of the foreign debt repayments that Sri Lanka’s public sector has to handle in the years ahead. But the public data that is readily available is not that forthcoming, requiring us to dig into some nooks to get a better picture. There are a few nooks I looking into in this article, CBSL Pre-determined FX net drains data, MoF documents, and right to information requests to the External Resources Department (ERD). Hopefully, CBSL or MoF will provide more clarity on this in their upcoming annual reports or in the upcoming Budget documents. But for now this is what I have at hand.

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Using & interpreting CBSL Pre-determined Net FX drains data

That’s a mouthful of words for the dataset and the nuances involved with using the data can be longer than that. This Pre-determined Net Drains data is found alongside the rest of the monthly reserves data release of the CBSL and is a requirement under the IMF data disclosure standards that Sri Lanka seems to be part of since around 2013 - which is as far back as this dataset goes. Sri Lanka only reports outflows data and not inflows data. The purpose of this data is to provide a picture of the FX outflows that might require use of the FX reserves. It is provided as outflows for the next 12 months, with a breakdown for next 1 month, 2nd to 3rd month, and next 9 months.

The pre-determined data is provided in three parts. The first covers FX flows pertaining to Foreign currency loans, securities, and deposits, which covers the conventional foreign debt including ISBs and IMF loans. The second covers FX flows pertaining to forward and futures in foreign currencies vis-a-vis the local currency (this is where swaps taken by CBSL are covered). The third covers other FX liabilities like repos. The first two are the significant ones. The third one is negligible, other than during Sept 2020 to Feb 2021 when $1bn in US Treasuries were repoed to the US Federal Reserve to obtain liquidity during the US Treasury market volatility.

Pre-determined Net FX drains pertaining to Foreign currency loans, securities, and deposits

Figure: Pre-determined FX Debt repayments for next 12 months at end of each month, $ million

As you can see from the chart, Sri Lanka faced substantial FX outflows through the 2014 to 2022 period, rising from just above $4bn in 2014 to almost $7bn in 2022. After the external debt default in April 2022, you can see the drop in FX debt repayment obligations. There was a second fall in FX debt repayments obligations in October 2023 when the Asian Clearing Union (ACU) debt was restructured away into a swap with the RBI. The chart also shows a clear rise in repayment obligations over the next 12 months in Dec 2024 with the completion of debt restructuring.

Figure: Pre-determined FX Debt Repayments in next 12 months in Principal & Interest, $ million

The FX reserves to FX debt repayments ratio can be a useful ratio to understand whether Sri Lanka’s reserves are adequate and was even used as a condition in the usability of the PBOC’s RMB 10 billion swap. When the ratio is above 1.0, it means that reserves are larger than the outflow obligations in the next 12 months - indicating space to handle those obligations through reserves. While for most of the time CBSL has managed to keep this ratio above 1.0, during the 2021-2022 period the ratio fell below that and even into negative territory underscoring the crisis faced by early 2022. At end-March 2022, pre-determined FX outflow obligations were $7.1bn against reserves of just $1.9bn (which included around $1.5bn in the then unusable PBOC swap). Since 2023, the reserves buildup has helped improve the reserves to FX repayments ratio significantly, but with the increased repayment obligations post debt restructuring the ratio declined a bit in Dec 2024.

Figure: Pre-determined FX Debt repayments to Gross Official Reserves, $ million & ratio

What’s not covered in the Pre-determined FX debt outflows?

However, the pre-determined outflows data does not cover all the potential FX debt outflows that Sri Lanka has to finance. It only covers the FX liability related outflows to be handled by the central government and CBSL, meaning that outflows related to the banking system, SOEs and private firms do not feature in it. While the central govt and CBSL accounts for over 90% of such outflows, it does not cover the totality.

Its not all about external debt repayments alone

In the past when Sri Lanka Development Bonds (SLDBs) were still around, the FX repayments pertaining to those also appeared to be included within the predetermined outflows, since it is an FX liability of the central government and if unable to source FX for their repayments from elsewhere the government might have purchase FX from the CBSL reserves for that. In the data for 2022 at end-2021, the size of the SLDB related outflows were probably as much as $1.5 billion of the $7 billion in outflows from conventional FX debt.

Another aspect covered within the data are payments related to the Asian Clearing Union (ACU), which allows netted repayments on trade with regional countries every 2 months. Every two months the CBSL has an FX repayment to handle which is included in the pre-determined data. Usually this is about $200-500 million, every 2 months (Jan, Mar, May, Jul, Sept, Nov). However, during 2022 the ACU debt was not repaid and instead accumulated up to $2bn, keeping the pre-determined FX outflows elevated until late-2023 despite the sovereign default reducing other repayments. As mentioned earlier, this was only removed after Oct 2023 when the ACU debt was restructured away into an RBI swap.

This has meant that the pre-determined outflows data relevant to principal and interest payments of loans and debt securities could not be taken to be entirely repayments related to external debt related to bilateral, multilateral and commercial debt. Some amounts of domestic FX debt and trade related payments were also covered within it.

Pre-determined FX Net Drains pertaining to Swap and others

These are covered separately as short and long positions relative to the domestic currency. Short positions relate to FX borrowed by CBSL and Long positions relate to FX lent to others. Long positions have been small and rarer, with $200-350mn during 2021-2023 being the most prominent. Short-positions have been there consistently, ranging from around $500mn to $3.5bn. The net short position as a result has varied over time, from peaks of around $3.5bn in mid-2015 and 2024.

Figure: Pre-determined Net Short Position of CBSL over next 12 months, $ million

The biggest driver of this net short position has been bilateral currency swaps obtained by CBSL, with the 2015-2016 and 2021-2024 having the largest such bilateral swaps. During 2015-2016 this was the large swaps from the Reserve Bank of India (RBI), then in Dec 2021 the decision to draw the People’s Bank of China swap into reserves, and the decision in Oct 2023 to restructure the ACU debt into a $2.6bn swap with RBI. However, beyond the bilateral swaps the net short position also includes FX swaps between CBSL and the domestic banks, as has been noted by IMF reports. The short position swaps allow CBSL to essentially borrow FX from local banks to boost FX reserves, without purchasing the FX in return for a permanent injection of rupees.

During the 2016-2019 IMF program, most of these swaps were wound down, reducing the net short position to less than $500mn in late-2019. Part of the external FX borrowings during this period went into this action which improved the quality of the FX reserves position. But that improvement was fully reversed in the next few years.

Only for short periods of time have CBSL FX reserves have been substantially higher than FX debt repayments and net short position since 2014, highlighting the challenges of reserves buildup.

Figure: CBSL FX Reserves vs. Pre-determined FX net drains (debt repayments & net short position), $ million

Of course, not all the net short position is repaid in full each month. Bilateral currency swaps have particular maturity periods and repayment schedules (though those might be adjusted under bilateral agreements between central banks). For instance, the $400mn RBI swaps are usually available for about 3 to 9 months, though the one given in Jan 2022 was only being repaid from Nov 2023 onwards until Sept 2026 (alongside the $2.2bn in ACU debt). In comparison, most of the rest of the swap (largely from domestic banks) are assumed to be capable of being rolled over unless settled by CBSL.

Exceptional case since crisis

Since late 2023, both SLDB and ACU related payments have not been covered since SLDBs were fully restructured away and ACU dues were restructured into an RBI swap. Therefore, since late-2023 the pre-determined outflow data essentially covers ongoing repayments to multilateral creditors - mostly by the central govt but also on the past IMF loans taken by CBSL.

The latest data available from pre-determined FX debt outflows for 2025

The Nov 2024 FX debt outflows data (that is excluding net short position), showed $1.36bn in repayments during Dec 2024 to Nov 2025, which indicates about $1.2bn in repayments during Jan-Nov 2025. The Dec 2024 data showed a significantly higher value of $2bn for Jan to Dec 2025. This ~$800mn increase can be attributed to the impact of the ISB restructuring finalized in Dec 2024. After the ~$500mn in repayments in Dec 2024, there are about $720mn in repayments due in 2025 on the ISBs alone.

An interesting thing I notice in the data is that the bi-annual ISB repayments now seem to be due in June and December, rather than in March and September as earlier expected, given the increase in repayments post ISB restructuring has happened in the Apr-Dec period in the data than in March. This makes sense given the new ISBs were issued in late-Dec and six months from that is June.

Technically, the $2bn in FX debt repayments should include interest payments on the $1.1bn in USD bonds issued to domestic banks that took the local option in the ISB restructuring. But the coupon rate in 2025 for these bonds is only 1%, which means only $11 million in repayments on these bonds. In addition, it’s likely that there is about $30-50 million in repayments to the domestic banks on their Past Due Interest (PDI) bonds. Therefore, close to 10% of repayments on the ISBs in 2025 might be going to the domestic banks, rather than flowing directly to foreign ISB holders.

However, the $2bn in FX debt repayments shown in the data is not all the FX repayments that the Treasury and CBSL have to handle in 2025. A big known factor outside of this $2bn is the $900 million in annual repayments on the $2.6bn RBI swap being repaid as $75 million monthly repayments from Nov 2023 to Sept 2026. This is part of the net short position outflows, since its related to a swap.

Figure: Pre-determined FX debt repayments over next 12 months in Nov & Dec 2024 pre-determined data, $ million

Using MoF documents & RTIs to verify debt repayments

External debt repayment forecasts of the government obtained from the External Resources Department (ERD) in June 2024 (via RTI) showed about $1.1bn in debt repayments to multilaterals in 2025. Beyond this there is likely $250-300 million in repayments to be made by CBSL to the IMF on the loan taken during the 2016-2019 IMF program, which is not covered in the ERD data.

After completing the external debt restructuring in Dec 2024, Secretary to Treasury Mahinda Siriwardana stated in a speech in January 2025 that the repayments on restructured debt in 2025 is likely to be about $1 billion. This $1 billion would cover the restructured ISBs (about $720mn), other commercial and bilateral debt (remaining ~$300mn). The chart from the Secretary's speech shows the repayments due on the current stock of external debt, so it would rise with future external borrowings.

So, for 2025 the combined data from these sources gives a repayment number of just above $3 billion. This includes ~$1bn on the bilateral and commercial debt, ~$1.1bn on the multilateral debt repaid by the Treasury, ~$250-300mn in IMF loan repaid by CBSL, and $900mn in RBI swap repayments by CBSL. That gives a $3.2-3.3 billion in external repayments for 2025.

