Harsha warns against potential risks of domestic debt restructuring

SJB MP Dr. Harsha de Silva has warned against the potential risks of domestic debt restructuring, stressing the need for extreme caution.

Addressing the media recently, Dr de Silva cautioned that if not managed carefully, domestic debt optimisation could become a burden rather than a relief for the economy.

Citing the net debt relief Laffer curve, de Silva stated that the more we increase the haircut on banks, the more likely we are to hit the curve’s negative impact zone, where debt restructuring becomes counterproductive, thus leading to a negative impact on the economy. Harsha provided another example of this phenomenon: taxes on wine and spirits. High taxation has resulted in a drop in consumption, which, in turn, has substantially reduced the expected revenue for the Excise Department. Therefore, de Silva emphasised that the risk of capital adequacy in banks could result from debt optimisation, which is when a bank’s capital falls below the recommended levels, raising questions about its stability.

Harsha emphasised the need for discussions on this complex issue to occur in the Committee on Public Finance. By summoning relevant officials and utilising data to work the numbers, the Committee could help avoid potential blame down the road.

Furthermore, Harsha proposed the establishment of a Financial Sector Support Fund to ensure macro-stability. He suggested that multilateral organisations, like the World Bank and ADB, would lend money to establish this fund, as over 1 billion dollars would be needed.

Another issue raised by Harsha concerns the Employees’ Provident Fund (EPF), where hard-earned people’s pension money lies. Harsha questioned whether the EPF, established to provide positive real interest rates, as envisioned by then Minister T.B. Illangaratne, when bringing in the Act, had fulfilled its mandate. Harsha believes that people ought to get a positive interest rate that has been adjusted for inflation, as opposed to a positive nominal interest rate. However, as per current statistics, this has not been the case. The real interest rate has been declining since 2015, with the rate being -47.2% in 2022. The EPF has already been subjected to a 32% haircut in US dollar terms, as the value of the fund in 2021 was $15.8 billion, and by the end of 2022, it was $9.5 billion due to the rupee crashing and the impact of inflation. Harsha proposed that if the interest rate given to the recipient is less than 2.5%, the Central Bank should be given a loan from the Treasury to give the recipients a minimum of 2.5% interest. Harsha hopes that this proposal would be discussed in Parliament and that necessary legislation would provide relief to the already suffering middle class.

Harsha reiterates support for the IMF programme but suggests tweaking it to make it more bearable for the people. Additionally, if Sri Lanka needs to undergo domestic debt restructuring, Harsha proposes extending a warrant, a domestic debt restructure warrant, in other words, a derivative or put option, to creditors subjected to domestic debt restructuring. Harsha suggests that since the government has promised the people stability and an increase in GDP growth to 3% by 2027, the people have agreed to tough measures, like high taxes and a reduction in subsidies. Therefore, if the economy grows beyond expectations, the extra growth should be extended to the people to honour their sacrifices. Harsha expressed support for establishing discussions on this topic. Finally, the SJB believes that the government ought to treat both foreign and domestic creditors equally and non-discriminately, with the primary goal being to stabilize the country’s debt, while minimizing its impact on the EPF and banks.