Sri Lanka is rich

Sri Lankan finance minister Ravi Karunanayake recently declared he would push capital market reform ahead in 2017 with eye-catching privatizations of state enterprises and securitization of billions of dollars of his government’s debt. These were big promises, but could such ideas deliver the desired results?

Too rich to be poor

In human development terms, Sri Lanka is rich. Its literacy rate is 93%, comparable to Europe, higher than that of the U.S. (86%). But in economic terms, the country is not rich. Current-dollar per capita income in 2015 was USD $3,638 (compare China’s in 2015, USD $11,007). Tax revenues are less than 15% of GDP. Over 90% of government revenues go towards debt service.

The Sri Lankan economy is made up of commodities, textiles and service industries. The first two are low-margin businesses, subject to considerable price and currency volatility; also, the working capital requirements of commodities businesses are high.

Growth prospects for service and especially information businesses are more promising, and the entry costs tend to be lower than for primary or secondary industries; but many Sri Lankan professionals work overseas. It is estimated that 2 million workers, or 10%, of Sri Lanka’s of 20.36 million people, are expatriate. Their earnings contribute substantially to Sri Lanka’s economy and its foreign reserves. On the other hand, the opportunity cost to Sri domestic enterprise and industry of such a large remittance economy is likely also to be substantial.

Sri Lanka’s sovereign credit rating is low. A high single-B by Moody’s, Standard and Poor’s and Fitch implies a default probability somewhere between 10% and 25%. On the other hand, Sri Lanka’s total debt-to-GDP ratio is 101%. This is not low leverage, but it is nowhere near as high as China’s, Japan’s or the United States’ debt levels. In sum, Sri Lanka’s credit problem lies with the structure of its real economy.

…but too poor to leave to its own devices

In 2016, when Sri Lanka experienced a sharp balance of payments crisis, the multilateral banks eagerly came to its rescue. The IMF issued Sri Lanka a three-year USD $1.5 billion loan facility, the ADB pledged USD 2 billion in loans or equity through 2018 and a World Bank-led syndicate lent almost USD $0.5 billion. The funding came with covenants to improve economic efficiency.

But there is another angle to Sri Lanka’s recent borrowing history. Since 2011, it has received USD $8 billion from China for strategic transport infrastructure finance. A 2017 article in Quartz argues that these investments were not underwritten with the idea that Sri Lanka could repay them but because they could advance China’s national goals of expanded access to resources and territory in Asia.

Is concessionary financing by the multilateral banks intended to help Sri Lanka recapitalize and rebuild, or to wean it from growing dependence on Chinese money?

In search of an authentic growth narrative

The success of Sri Lanka’s future plans for capital market development revolves around one reality: profits. If the missing element for Sri Lanka to create profitable businesses to solidify the government’s tax base is entrepreneurial talent, then Ravi Karunanayake’s idea of selling state enterprises with growth potential to owners with the right skills is solid gold.

On the other hand, nothing leads me to believe securitizing Sri Lankan sovereign debt is a good idea. Securitization works on credits with strong cash flows but optically weak balance sheets. Here we see the opposite condition. The Sri Lankan government has weak powers of taxation but can attract concessionary financing for reasons that have nothing to do with economics.

Sri Lanka needs to take back its own economic narrative and engage government, business and investors in a collaborative story-boarding of new growth and financing plans. Like a Hollywood storyboard (or a securitization) the storyboard should detail the steps by which investment funds will be deployed to new investments, and from which sources (and when) investors will be repaid. (Forbes)