Figure: Rough estimate of external repayments in 2025, $ billion

Going into 2026-2027, the repayments on the RBI swap would reduce to $650mn in 2026 and zero in 2027, while multilateral repayments by the Treasury are likely to rise to $1.3bn or so by 2027. So, the external repayments are likely to be lower in 2026-2027 then in 2025, before of course rising significantly from 2028 onwards as ISB repayments rise.

Beyond all this what we don’t know of course is how much external debt repayments the SOEs have to make. Some of their external debt to foreign creditors, including Chinese ones, were restructured. The other is we don’t know the exact debt repayment obligations of the private sector and banks. However, these combined are unlikely to be more than 20-30% of the government and CBSL’s external FX repayments.

The analysis and opinions herein are my own, based on the overall macro work I do. The data of course is based on the latest available public and RTI data I have at hand. Others may have more up to date and more in detail data than this. I hope that the CBSL or MoF releases better future FX repayments data, without the market having to depend on guesstimates like this. I hope this article also serves as a guide to anyone trying to better use the CBSL’s pre-determined FX net drains data.

Sustained current account surpluses lead to subsequent changes in the external liabilities and assets of the country. The surplus has to be ‘financed’ - that is used in paying down liabilities and/or accumulating assets. The headline development here has been the increase in foreign assets held by the Central Bank. But there is also an increase in the foreign assets accumulated by the domestic banking system. Inherently, a surplus country is going to end up financing deficit countries. This was anecdotally shown very clearly in a recent news item.

Sri Lankan lending to India!

Sampath Bank, one of the largest domestic privately owned banks in Sri Lanka, announced that it had essentially lent money to the State Bank of India (SBI) - one of the largest state-owned banks in India. Sampath Bank participated in the issuance, contributing around $25mn (as reported by EconomyNext) of the $ 750 million senior unsecured syndicated term loan facility for the State Bank of India (SBI), facilitated by Mashreq Bank. SBI was initially hoping to issue $350mn in this issue, but widespread interest prompted upsizing to $750mn by the time it was completed at end-July (as reported by Indi’a Business Times). Syndicated loans are where a group of different banks come together to lend to a borrower, reducing the individual banks exposure.

SBI was among the Indian financial institutions that supported emergency financing to Sri Lanka during the 2022 economic crisis, providing a $1bn import credit facility of which about half was used by Sri Lanka. Sri Lanka was accumulating foreign liabilities at the time to finance the external debt repayments and current account deficit it was still experiencing. One could also argue that the availability of financing facilitated the current account deficit at the height of the economic crisis at a point where most other forms of financing was unavailable.

Now with Sri Lanka running a current account surplus for the past 2 years, paying down liabilities (including to India) and accumulating assets, a Sri Lankan bank is helping finance the Indian current account deficit through lending to one of India’s largest banks. Life comes full circle!

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There is a limit to how much liabilities can be paid down

Over the past two years we have seen the Sri Lankan banking sector paying down a big part of its external borrowings. But as the current account surplus continued, there were more FX balances left in the banks than could be used for paying down external debt. This meant an increase in the foreign assets held by the banking system, in addition to the foreign assets held as reserves by the Central Bank.

(Important note - when this article refers to foreign assets and liabilities, it only refers to those assets of and liabilities due to non-residents. That is those not resident in Sri Lanka whether they are individuals, firms or other institutions. Sri Lankan banks do have foreign currency assets and liabilities of and due to those resident in Sri Lanka as well. Those are not covered here since the article is only looking at foreign assets and liabilities as referred to in the IIP dataset.)

The International Investment Position (IIP) data shows that the foreign liabilities of the Sri Lankan banking sector has been falling consistently since 3Q-2021 from $7.4bn to ~$5bn in 1Q-2023. A reduction of about $2.5bn. However, there was a shift in the foreign liability make up even before 3Q-2021.

After 2020 the quantity of short-term foreign loans reduced from ~$4bn to just $275mn by 2Q-2024. Long-term foreign loans were also reduced from ~$1.5bn to $441mn. Overall, the banks’ foreign loan liabilities reduced by ~$3.8bn over the 3.5 years, with not much further space to use the surplus to pay down bank foreign loans.

Counteracting part of this, foreign currency & deposit liabilities increased from ~$1.1bn in 3Q-2022 to just over $4bn since late 2021. Part of this could be an increase in rupee deposits held by non-resident Sri Lankans in local banks during the economic crisis. Another factor could also be the attractiveness of FX deposit rates of Sri Lankan banks.

Figure: Foreign Liabilities of Sri Lankan Banking sector
(technically all depositing taking institutions, but non-banks have little foreign assets & liabilities)

The foreign asset accumulation to keep up with the surplus

Initially in 2023 most of the foreign assets were in the form of deposits accumulated in foreign banks. But from late-2023 onwards there was an increase in allocation to other forms of foreign assets including investments in foreign debt securities and loans. The decision by Sampath Bank to invest in SBI’s syndicated loan issuance is part of that.

The IIP data shows that Sri Lankan banks saw jumps in their foreign assets during mid-2021, across 2022 and in 3Q-2023. Overall, the total foreign assets doubled between 1Q-2021 and 3Q-2023 - around a ~$2.5bn increase (similar to the reduction in foreign liabilities). About $1.5bn of this was in the form of currency and deposits. The rest is classified as other accounts receivable in the IIP data, which might also imply being invested in some form of deposit or short-term instrument. The CBSL’s 2024 Financial Stability Review does note that by 2Q-2024 banks held about $3.7bn as balances or deposits with financial institutions abroad.

While these other accounts receivable amounts have remained constant during 1H-2024, $332mn of the currency and deposits have been converted into investments in foreign debt securities. There were no loans held as assets by end of 2Q-2024, but the Sampath Bank investment in the SBI syndicated loan completed in July might show up as one in the next IIP update for 3Q-2024.

It is however important to keep in mind that the accumulation of foreign assets might not be among all Sri Lankan banks. The CBSL’s 2024 Financial Stability Review does note that DSIBs (the 4 largest domestic banks) and foreign banks hold most of the balances with foreign banks.

Also a driver behind the big jump in foreign assets of the banks in 3Q-2023 was the restructuring of Sri Lanka Development Bonds (SLDBs). These were domestic law dollar bonds that were held largely by the domestic banks as a domestic FX asset. With the restructuring they were converted into rupee bonds, reducing the FX assets held by the banks. The accumulation of foreign assets was likely needed to balance with the banks’ FX liabilities and meet FX net open position requirements.

Figure: Foreign Assets of Sri Lankan Banking sector
(technically all depositing taking institutions, but non-banks have little foreign assets & liabilities)

Net Foreign Assets of Banks show a slightly different picture?

In a separate dataset on monetary aggregates, CBSL reports the net foreign asset (NFA) position of the banking sector was a positive $1.3bn by June 2024. But the difference in the foreign assets and liabilities in the IIP data is only a positive ~$300mn net foreign asset position.

The total reserve assets figure reported by CBSL, which includes foreign reserve assets of CBSL and the banking sector, can be used to show that by June 2024 the banks’ foreign assets was ~$5.1bn. In line with the foreign assets shown in the IIP. Therefore, its likely that the foreign liabilities used in the NFA calculation is lower by ~$1bn than what’s shown in the IIP. Part of this could be the rupee deposits of non-residents and differences in how certain balances abroad might be reported in the two datasets.

Figure: NFA & Net IIP give two different pictures on net assets of banks but similar trend of improvement regardless

Anywhere else the current account surplus has seeped into?

The obvious place where this has happened is the CBSL’s foreign reserve assets, which increased in usable form from near zero in April 2022 to $4.5bn by Sept 2024.

Part of this was enabled by CBSL purchasing FX in the domestic FX market, with net purchases of about $3.7bn from July 2022 to June 2024. This accounts for about 70% of the $5.3bn in accumulated current account surplus (when excluding accrued interest arrears).

According to the IIP data, there has also been changes in the net foreign asset balance sheets of the other sectors (private sector and SOEs) beyond the govt, CBSL and banks. The Other sectors have also seen a paying down of foreign debt liabilities with regards to long-term loans and trade credit, amounting to a reduction of ~$2.1bn since mid-2022 and ~$3.3bn since mid-2021. The other sectors have also increased the amount of trade credit granted to foreigners (which is a foreign asset for the other sectors) by about ~$400mn and ~$700mn, respectively, since mid-2022 and mid-2021.

Does all this have an implication on Sri Lanka’s future current account balances?

Countries like Japan and Taiwan which have had long run current account surpluses are in a situation where their financial and corporate sectors have accumulated significant amounts of foreign assets over a long period of time. This has meant that these countries receive a significant amount of interest, dividend and other incomes from these investments. These are recorded in their current account, so even when they are export earnings are stagnant, these other foreign incomes can help keep their current account balances in larger surpluses or smaller deficits, than would be otherwise the case.

Of course, Sri Lanka is not in such a situation. Since mid-2022 the increase in foreign assets accumulated by the CBSL, banks and other sectors are only about $6bn. So, the foreign income from that is not going to be very significant for the country as a whole, though for individual banks or firms it can be significant in rupee terms. Current account data shows an increase in investment income driven primarily by foreign interest income of commercial banks’ and CBSL on their increased foreign assets. In reaching ~$100mn per quarter from late-2023 onwards, this is the largest such foreign investment income going back to 2012, and goes well in line with higher US interest rates since the foreign assets held are likely to be US Dollar denominated ones.

One way the current surpluses can matter to future balances is how the foreign assets accumulated so far are used in the coming years. Just like incurring foreign liabilities can be used to finance a current account deficit, selling down foreign assets can also be used to finance a deficit. Another way is whether the reduction in external indebtedness of the banks and firms in the current period, having paid down a lot of external liabilities, allows increased access to foreign borrowings in the future.

Disclaimer - All of this is my own analysis and opinions. None of this involves any investment recommendations or advice. Any errors and omissions are my own. It is likely that there are issues/errors in the data, even though I have pre-dominantly used official data sources.

What’s the amount restructured?

At end-June 2024, the Debt Bulletin notes that $4187mn was outstanding to China EXIM Bank (ChEXIM), including $5.5mn in unpaid principal. A footnote to the relevant table notes that 39 loans were restructured with effect from 01 January 2024. This likely implies that ChEXIM applied the restructuring taking into account arrears accrued up until end-2023. Thereby ChEXIM also completed the restructuring within the 2-year debt moratorium it granted to Sri Lanka for 2022-2023.

In the March 2024 Debt Bulletin, ChEXIM was owed $3993Mn, including $903.8Mn in unpaid principal. Therefore, its clear that the unpaid principal has been capitalized and added back on to the restructured loans, with no principal haircut as expected. The increase in the outstanding amount to $4187mn by the June Bulletin likely implies that about $200mn in accrued unpaid interest arrears was also capitalized on to the principal amount.

Entries corresponding to ~$200mn in total are visible in the Sri Lankan Ministry of Finance external disbursements report for Jan-Jul 2024. There are 39 individual entries for 39 different loans labeled as refinanced with effect from 01 Jan 2024. Therefore, we can I think confirm with some confidence that about $200mn in accrued interest arrears has been capitalized on to these 39 restructured loans.

Do we know the maturity structure of the new restructured loans?

The June 2024 debt bulletin also provides the maturity structure of the external debt at present, which clearly shows the restructured ChEXIM loans falling within the 16-20 year maturity bucket (the green bar). The other debt that is still pending restructuring is in the blue bars and the multilateral and Indian emergency loans not being restructured are in the brown bars.

To understand how much of a maturity extension the ChEXIM loans might have gone through we have to take a look at the same maturity chart in the March 2024 Debt Bulletin. Its clear from the difference between the two charts that most of the ChEXIM loans would have moved from the 6-10 year and 11-15 year maturity buckets, with a bit from the 1-5 year bucket as well. Therefore, most of the 39 loans would have seen a 10-14 year maturity extension.

Overall, this maturity extension of the ChEXIM loans to 16-20 years means it falls right within the 2040-2044 period, with the government having earlier said bilateral lenders have agreed to extend maturities up to around 2042.

In the coming months we will also see other bilateral lenders completing these administrative procedures for finalizing the bilateral restructuring on lines similar to what ChEXIM has done.

But this is not the end of Chinese debt restructuring for Sri Lanka!

As highlighted multiple times, there is still no information on the progress for restructuring the China Development Bank (CDB) loans to Sri Lanka. There is likely about $3bn in CDB loans which are considered commercial debt and would likely be restructured in a manner comparable to the NPV loss taken on the ISB restructuring. However, the ongoing delays on finalizing the ISB restructuring, might be delaying the CDB progress as well. Or vice versa. Who knows.

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If you are looking for more information on China-Sri Lanka dynamics have a read through the Sri Lanka-China Economic Brief that I compiled with Umesh Moramudali as part of our China work with Arutha.

https://arutharesearch.org/2024/05/19/sri-lanka-china-economic-brief-issue-i/

https://arutharesearch.org/2024/08/15/sri-lanka-china-economic-brief-issue-ii/

Figure: Depreciation against USD, % change at end-June 2024

What’s Sri Lanka been doing?

Exchange rate & Interest rates are simply outcomes of the broader macro stabilization achieved. Of course, that stabilization has come at the cost of growth, increased poverty, and lowered/stagnating standards of living for most of the population. Real GDP growth only began to move towards positive territory from 2H-2023 onwards. Yet, real GDP levels remain well below pre-crisis and would take till 2027 to get back to above 2018 peak if growth averages 3% from 2024 onwards.

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Figure: Real GDP growth picking up since 2H-2023

Figure: Real GDP level remains below pre-crisis

Understanding what is behind the LKR appreciation

The obvious and straightforward answer is that Sri Lanka has been recording quarterly current account surpluses since 3Q-2022 and will likely continue to do so in 2024 as well. No time in the past has Sri Lanka managed to record such consecutive current account surpluses. But even those surpluses are simply an outcome of other factors at play - the sovereign default and the tight fiscal and monetary policies since April 2022.

Impact of the sovereign default

Pre-default, the central government external debt repayment schedule had Sri Lanka committed to a daunting task with $4.5-5bn in annual repayments. And that’s before accounting for FX debt obtained domestically by the government and foreign liabilities of CBSL. Getting through 2022 without default would have involved handling over $7bn in FX repayments by the government and CBSL. The 12th April 2022 decision to suspend most external debt repayments of the government led to the reduction of those repayments.

Figure: Central Government External Debt Repayments actual forecast at end-2021 (pre-default), $ billion

The IMF program’s debt targets involved reducing external debt repayments of the government during 2022-2027 and that’s part of what has been achieved with the debt restructuring deals. Even with repayments likely to restart from late-2024, the repayments are going to be much less than pre-crisis forecasts (at least until 2028/2029).

Figure: Central Government External Debt Repayments actual up to 2023 & estimates for 2024-2025 (based on recent debt agreements)

There has been total current account surplus of $2.5bn since 3Q-2022. But this includes the interest Sri Lanka has not been paying on its external debt since April 2022. This is because the accrued interest arrears is offset by incurring a new external liability on the financial account. As a result, when the accrued interest arrears accounting entry is excluded, the current account surplus is $4.5bn for these past seven quarters.

Figure: Quarterly Current Account Surpluses - with & without Accrued Interest Arrears, $ million

Most of this current account surplus has been purchased into CBSL’s FX reserves or improved the net foreign assets of the banking sector, increasing Sri Lanka’s international reserves position significantly. CBSL’s Usable FX reserves (excl the PBOC swap) increased by around $4bn from Aug 2022 to June 2024, driven by $4bn in net FX purchases from the domestic banks and government retaining a significant portion of the multilateral disbursements in its CBSL accounts. This is even as CBSL likely paid about $1.4bn in external liabilities and govt made over $3bn in external repayments to multilaterals and India during the same period.

Figure: Foreign debt disbursements to Public sector, $ million

Loan disbursements by multilateral lenders amounted to around $3.5bn since April 2022, helping to finance the external debt repayments (to the multilaterals and India mostly) handled by the government and CBSL since then. The crisis has significantly increased dependence on multilateral financing (IMF, ADB, WB, AIIB, and others) which have been the largest source of foreign financing - especially outside of India’s 2022 emergency financing. As above chart shows (in yellow), foreigners did return to invest in rupee govt securities in 2023 (mostly in 1H 2023), but since then have been gradual net outflows.

Figure: CBSL & Banking sector international reserves, $ million

Low imports as driver of current account surplus

The recovery in tourism and remittance earnings back towards pre-crisis levels is the good news that has been helping towards a current account surplus. As I have noted earlier, growth in port services is also helping. The bad news that’s been contributing to it is monthly non-fuel imports remaining at 10-yr lows (excl 2020 pandemic impact), despite some recovery since the height of the crisis.

Figure: Non-Fuel imports at 10-yr lows

This is seen across most major import categories, each reflecting the suppressed demand conditions across varied economic activities/sectors. The recovery since the post-default low saw consumer and investment goods recovering to current monthly import levels by 2H 2023. But non-fuel intermediate goods have continued to grow since mid-2023.

Figure: Non-Fuel imports by category, 100=Avg monthly imports (in USD) in 2017

This containment in imports is driven by the massive domestic adjustment since the start of the debt crisis period in mid-2021. Loss in real incomes due to high inflation, reduction in disposable income due to rapid rise in income taxes, and credit contraction have severely depleted domestic purchasing capacity relative to pre-crisis. Combined with the lower govt debt repayments, these lower domestic demand means that there is less demand for the USD relative to its improved supply from tourism and remittance recovery. Therefore, it is important to see the external surpluses and LKR appreciation, and reserve accumulation, as partly outcomes of the domestic adjustments. In Part 2 of this, I will be exploring these domestic factors in some detail.

As usual, this is my own analysis and opinions. I focus on providing a look back, in line with my interests in economic history. Frontier Research, where I work, provides clients with more detailed ongoing updates on how the external surplus matters, how it’s linked to domestic adjustment factors. If you are interested in subscribing to Frontier’s reports and outlooks click here.

The monthly data does increase the categories of services sector data reported, allowing for a better understanding. Unfortunately the new monthly data does not improve on the existing monthly tourism earnings data, which continues to be estimate based on a survey done at the airport. As my colleagues at Frontier Research pointed out in a recent report, using other proxies, the actual tourist earnings can be around 20% below the estimated figure. Given the tourism recovery is obvious, I will be focusing more on the other service exports in this article. (Note that in the data travel refers to direct tourism related transactions.)

The new monthly data

Currently we only have monthly data for Jan 2023 and Jan 2024. On the tourism/travel side the data shows about $15mn/month in travel related outflows. Excluding travel, services exports appear to be about $250mn/month. But Jan 2024 seems to have more service imports, reducing net exports when tourism is excluded.

Within the services exports excluding tourism, the sectors of sea transport (related to port services), air transport (related to airport & air travel services) and Telecom/IT services (including BPO) are the three largest export sectors accounting for 75-80% of exports. Of the other smaller sectors, construction and other business services are the largest, both of which have increased in size since the 2021-2022 crisis.

Table: Services sector data breakdown for Jan 2023 & Jan 2024, $ million

There are also sectors in this data that were not covered in the quarterly BOP data previously, especially manufacturing services, so the two datasets are not directly comparable. But for those sectors that are covered in both, it is possible to get an idea of the avg monthly trend in recent years.

In terms of FX earnings outside of merchandise exports, on a monthly basis services exports (excl tourism) remain small. And the growth in both services exports excl tourism and merchandise exports has been stagnant. As a result, Sri Lanka remains highly dependent on tourism and remittances growth to boost FX earnings in the near term.

Figure: Major types of Monthly FX earnings, $ million

Services exports over time

The quarterly BOP data from the past can be used to see what average monthly services exports were like each quarter till 3Q-2023. Overall, it shows that during 2018-2019, monthly services exports (excl tourism) were about $300-350mn. But this dropped to around $150mn during the pandemic and economic crisis (2020-2022), particularly due to lower earnings from air transport related services as air travel dropped and lower shipping as well. Increased Telecom/IT services helped somewhat. From 2023 the exports have recovered to around $200-250mn per month.

Note that it is possible that with the introduction of the new data collection and categories, some of the older categories have been restructured, with the older quarterly data not directly comparable. But the analysis here is to get an idea of the changes and growth overtime, rather than provide exact numbers.

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Figure: Avg monthly Services (excl tourism) exports, $ million

But the picture with regards to net service exports (exl tourism) is a bit different, due to the imports attached to services sectors. Net exports were only around $100mn a month prior to the crises, dropped to ~$50mn during the pandemic and then recovered to over $100mn since 2021.

Figure: Avg monthly Services (excl tourism) net exports, $ million

The imports related to these services sectors (exl tourism) have reduced significantly over this period, reducing from around $200-250mn per month pre-crisis. Even now its only recovered to around $100-150mn.

Figure: Avg monthly Services (excl tourism) imports, $ million

Changes in the makeup of Net Service Exports

An interesting tidbit within the ‘Other’ service exports category above is the increase in exports related to construction services and other business services, albeit at small numbers. Meanwhile exports of financial services and insurance & pension related services have reduced.

Figure: ‘Other’ smaller services export sectors, $ million

The increase in construction related service exports is interesting since it’s been one of the most affected sectors due to the crisis. Anecdotally, there have been indications the sector has been looking to get foreign projects. It’s managed to become a non-insignificant net exporter in the process, driven mostly by “Architectural, engineering & other technical services” going by the monthly figures for Jan 2024.

Figure: ‘Other’ smaller services net exports, $ million

But there has also been an expansion in net imports from the Other Business services sector. Given the breakdowns given for January, it might be an impact of some firms moving certain operations to places like Singapore and Dubai during 2022-2023.

Table: Breakdown of Construction & Other business services for Jan 2023 & Jan 2024, $ million

Services exports critical to external balance

Net services exports (excl tourism) plays a significant role in the current account surplus that Sri Lanka has been maintaining since 3Q-2022.

Figure: Current account surpluses & Net Service Exports, $ million

Tourism and remittances are of course much larger in their contribution to the overall external balances, but expanding other services exports allows diversification and reduce the impact of shocks concentrated in the tourism and remittance earnings.

The analysis is based on data that is currently available and would likely change as its updated and revised by CBSL. This is my analysis and opinions, but forms part of my macro work at Frontier Research.

A significant $1.2bn current account surplus in 9 months

A major overperformance is on the current account surplus. The Dec 2023 IMF report assumption is for a $1232mn surplus for the whole of 2023. But in the Jan-Sept period alone, Sri Lanka recorded a $1231mn surplus. With remittances continuing to be high, tourism recovering into the winter tourism season, and imports still contained, the current account surplus is likely to expand in the last quarter, making it higher than projected by the IMF staff in December.

Figure: Current account balance projection by IMF staff, % of GDP

Current account balance includes the interest payments on defaulted external debt that are accrued as arrears. The accrued interest in arrears amounted to $709mn in 2022 and $866mn in Jan-Sept 2023. This amount is simply an accounting entry. Sri Lanka does not pay the interest, its simply entered as an outflow in the current account and balanced off by entering it as an inflow in the financial account. This means that the current account surplus in the Jan-Sept 2023 period excluding the accrued interest would be about $2.1bn.

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Figure: Current account balance components Jan-Sept 2023, $ billion

A significant part of the current account surplus, as opposed to the $1.2bn deficit projected for 2023 by the IMF in March 2023, has been the contained imports. With private sector credit growth recovery being sluggish, real incomes depleted by inflation and disposable income reduced by higher taxes, consumption and investment remains weak. Monthly non-fuel imports have remained at levels last seen in 2010/2011, indicating this weakness.

Figure: 3-month rolling average monthly imports, $ million

Reserves jump in December

According to the CBSL, its forex reserves increased to $4.4bn by end-2023, a rise of about $2.5bn during the year, and a rise of $829mn in December alone. This clearly puts Sri Lanka’s reserves above the 3-months of merchandise imports coverage ratio and was in line with the $2.5bn increase expected by the IMF in its March 2023 staff report. But significantly higher than the $1.9bn increase assumed in the latest Dec 2023 update.

Figure: CBSL Forex reserves increase projection by IMF staff, $ billion

The large reserve increase in Dec was driven by the disbursement of funds by multilateral agencies following the IMF 1st review, with over $800mn in disbursements from IMF, ADB & World Bank.

Figure: CBSL Forex Reserves, $ million

Significant external asset accumulation by banks as well

In the Jan-Sept period, Sri Lanka also obtained $1772mn in net inflows (accounting for principal repayments) by incurring external liabilities - loans, FDIs, portfolio inflows. Of this $866mn was the accrued interest in arrears, leaving $906mn in actual net inflows. Combined with the current account surplus exl the accrued interest, Sri Lanka thereby had about $3bn in inflows, that was balanced by acquiring $3bn in net external assets - $1678mn by the CBSL’s forex reserve accumulation and the rest by the banks and private sector.

The banks’ external asset accumulation actually played a significant role in why Sri Lanka struggled to build up reserves further during the July to November 2023 period, stagnating around the $3.5-3.6bn range. With the restructuring of foreign currency govt debt, including SLDBs and dollar loans, domestic banks had to narrow their FX net open positions (difference between their FX assets and liabilities). These needs heightened in 3Q-2023 when the govt’s dollar SLDBs were restructured into rupee T-bonds in Aug 2023.

Using the International Investment Position (IIP) data its possible to see that the financial sector increased external assets by about $1.2bn in Jan-Sept 2023, with about $850mn happening in 3Q alone.

Figure: Quarterly Change in External Assets of Financial Sector, $ million

Multilateral inflows play a critical role in external balances

According to the External Resources Department of the MoF, the government received $1.59bn in loan disbursements from external creditors during Jan-Nov 2023. Of this $1.39bn are from the IMF, World Bank and ADB, with about $50mn from other smaller multilateral lenders (OPEC Fund, Intl Fund for Agri Dev, and AIIB) and the remaining $165mn from a few bilateral linked lenders (EXIM India, State Bank of India, Govt of France, Co-op Centrale Raiffeisen Netherlands, Saudi Fund). With around $900mn in multilateral inflows coming in December, overall loan disbursements are likely about $2.5bn in 2023.

Figure: Estimated Disbursements & Repayments on Multilateral & Indian debt for 2023, $ billion

The IMF’s Dec assumptions were for $682mn in IMF and $1220mn in other multilaterals’ budget support financing, a total of $1.9bn. So, the rest of the external financing from multilateral and bilaterals are for project financing. But overall external disbursements in 2023 of around $2.5bn would be significant lower than expected at the start of the IMF program (about $3.7bn) in March, partly due to the delays in progress on external debt restructuring as noted in the IMF’s Dec 1st review.

While the commercial debt and most of the bilateral debt is in default with no repayments happening, the multilateral debt and Indian emergency credit lines continue to be repaid. With the increased reliance on new multilateral debt, repayments on multilateral debt, including to IMF, has been rising to about $1.15bn in 2023. So, a substantial portion (40-50%) of the multilateral disbursements flow out for meet debt repayments to them. The ERD also expects repayments on the Indian credit lines to be about $560mn in 2023, indicating a total repayments of $1.7bn in the year (closer to $2bn when CBSLs swap repayments are factored in as well).

The IMF expects bilateral and multilateral loan disbursements to be about $2.7bn in 2024, dominated by multilaterals once again. But repayments in 2024 by the government can be estimated to be around $1.8bn (depending on final debt restructuring arrangement) and a further $1.1bn by the CBSL, largely on account of the restructured Indian swap I discussed last month. The disbursements finance the repayments due.

But the question is whether the Presidential election in October 2024 would cause delays in finalizing the 3rd IMF review currently scheduled to be in October 2024 as well. If the review does get delayed on account of the election and any potential changes in policy post election, then multilateral disbursements due alongside the review might not get disbursed. Continuing to maintain a current account surplus in 2024 (contrary to IMF projections) would provide an external buffer to Sri Lanka for such a risk, similar to how it did with external loan disbursements being lower than expected in 2023.

Note: The data used in this article are based on data available as of early Jan 2024. This includes Jan-Sept 2023 BOP data, ERD data via RTI as of end-Oct, ERD disbursements data as of end-Nov, and latest CBSL reserves estimate for end-2023. Actual numbers for overall 2023 via BOP data will take till early April to be released and there can be changes with data updates and revisions in the coming months.

Background to the two liabilities

Earlier in the year I highlighted that Indian emergency financing facilities to Sri Lanka in 2022 amounted to about $4bn, of which about $3.3bn was utilized in 2022. The biggest portion of this financing came through $2bn in Asian Clearing Union (ACU) trade liabilities. A further $400mn swap was provided by the Reserve Bank of India (RBI). At the point of being provided in early 2022, it was unclear what the duration of these facilities were and at what point Sri Lanka had to repay them. Given Sri Lanka’s sovereign default and low forex reserves until mid-2023, their repayments were continuously pushed back. And coming into late-2023 there was no clarity on whether Sri Lanka will have to repay substantial portions of these two liabilities (ACU & RBI swap) in 2023 and 2024. The external debt repayments Sri Lanka would have to facilitate in these years changes drastically depending on the assumptions taken for them.

The ACU allows for clearing of net liabilities every 2-month through the 6-member Central Bank. Typically, this facility provides about $200-500mn in net trade credit liabilities to Sri Lanka for 2-month periods, largely used for trade with India, reducing the use of foreign currency. In 2022, Sri Lanka was allowed to run upto $2bn in trade credit and not repay every 2-months. While the ACU does allow for short-term swap facilities to help members extend repayment period of outstanding credit in emergencies, what Sri Lanka was provided was extraordinary.

The $400mn RBI swap was provided in January 2022 as the standard 6-month SAARC-facility that Sri Lanka has regularly accessed. But was later extended in tenure continuously. While the 2021 $200mn swap from Bangladesh was repaid fully by Sept 2023, the RBI swap has remained outstanding.

Figure: Outstanding ACU & SAARC swap, $ billion

Both of these are liabilities of CBSL and repayment would have to be from its forex reserves. Current usable gross reserves of about $2.2bn (excluding the unusable RMB 10bn PBOC swap) are too low for repayment. Having the two liabilities without a set repayment schedule would have continued uncertainty and created tension with other external creditors. It’s also impossible for the IMF to create a projection for Sri Lanka’s balance of payments and forex reserves situation without credible assumptions on the repayments to RBI on ACU and the swap.

“There are significant expected net drains on gross reserves over the program period, with the largest being repayments on restructured debt, and payments on central bank credit lines including US$2.6 billion for the ACU repayments and the RBI SAARC swap.”
IMF in First Review of EFF program - December 2023

Hence the creation of a $2.6bn mega swap

The IMF report clearly states that there is a penalty interest cost attached to the ACU liability on account of the late repayment. Ofcourse, Sri Lankas has not been repaying to ACU from January 2022 onwards. As a result it seems about $200mn in penalty interest has been added, increasing the liability from ~$2bn to $2.2bn.

“The CBSL and the Reserve Bank of India (RBI) agreed to settle arrears on the Asian Clearing Union (ACU) balances by turning these liabilities and associated penalty interest (due to late payments) into a special swap (US$2.2 billion) and combining it with the RBI South Asian Association for Regional Cooperation (SAARC) swap (US$400 million). These liabilities (US$2.6 billion) will be paid during 2023-26.”
IMF in First Review of EFF program - December 2023

I also noted this increase ACU liability in the CBSL’s end-Sept 2023 balance sheet released at end-Oct. This indicated an agreement with RBI was likely reached on this de facto restructuring in Sept-Oct 2023. There was also significant changes to the pre-determined net drains data at end-Sept of a magnitude that indicated changes were being made to the ACU. In the pre-determined net drains data for the next 12-months (which covers central govt & CBSL forex payments), the ACU was recorded under the financial liabilities related outflows until end-Aug 2023. But by end-Sept, this category had net reduced by $2bn (the size of the ACU) and the liabilities related to swaps had net increased by about $500mn, indicating an increase in swap liabilities.

Figure: Pre-determined net FX drains for next 12-months, $ billion

The IMF’s external financing projections figures can be interpreted to provide a rough repayment schedule for this $2.6bn swap during 2023-2026. Under the “Other central bank liabilities, net”, there are net repayments of $900mn in 2024, $900mn in 2025 and $555mn in 2026 for a total for $2.355bn (reflected in Table 4a. Sri Lanka: Balance of Payments, 2019-28 (Restructuring Scenario) as well). Assuming these relate fully only to the new $2.6bn swap, then it implies a $245mn repayment in December 2023 as well.

This implied repayment schedule for the new $2.6bn swap in the December 2023 IMF report actually reduces the repayments assumed on the ACU & SAARC swap in the IMF program projections back in March 2023. That assumed repayments to ACU of $736mn in 2023 & $997mn in 2024 and $400mn RBI swap repayment in 2024. Therefore, the de facto restructuring of these two liabilities into the new swap has reduced 2023 repayments by around $500mn and 2024 repayments by $500mn, by extending the repayment period upto 2026.

Figure: ACU & SAARC swap repayment assumption implied from IMF reports,
$ billion

Significance of this de facto restructuring

Of course neither the ACU liabilities nor the SAARC swap fall within the official external debt restructuring parameters. But their repayment has a bearing on the availability of forex to service the external debt that is to be restructured, the ability to accumulate forex reserves, and implicitly the availability of forex to finance import recovery as the economy recovers.

Trade credit and bilateral swaps are usually handled on a bilateral basis during crisis periods, with no transparency on the terms under which they are modified. Questions to the CBSL from the media about the ACU repayment schedule had been met with the standard response of it being a bilateral matter between the two central banks.

The details in the IMF report indicates that the new $2.6bn swap will also be provided a guarantee from Sri Lanka’s Treasury, making it a contingent liability of the Sri Lankan government and not just a direct liability of CBSL. This is revealed because the government had to get the IMF to increase the ceiling on Treasury Guarantees to accommodate this. It also reveals that the new swap will be repaid in monthly installments, which helps explain the pre-determined net drains data from Sept-2023 onwards.

“an increase in the IT [indicative target] on the limits on treasury guarantees from Rs. 1,700 billion to Rs. 2,100 billion to account for the guarantee of the Special Swap Agreement of about US$2.6 billion between the CBSL and the Reserve Bank of India to restructure the outstanding liabilities under the Asian Clearing Union (ACU) agreement (including past due interest) and Bilateral SAARC Swap Agreement, which will be repaid through monthly installments over the next 3 years”
IMF in First Review of EFF program - December 2023

Through the repayment extension to 2026, the RBI has contributed implicitly to a limited extent to debt relief in the near term and increased the CBSL’s space to maneuver in terms of foreign currency and reserves in 2024. Especially to meet the IMF expectation of raising gross reserves from $3.6bn at end-Nov to $3.8bn at end-2023 and further to $5.3bn at end-2024.

Another important matter is whether the restructuring of the ACU liabilities into a swap with the RBI means that the ACU facility once again becomes available to Sri Lanka as a means to handle import financing from the regional countries.

However, it also important to note that the repayments on the $2.6bn swap are not the only ones due to India during the 2023-2026 period. Repayments on the $1.5bn credit lines extended in 2022 were not halted or restructured. So they are ongoing, with about $560mn in repayments in 2023 alone, mostly on the $500mn oil credit line from EXIM Bank of India (based on data from External Resources Department via RTIs).

This is my analysis and reflects my opinions. The underlying work was done with and the Frontier Research team as part of the firm’s macro-intelligence and macro-analysis work.

The IMF’s debt sustainability analysis (DSA) for Sri Lanka has a whole bunch of questions. Theo Maret and Brad Setser had explored this in an excellent piece recently as well. A specific point within this was on the IMF’s Gross Financing Needs (GFN) indicator - an indicator I share some (relatively) strong thoughts on. In this piece, I’m going over GFN and issues with a focus on it, and in a follow-up piece I’ll use Sri Lanka’s example to illustrate additional complexities.

What is GFN?

I won’t go into the origins of GFN as an indicator (though I think there is merit in exploring whether corporate quarterly cashflow projections are a relevant methodology for long-term sovereign financing requirements). Instead, let’s look at what it is, and how there are plenty of issues with it.

Gross Financing Needs effectively refers to all the financing requirements a sovereign has within a given time period. This includes fiscal deficits (including interest payments due) as well as debt amortizations. One way to think of this is how much money is needed to be raised to meet the payments due in a particular year. GFN is often given as a % of GDP, and the IMF used to have a 15% of GDP benchmark for GFN, though this is now more context-specific. In any case, what GFN is quite straightforward. However, projecting this can create significant issues.

Tenors matter for GFN - when will the new cashflows come due?

A key issue with GFN projections is that it requires projecting what future cashflow needs would be. For deficits, this is somewhat straightforward, if you can project revenue and expenses, you can get a good enough idea (excluding interest for now). However, when you take debt that is due, a key issue is how you refinance it and at what tenor.

To illustrate this, let’s take an example where a country (let’s call it GFNland) has USD 100 of debt maturing in 2023, revenue and non-interest expenditure balances off (primary balance), and has a GDP of USD 1000. Let’s project that the primary balance remains in balance and GDP grows at 2% annually.

When looking at the GFN for GFNland in the future, you now have to decide what to do with the USD 100 maturing in 2023. 

Let’s take 2 examples to show the divergent GFN that can exist. 

• In Option A, the USD 100 is refinanced as a 5% interest 12-month T-bill that is refinanced similarly every year. 

• In Option B, the USD 100 is refinanced through a 5% coupon 5-year T-bond that is refinanced similarly when it’s due. 

The following graph shows the GFN as a % of GDP for the 2 options.

Just this single assumption makes two widely different GFNs. If you take Option A, the country maintains GFN that is slowly rising across the 10-year period we’re looking at. This is a completely different message from Option B, where GFN is low in between, and spikes in the years that the principal is due, but at the end of the 10 years is actually LOWER than starting out.

Reinvestments of reinvestments - how are those accounted for?

But what about the reinvestment of the coupon? Doesn’t that cause the GFN to rise too? Good question! But the complexity still exists. 

Let’s take 2 more options - 

• In Option C, the coupon is reinvested in a 5% interest 12-month T-bill 

• In Option D, the coupon is reinvested in a 5% coupon 12-month T-bill and rolled over, but every 5 years, that T-bill is reinvested into a 5-year bond.

  

Once again, these two options give two significantly different GFNs. in one, the GFN falls from 2028 to 2032, while in the other it’s an increase. All of these have changed so much based on the reinvestment and tenor assumptions, and this matters.

Inflation and interest rates can have large impacts on GFN

Beyond this, there are other factors that matter significantly. In my view, the two most important are what we assume future interest rates are and what we assume future inflation is. Interest rates matter because they directly affect the reinvestments and what rate the reinvestments happen at. Inflation matters because GFN as a % of GDP is against nominal GDP - so rising inflation affects the denominator.

To illustrate this, let’s take 4 scenarios for just the 12-month T-bill option.

• In Option E, the interest rates are at 7%

• In Option F, the interest rates are at 9%

• In Option G, the interest rates are at 7%, but there is 2% higher inflation per year

• In Option H, the interest rates are at 9%, but there is 4% higher inflation for 3 years, before returning to 2% inflation

  

Since we’re using only the 12-month T-bill, it’s not as divergent as if we used different instruments, but as you can see, there are still significant divergences among the trajectories. If you add varied instruments, tenors, and reinvestments into the mix, these differences become compounded with the interest rate/inflation issues.

So why use GFN at all if it’s so inaccurate?

In reality, things are even more complex since different instruments have different rates and different reinvestment needs. The simple answer is this - getting an accurate indicator of GFN is not realistic. Whatever you choose to do involves taking many assumptions upon assumptions upon assumptions, and the likelihood of getting all of this right is so low it’s almost impossible.

My view is that it shouldn’t be used as a priority indicator. GFN projections still have their uses in seeing where payments can bunch up, and how changes in different factors like inflation, rates, and tenor management can affect government financing needs. However, these aren’t accurate indications and should be treated as such. These are only useful indications, not correct ones.

Trying to get precision into GFN targets can lead to inaccurate understandings of the future. A great example of this is Sri Lanka itself - what Sri Lanka’s ACTUAL GFN looked like in the past compared to the IMF’s past 15% benchmark. GFN ALWAYS did worse than the benchmark, and a big reason was due to the fact that reinvestments of reinvestments can’t be accurately included within this indicator.

Using GFN as a priority indicator can create issues - such as for Sri Lanka where the GFN target is a key part of the country’s DSA. Thankfully, the restructuring of the domestic bonds likely had a marginal impact on the actual long-term value of the bonds, but in a context where the impact HADN’T been marginal, it would have been done for an inaccurate and likely impossible to be an accurate indicator.

Of course, countries like Sri Lanka that have little ability to change the global sovereign debt architecture on their own (though precedents from Sri Lanka obviously matter) can’t unilaterally challenge and refuse to accept the IMF, and would likely have to go along anyway. But could there be better approaches from the IMF in the future? I think so. To me, GFN is at best a weird indicator that is useful to fiddle around with to see different scenarios, and at worst a complicated overly metricized mess. It shouldn’t be the basis of what determines a country’s future in my view.

I will end this piece with a short quote from Theo and Brad’s piece on this that excellently encapsulates their advice to the IMF on this, and follow up later with more specific issues with GFN from a Sri Lankan context including how the CBSL T-bills reprofile, the 0.5% of GDP reduction from T-bonds, and local inflation and interest rates affect the DSA through the impacts on GFN.

“Complex models should not trump common sense”

- Theo Maret and Brad Setser

(My thanks to Anjali Hewapathage and Navinda Meepe of Frontier Research for their work and support on some of the data and analysis on this. While this piece is not done by Frontier Research and reflect my own personal thinking (Frontier doesn’t engage in policy recommendations or civic education, and focuses on macroadvisory), some of the data and initial analysis comes from internal work done with Anjali and Navinda across the last few months)

There has been a lot of conversation about Sri Lanka’s DDO, and the supposed impact on the EPF (as well as other superannuation funds). I’ve personally found most of this conversation lacking in analysis and when analysis has been present, to be woefully lacking in the technical reality of how markets work. In this piece, I’m aiming to set out an analytical basis for the impact of the DDO on the EPF - taking an approach that prioritizes getting an accurate magnitude of the impact over precise figures that lack accuracy.

The EPF is a long-term fund - it doesn’t compound every year

The EPF, being a superannuation fund, is a long term fund. This gives 2 very important points when discussing the impact of the DDO. 

First, the market value of instruments only really matters at point of purchase. This means losses in the “market value” of the bonds make absolutely no difference to the EPF since it holds its bond to maturity. At the end of the maturity term of the bond, the full face value of the bond is paid back in full regardless of how much the bond price has fallen or risen during the period the bond was held by the EPF. Talking about the “market loss” or “NPV loss” of the EPF, thereby, has no real practical point to it in my view. 

However, there is one point at which the market price DOES matter, and that is the point of purchase. If the EPF bought bonds at discount (as it almost definitely did after rates rose in 2022), then there is an additional “capital gain” on the bonds since the EPF gets paid back the full principal of the bond despite having invested less than the principal. Went over this here - https://twitter.com/ChayuDamsinghe/status/1700084753318216156.

Second, the EPF being a long term fund means its investments mature over a long period of time - the pre-DDO bonds had maturities up to 2045 for example. This means, we can’t assume that the full value of the EPF can be compounded each year, because the EPF’s assets don't mature each year (like a 1-year FD or 12-month T-bill). 

However, we can take a “coupons reinvested” approach and argue compounding, but as those who’d be involved in markets would know, in reality this doesn’t give an accurate answer. Actual returns and “coupons reinvested” returns are very different, primarily since you can’t necessarily assume that coupons CAN be reinvested at a constant rate. In order to calculate returns of a long-term fund, a more accurate approach is to use a cash-flow analysis, and then secondly add reinvestment of that cash flow. However, if we ASSUME that future interest rates ARE similar to current, then the coupon reinvestment approach can give a reasonably accurate answer - and this seems to be what the CBSL has done in their calculations to get a 4% difference. But as we all well know, in Sri Lanka interest rates hardly remain similar from one year to the next.

What does a cash-flow analysis show for the EPF?

While we don’t have up to date info on the coupon rate per year of the EPF’s current bond portfolio, we do have information on the maturity structure of the bonds’ principal face value as at end-2022. Using this data, and the coupon rate we DO have for the government’s overall bond stock, we can come up with an estimate for the EPF’s current interest rate cash flows. Incidentally, this approach also gives us that the average coupon of the EPF’s bonds were likely around 11-11.5% by end-2022, in line with public statements on the same.

Taking this approach, we can come up with the following cash-flow projection for the EPF’s current bond stock.

We can then look at what the cash-flow of the DDO would imply. To sum up what the DDO does for the EPF’s bond stock, the face value of the bonds are exchanged for new bonds. These new bonds give a coupon of 12% for 3 years and 9% for the years after that. The new bonds also mature at a different schedule than the previous bonds as well.

Comparing these 2 cash flows show that the pre-DDO and post-DDO cash flows are such that the EPF’s cashflow would have been higher in a pre-DDO scenario until 2028, after which the post-DDO cashflow is higher until 2038 at which the post-DDO cashflow ends.

If we take a cumulative look at these, what this means is that in the pre-DDO scenario, the EPF would have had a higher “bond stock” until around 2028 and that after 2029, the post-DDO scenario actually results in a higher bond stock (the term “bond stock” here is a bit of a misnomer, actually it’s the cumulative cashflows, but using bond stock for ease of understanding. The cumulative cashflows for post-DDO actually end at 2038, and I’m showing them as stable afterwards). The reason this happens, is that in the pre-DDO scenario, the principal is paid back quicker, which means that there’s less principal to take interest income on in the middle years. Conversely, since the DDO scenario doesn’t pay back the principal that soon, there is larger interest income in the middle years in the DDO scenario.

But what about the reinvestments?

The issue with this approach is that it doesn’t take into account reinvestments. In order to show this as well, what we can assume is that every principal that comes due and every interest payment that comes due from the current bond stock is reinvested in a 2046 bond (beyond the period we’re looking at so we don’t have to worry about the principal of THAT bond being reinvested). To simplify, let’s not reinvest the coupons from this reinvestment again (since that can be a bit of an infinite process - what about the reinvestments of the reinvestments of the reinvestments of the reinvestments etc?).

Taking this approach results in another question I tackled here -

https://twitter.com/ChayuDamsinghe/status/1676064993463390210.

What interest rate should we use for the reinvestment? This is actually a critical part, since if we assume a high interest rate for pre-DDO and a low-interest rate for post-DDO, obviously the situation will show a better performance for the high rate pre-DDO situation (even what the CBSL has taken seems to be the two coupon rates of the two scenarios, but like the CBSL itself says, maintaining the pre-DDO interest rate is a non-realistic scenario since it can’t be maintained without another round of restructuring in the future). 

But in order to show the varied options that ARE possible, and excluding the possibility of a future restructuring, let’s take 2 scenarios for both the pre and post DDO cash flows - a 9% low rate and a 15% high rate.

If we take this approach, we can show the reinvestment cashflows are higher for the pre-DDO approach compared to the post-DDO approach overall until 2035, at which point the size of the post-DDO reinvestment cashflows are larger.

If we add the without reinvestment cashflow onto this, and then accumulate these cashflows, the full effect of the DDO across scenarios can be seen. The two total accumulated cashflows go largely in line but begin to diverge clearly in around 2035, with the post-DDO cashflows growing larger by 2045. Once again, this is because there is more interest income that is reinvested earlier on in the post-DDO cashflow, because the principal is only paid back later.

What about the different interest rates though?

However, as it is clear, the 9% vs 15% coupon rates give different results. This is important, since in reality, the two interest rates that reinvestments would have happened in would have been different. If we compare a high rates cashflow vs a low rates cashflow alone, we can easily show the high rates is better.

However, the inflation impact would have been higher if rates are kept at 15%, or if rates are higher in real terms. This means that the economy would have kept high rates for longer. This means that in all likelihood, high rates at high inflation could actually mean a WORSE outcome for the EPF. This is also complicated by the fact that if rates would have stayed higher for longer, some of these cashflows might not have actually happened if the GOSL is pushed to do a larger DDO in the future. 

To account for all this, let's take the following assumption - let’s assume inflation is 6% for the 9% reinvestment and 8% for the 15% reinvestment - implying real rates of 3% and 7% respectively, and that the government doesn’t do a future DDO in either scenario. What does that do for the accumulated cashflow?

As is clear, the high rates scenarios, even if the real rate is higher (maintaining 7% real rates is extremely difficult - if rates are 15% long term, in reality inflation is probably in the double digits), results in bigger erosion of real value of the EPF bond stock. This happens because it’s not just the future cashflows that are inflated, but also the current stock. Being ahead of inflation results in the stock rising for a while, but at a point, the inflationary impacts of the whole stock dominate. Arguably, it makes more sense thereby for the long term, even if rates are “lower” now, for the EPF to have a lower inflation. That matters more than the interest rate.

What is the actual rate of return of the EPF?

Combining all of this, we can get a value for the “return” of the EPF. There are varied ways we can do this, but to make it very simple, let’s take the difference in the value of a given years’ value of the EPF and the purchase cost of the EPF bonds at end-2022, and then take what the growth rate between the two would be. A more precise method would be to take the return at each year compared to the purchase price at each year, but lets not be too complicated.

What this shows is that the return of the EPF is quite significant for the first few years, but gradually trends lower towards 9%. The two post-DDO returns are higher at the start since the returns on existing portfolio is at 12% while the reinvestment portfolio is still small, but then the 15% pre DDO return catches up once the size of the reinvestments are large enough. The actual return of the EPF would in fact, be higher than all these, since there is also additional contributions from the EPF members that come in as new investments that I haven’t factored in so far. In any case, below is the inflation adjusted return graph - here, the catching up of the pre DDO cashflow is slower since inflation eats away the existing portfolios faster. In all cases, the return trends towards 1-1.5%.

What does all this mean for the EPF?

Fundamentally, the point in putting out this analysis from my perspective is to show a more accurate approach to think about the EPF’s loss. This basis will give varied numbers and scenarios to look at, and one can select and compare the relevant pre vs post DDO numbers one wants. For example, if you compare a 15% pre DDO vs a 9% post DDO, you can show that there is a LKR 5 trillion difference between them by 2045. However, if you compare an inflation adjusted value of the same, you would see that the post DDO gives a better deal. However, if you change the inflation rate again, you can once again get a different deal. Similarly, if you choose a different point (say 2028 or 2035 or 2040) you can give different messages for different points in the future.

The point is that when talking about the DDO’s impact on the EPF, all of these have to be considered. You’re talking about many assumptions about the future, and sometimes assumptions upon assumptions. All of these assumptions can change at varied points in the future. This can make it easy to oversimplify and accidentally give an inaccurate message, or hide reality and intentionally give an inaccurate message. 

But what the most accurate message I can give is, in my opinion, taking a look at the wide range of options, it feels difficult to fairly argue that the EPF has lost out on a lot as a result of the DDO, and it’s not too tough to show that the EPF could even have gained a little as a result in inflation adjusted terms. Even if we put that aside, my best guess is that this has a very marginal impact on the EPF, and that the impact of things like inflation, how wages grow (and thereby how contributions grow), how much government debt is available for the EPF to invest in, etc matter far far more. 

I’ve also pointed out that it isn’t very accurate to say the EPF was singled out -

https://twitter.com/ChayuDamsinghe/status/1694892687273738663.

Different treatment for different creditors, including better/worse treatment for social security funds has happened in other countries. Similarly, many other countries have included social security funds. The bond restructuring is also not the only part of the DDO, and only accounts for about half of the full DDO - the CBSL’s T-bill holdings and the government’s dollar debt from the banking sector accounts for the rest.

However, a major issue I see is that of transparency and communication. Why is it that varied people, myself included, take it upon themselves to do analysis on this? Fundamentally, that speaks to a lack of information and also a lack of trust on the limited information that DOES exist. Given that the EPF is very much a sociopolitically sensitive matter, much more communication and information could have made the situation far easier to handle in my view. I recognise that there are market impacts on all these that limit how much current information can be provided by the authorities, but there could have been far more info released ahead of time and better communication overall to account for that in my view.

All this aside, there’s another benefit of this whole situation. People are finally talking about serious questions regarding the EPF. Whether the EPF should be under the CBSL, whether the EPF should invest in more diverse assets, whether the EPF should have an opt-out option, all of these are important questions I think need to be discussed. Actually implementing these might not be realistic right now, but the conversation around it can one day result in something or at least in more public scrutiny and better management in the meantime.

For now, I will take solace in this and the fact that it doesn’t seem to me that there’s an actual huge loss to the EPF (or even a clearly noticeable loss at all). Hopefully, this piece serves to clarify the varied matters on this, serves to improve the conversation on the matter, and gives a basis for people to analyse varied claims on their own as well.

In January 2022, Sri Lanka faced a precarious situation on its external financing. It had $3.1 billion in reserves at end-2021, including an unusable PBOC RMB swap of about $1.5 billion at the time - so effective usable reserves were just $1.6 billion. But CBSL estimated FX repayments obligations of the government and central bank at $6.9 billion for 2022,1 including a $500 million ISB maturing in January itself. In addition it would have to finance a significant current account deficit. With market access not available to raise new FX debt, Sri Lanka needed a lender of last resort that would come through faster than an IMF program.

On cue, India surprised everyone with the magnitude of emergency financing it provided Sri Lanka in the first few months of 2022. First, it provided a $400 million currency swap from the RBI and agreed to a deferment of Asian Clearing Union (ACU) trade liabilities in early January (by year end ACU outstanding increased to $2 billion!). Second, it indicated the provision of trade credit facilities - which would eventually be the $500 million fuel credit line from EXIM Bank of India and $1 billion multi-sector trade credit from State Bank of India. By the second half of the year, India added on the $55 million financing facility for urea fertilizer imports from the EXIM Bank.

All that adds up to close to $4 billion in financing facilities. Below is a breakdown of these facilities and how big they were compared to Sri Lanka’s overall external sector situation.

What’s ACU trade liabilities & how critical was it?

The Asian Clearing Union (ACU) “is a payment arrangement whereby the participants settle payments for intra-regional transactions among the participating central banks on a net multilateral basis.” It consists of the seven South Asian countries (excl. Afghanistan) plus Myanmar and Iran. While the transactions occur through the banking system, outstanding net amounts are liabilities of the central banks and cleared on a net basis every 2-months. In effect it allows the participating central banks to reduce the amount of dollar liquidity needed to settle trade between the member countries.2

As the largest economy in the region, India is the largest provider of ACU credit including in the case of Sri Lanka. India is usually the largest or second largest trading partner for Sri Lanka. In 2022, of the $1.74 billion in debit from ACU members, $1.62 billion was to India alone.

Figure 1: Cumulative transactions among ACU members in 2022, USD

While large amounts of transactions are routed through the ACU over the year, because outstanding amounts are repaid every 2 months the outstanding amounts due to ACU members at the end of each year in Sri Lanka’s case has usually been under $600 million during 2012-2021. So, allowing Sri Lanka to first delay repayment of the $523 million due to be repaid in early 2022 and then to increase its outstanding to ACU members to close to $2 billion by mid-2022 was a massive source of external financing at a time Sri Lanka’s usable reserves were near-zero and banks were finding it very difficult to process letters of credit for imports in the 1H 2022. In, essence Sri Lanka was able to defer payment on about $1.5 billion of imports from the region in 2022 and $523 million in imports for 2021, mostly from India.

Figure 2: ACU liabilities payable by Sri Lanka’s Central Bank at end year, USD million3

The importance of this ACU repayment delay is well highlighted when you see that Sri Lanka’s 2022 current account deficit was $1453 million, similar in size to the $1492 million in net increase in ACU outstanding.

The RBI $400 million swap - Reserves lifeline?

Under the Reserve Bank of India’s (RBI) SAARC currency swap arrangement, Sri Lanka has been able to access a $400 million swap facility regularly in recent years, usually for 6-month tenures. The RBI provided this $400 million facility to CBSL in January 2022, but its tenure has continued to be extended. While the then CBSL Governor Cabraal talked of getting larger swaps from Gulf countries in late-2021, the only ones he could access in reality were the PBOC and RBI swaps. Of which only the RBI one was readily usable without constraints.

The decision to keep making external debt repayments during Jan-Mar 2022 meant a significant reduction in the meagre usable reserves left. While $400 million seems quite small, in reality CBSL's usable reserves during much of 2022 was below $400 million, as highlighted in the figure below. In a way it allowed some room till the 12 April 2022 decision to suspend external debt repayments and it also meant that there was some liquid reserves left after April to continue repayments to multilateral lenders, including the IMF. If Sri Lanka was forced into being in arrears to the IMF as well, the process of getting an IMF program could have got delayed further.

Figure 3: Sri Lanka Forex Reserves monthly breakdown, $ million4

$1.555 billion in credit lines - Import lifeline?

With usable reserves reducing, the then government’s policy in late 2021 and early 2022 was to try to negotiate credit lines with major trade partners to ensure essential imports could keep coming into Sri Lanka. Overtures were made to India, Pakistan, China, Gulf oil producers and Australia for credit lines relevant to major imports from these countries.

But eventually only credit lines from India materialized. During 2019-2021 19% to 22% of Sri Lanka’s goods imports came from India5, with major imports including petroleum, iron & steel, fabrics, machinery, sugar, pharmaceuticals, vehicles and other essential food items and inputs into local production (including for exports).

The first of the credit lines made available was the $500 million oil import credit line via the EXIM Bank of India in Feb 2022. According to International Trade Centre (ITC) data, petroleum imports from India was about $605 million in 2021, so it made sense to have access to this credit line.

Sri Lanka’s domestic petroleum fuel sector is dominated by the state-owned Ceylon Petroleum Corporation (CPC) and the smaller presence of the Indian Oil Corporation (IOC). The loss-making and heavily indebted CPC was struggling to open Letters of Credit (LCs) to import oil on credit terms and already had large payments due on 2021 imports. CPC was forced to rely on spot payments for oil shipments coming into the country, but the banking system was struggling to source dollars for these payments and usable reserves of CBSL were also too low to support all oil imports. And the situation was so dire that the $500 million credit line was fully used up by June.

A second credit facility of $1 billion equivalent was provided by State Bank of India (SBI) in March 2022. This was for multiple types of imports and with the first oil credit line exhausted, in May $200 million from this was allocated for oil imports. But this too was exhausted by July. Overall during 2022, $300 million from this SBI credit line was used according to the Ministry of Finance preliminary data. In addition to these, the EXIM Bank also provided a $55 million credit line for urea fertilizer imports to support the Sri Lanka agricultural sector, of which $46 million seems to have been used in 2022.

Therefore, in total these Indian credit lines provided about $846 million in forex financing for imports. These formed a majority of the $875.5 million in loans provided to the Sri Lankan government by India in 2022. This sum accounted for about 38% of total foreign loans & grants disbursed to the government in 2022, a significant increase from India’s typical annual share of loan disbursements to Sri Lanka’s government.6

India’s Lender of Last Resort operation as a whole

Based on the MoF disbursements data and CBSL BOP data, my estimate for overall use of Indian Financing Facilities by Sri Lanka in 2022 is about $3.3 billion. I have included the $523 million in 2021 ACU liabilities repayments deferred since that saved forex reserves, but excluding that the total new financing accessed was about $2.8 billion.

Figure 5 shows that this financing was overwhelmingly used in the first half of 2022, exactly when Sri Lanka was running significant current account deficits and still servicing external debt repayments until 12 April.

Figure 5: Total use of Indian Financing Facilities in each quarter of 2022, $ million

If the new Indian financing (excluding the 2021 ACU liabilities deferred) used is considered as a share of goods imports by quarter, they were about 23% in 1Q and 27% in 2Q.

Figure 6: New Indian Financing Used as a share of Goods Imports by quarter, %

It is possible to see that without this emergency financing, imports could have contracted faster and made the economic contraction faster and deeper in the first half itself. In lieu of this critical role, it is not surprising the Indian credit line loans provided in 2022 have been exempted from debt restructuring according to the IMF staff report. And that means these need to be repaid in the next few years, with some already starting to be repaid.

Figure 7: Sri Lanka Real GDP growth, %

In the second half of 2022, as Indian Financing dried up the Sri Lankan economy was also making the necessary adjustments (depreciation, reducing imports, contracting credit with high interest rates and fiscal consolidation) and no longer making most of its external debt repayments. So, the financing needs reduced and the quarterly current account deficit turned into a small surplus. The use of only $300 million of the $1 billion SBI credit facility,7 available only after Mar 2022, is an indication of these painful adjustments taking effect.

Thanks to and for the conversations that lead to these articles and for their valuable comments. Hoping to cover Sri Lanka’s overall 2022 current account and balance of payments situation in the next one.

Having been stuck with official gross reserves of less than $2 billion for the last year, Sri Lanka has managed to increase it to $2.7 billion* by end-March 2023. In March the LKR also appreciated by about 11% against the USD, from around 360/$ to 320/$, on the official middle spot rate. While on the surface this appears to have happened due to the first trance of the IMF program (about $333 million) following Board level approval, there were lot more things happening in Sri Lanka that supported a relatively big jump in reserves.

*Of course, while the reported gross reserves is $2.7 billion, about $1.4 billion of it is the PBOC RMB 10 billion currency swap which remains unusable with reserves still below the 3-months of imports level that is apparently one of the conditions for its usability.

Figure: Gross Official Reserves, $ million

Imports contracted further in February

Given goods imports had already contracted sharply over the past year on the back of lower domestic demand, to average around $1.3-1.5 billion in recent months, it was interesting to see a drop to $1 billion in February, lowest since the height of the COVID-19 pandemic lockdown in mid-2020. It was clearly driven by a drop in intermediate imports which provide inputs to domestic activity.

Figure: Monthly Goods Imports by category, $ million

This appears to have been on the back of a contraction in fuel and textile related intermediate imports. The Energy Minister has been indicating they have built up sufficient stocks of petroleum stocks and there is supposed to be a slowdown in apparel export demand and a moderation of prices of inputs. The monthly PMI and exporters have been reporting a reduction in export orders. However, exports remained resilient in February just below $ 1 billion. As a result the monthly trade deficit dropped to a very narrow $39 million in February 2023, the lowest since a marginal trade surplus in June 2022.

Figure: Monthly Imports of Fuel & Textile Intermediate goods, $ million

Figure: Monthly Trade balance, $ million

Remittances & Tourism have continued to recover

As two of the largest forex inflow sources, their recovery in recent months have helped the local economy. Estimated monthly tourism earnings* have increased above $150 million, but remain low compared to pre-pandemic earnings. Remittances increased to over $500 million in March for the first time since early 2021, though this increase could be seasonal on regard of the local new year celebrations in April. Overall, March saw the highest combined remittance-tourism inflows since Dec 2020.

*Sri Lanka’s estimated tourism earnings data is not fully reliable and might be overestimated as highlighted by this brief by Verite Research.

Figure: Monthly Remittance & Tourism inflows, $ million

Combined with the contraction in imports in February, this has helped boost forex liquidity in the domestic financial system. Overall, Sri Lanka recorded small current account surpluses of $145 million & $120 million in the third and fourth quarters of 2022, respectively. And seems on the way to doing the same in first quarter of 2023.

Figure: Quarterly Current Account balance, $ million

A pick up in foreign holdings in rupee treasury bonds/bills

After a long hiatus, foreigners or non-residents appear to have increased their holdings of rupee denominated treasury bonds/bills. Between 16 February and 04 April, it increased 290% - LKR 48.4 billion or about $ 140 million. This too has added to forex liquidity.

Figure: Weekly Foreign Holdings in Rupee Treasury bonds/bills, LKR million

These factors had already helped CBSL to step up its net purchases of forex into reserves since December, reaching $253 million in February. But the big pick up appears to have occurred in March, for which data is not out yet.

Figure: Monthly Net Purchase of Forex by CBSL, $ million

LKR appreciated sharply in early March, even before the IMF program announcement

On 27 February, CBSL announced that it would be relaxing the exchange rate guidance band it had been maintaining since May 2022, which had kept the exchange rate stable just above 360/$ until then. Over the next week the band was relaxed further and on 03 March CBSL Governor announced it was being removed completely from the following week. Removal of a forex surrender rule on banks of 25% of forex inflows also supported this trend.

This coincided with the announcement on 01 March that the International Finance Corporation (IFC) of the World Bank Group would be extending a 1-year $400 million cross-currency swap to three Sri Lankan private banks. This surprise ‘new foreign financing facility’ ahead of the anticipated IMF program helped boost domestic sentiment and confidence within the financial system.

Figure: Average Daily Interbank Forex transactions volume by week, $ million

With the overall external sector developments discussed earlier contributing to a boost in forex liquidity, the guidance band relaxation and news of the IFC swap appeared to have helped increase activity in the domestic forex market in early March. With forex supply increasing amidst suppressed import demand, the official spot rate appreciated sharply in the first weeks of March from around 363/$ to 318/$ by 10 March, though some volatility has persisted as the market gets used to the lack of a guidance band. This appreciation was sustained by news of the IMF Board Approval being scheduled for 20 March, after the second Chinese financing assurance letter was confirmed on 07 March to be in line with IMF needs.

Figure: LKR-USD exchange rate - Official Spot Middle Rate

Further appreciation was contained by the CBSL stepping into aggressively purchase forex from the market into its reserves. Reportedly, it bought around $500 million in those first weeks of March which would be the largest in a single month in a long time. That means that in the first three months of 2023, CBSL has purchased around $900 million on a net basis, helping to raise reserves from around $1.9 billion at end-2022 to $2.7 billion at end-March.

The IMF tranche disbursement helped sustain this

With Board Approval confirmed on 20 March, the $333 million equivalent IMF first tranche was received. However, unlike in previous programs where the tranche went straight to the CBSL for reserves buildup, this time the tranche went to a Treasury account for use in budgetary financing. Given the need to quickly end the government’s dependence on CBSL monetary financing, the IMF has allowed the government to use the entire IMF financing for budgetary financing.

So, its unclear how much of this tranche ended up in the forex reserves of CBSL. The State Minister of Finance did mention that $121 million from the IMF tranche was utilized to repay an emergency credit line obtained from India in 2022*. Thus, the IMF tranche reduced the use of forex reserves for the limited debt repayments Sri Lanka continues to do.

*The IMF staff report confirmed that these Indian credit lines disbursed in 2022 would be exempted from debt restructuring and Sri Lanka is repaying this short-term credit line. Multilateral debt is also exempted from debt restructuring and continue to be serviced.

The IMF first tranche and the positive sentiment about the anticipated IMF Board Approval helped. But it wasn’t the only reason behind the almost $500 million boost to forex reserves in March. There was more going on in terms of Sri Lanka’s external sector and domestic forex liquidity that facilitated CBSL to purchase forex into its reserves in March. It is important to keep in mind that on the other side of these improvement in macro indicators is a contracting economy and suppressed consumption, with the most vulnerable groups the worst off.

What to expect from Macro Colombo in the weeks ahead?

I am hoping to dig deeper into the 2022 balance of payments data that was released recently, both in terms of the current account and the financial account, with a focus on the important role of Indian emergency financing.

Quite a few articles refer to a $50 billion odd number as Sri Lanka’s external debt burden. And that number is clearly different from the public external debt burden I described in the previous article, because the total external debt includes other foreign liabilities, especially those of the financial sector and private sector firms. And not all of this $50 billion plus debt falls under the sovereign default and debt restructuring.

CBSL releases the external debt data on a quarterly basis - the latest being up to end-Sept 2022 - based on the World Bank-IMF Quarterly External Debt Statistics reporting standards. This reporting follows the residency based definition to identify what is external (or foreign) debt - that is debt held by non-residents regardless of legal jurisdiction and currency denomination.

In case that last sentence does not make sense, give my previous article a read first:

Market value vs. Face value

The curious case about this quarterly CBSL dataset on total external debt is that market traded debt securities - like International Sovereign Bonds (ISBs) - are reported using their market value rather than their nominal face value (outstanding value of the debt that needs to be repaid). When the bonds were trading at market values close their face value, until 2019, this is not an issue. Since 2020 the market values dropped amidst concerns about default, so the total outstanding under market value became significantly lower than under face value. By Sept 2022, this deviation was a massive $8.1 billion! Therefore, it is vital to adjust the data manually to calculate face value outstanding, for which the data is provided in the CBSLs excel.

Figure 1: Market value vs. Face value of International Sovereign Bonds (ISBs) held by non-residents, US$ million

This adjustment applies for a few other instruments besides the government’s ISBs - rupee Treasury bonds/bills held by foreigners (listed under govt) and the Sri Lankan Airlines eurobond (listed under Other Sectors, which includes SOEs). As a result the total deviation between market and face value is about $8.1 billion (but $8.0 billion of the deviation comes from the foreign held ISBs alone).

Table 1: Market value vs. Face value of overall external debt, US$ billion

Therefore, the overall external debt burden is about $56 billion over the most recent quarters as shown by the face value figure above. Of this, a significant portion is listed under sectors outside the central government.

Table 2: Face value of external debt outside of central govt, US$ billion

What’s all that debt under the Central Bank?

In my previous article, there was only $3.2 billion in external debt listed under CBSL, but here there’s $6.4 billion. That’s because in addition to the IMF loans and bilateral currency swaps covered under public debt, CBSL also has two other additional liabilities - the IMF’s Special Drawing Rights (SDR) allocation and the Asian Clearing Union (ACU) trade liabilities.

• The SDR allocation of about $1.2 billion is provided proportionally to all IMF members - the most recent and largest allocation happened in Aug 2021 - and need not be repaid, its simply an accounting entry.

• The ACU liabilities are a regular feature that allows regional countries (South Asia, Iran & Myanmar) to save up on dollar reserves in settling trade payments on a netting out basis every 2 months. Usually ACU liabilities of CBSL are about $200-500 million. But since early 2022, the ACU members have been considerate enough to allow Sri Lanka to essentially borrow up to $2 billion in ACU trade liabilities - so we’ve imported from our neighbors (mostly India) without paying. As CBSL builds up its forex reserves, it will have to gradually pay it down.

Figure 2: CBSL’s external debt, US$ million

How is the rest of the financial sector borrowing abroad?

The quarterly data shows that the deposit taking institutions (banks & finance companies) have been reducing their short-term loans, to be replaced by a rise in currency and deposits from non-residents since mid-2021. This coincided with the worsening in Sri Lanka’s forex availability situation and market access.

A possibility is that non-residents have been building up rupee deposits in domestic banks as its been difficult to make outward payments. Some non-resident Sri Lankans also facilitate forex payments abroad in return for rupee deposits domestically. USD fixed deposit interest rates are also high at local banks (6% and above).

Figure 3: Deposit taking financial institutions’ external debt, US$ million

What about the rest of the sectors?

The template oddly reports private sector and SOE debt together under Other Sectors. But luckily there is some breakdown.

As at Sept 2022, the biggest liability here is intercompany loans of FDI firms registered with the Board of Investment (BOI) amounting to $5.6 billion. Private sector firms have $2.3 billion and SOEs have $1.4 billion in foreign loans according to this data. With a further $175 million in the Sri Lankan Airlines (an SOE) eurobond, that is currently in default. There is also $1.3 billion in trade credit - most of which is likely for petroleum and coal imports by CPC and CEB (the two large energy SOEs).

Figure 4: Private sector & SOEs external debt, US$ million

Takeaways

• Use the face value to give a better picture of Sri Lanka’s external debt burden, which was around $56 billion at Sept 2022. The $48 billion market value figure is also accurate, but for that definition. So, being aware of these complexities is vital when reporting/discussing debt.

• The government is not the only entity with external debt, the central bank, financial institutions, SOEs and private sector firms also do. Keeping track of how these other borrowers’ external liabilities change is also vital.

• The external debt that is in sovereign default and are to be restructured are debt that is under the central government and the SOEs, as I explained about previously. It does not apply to the entire $56 billion external debt, especially the debt reported under the financial sector and private sector.

• As discussed in my previous article, there is also the government’s domestic foreign currency debt to be aware of, which do not fall within this $56 billion. The $1.75 billion in ISBs held by domestic banks, the SLDBs and other domestic dollar debt of the government and the dollar loans of SOEs from domestic banks need to be factored in too.
  
  Note that the external debt numbers for the government in the quarterly CBSL external debt statistics seem to have slight differences to what’s reported by Ministry of Finance, which I explained in the previous article. There could be private sector, financial sector or SOE external debts not covered by this CBSL data reporting. There will always be things missed, misreported or overlooked. Data reporting improves over time. Just glad to have at least this quarterly data set going back to 2013 to work with.