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Tuesday, May 30, 2023

‘Carrot and stick required for debt restructuring’ – The Morning

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  • London Uni Prof. Ulrich Volz urges Govt. to incentivise and pressure creditors 
  • Notes private creditors also needed at restructuring table
  • Says private sector involvement essential

By Imesh Ranasinghe

Sri Lanka will need a “carrot and stick” approach to bring private creditors to the debt restructuring table, stated an internationally renowned economist.

Speaking at an event held by the International Chamber of Commerce Sri Lanka (ICCSL) last Saturday (4), Prof. Ulrich Volz, a Professor of Economics and Director of the Centre for Sustainable Finance at the SOAS University of London, said that the private sector’s involvement in Sri Lanka’s restructuring of its debt – the majority of which is owed to the financial market – is critical.

“Private sector involvement in debt restructuring is crucial, but it has been lacking to date, so this is also critical in Sri Lanka’s case,” he said.

He noted that as of October 2021, about 60% of Sri Lanka’s total debt (around $ 35 billion) is owed to financial markets, while a third of Sri Lanka’s foreign debt is owed to international sovereign bondholders.

“When talking about debt restructuring in Sri Lanka and elsewhere in emerging and developing economies, we need to talk about how to bring the private creditors to the negotiation table,” he added.

Prof. Volz said that to bring the private creditors to the table, a “carrot and stick” approach is needed, which includes both incentives (carrots), as well as pressure (sticks).

In terms of incentives, he added that his colleagues and himself have put forward a plan for debt relief for green and inclusive recovery that could be administered by the World Bank, enticing the commercial sector to restructure debt.

“In terms of pressure, the financial authorities of the jurisdiction in which the major private creditors (i.e. both banks and asset managers) reside and govern the majority of sovereign debt contracts – mostly the US, the UK, and also China – will have to use strong moral suasion and regulation on accounting, banking supervision, and taxation to improve creditors’ willingness to participate in debt restructuring,” he said. 

Therefore, he noted, the major economic powers need to put pressure on financial institutions to engage in debt restructuring.

“The way Sri Lanka’s sovereign debt crisis is being addressed not only matters to the people of Sri Lanka, but also to a large number of emerging and developing economies that are facing severe debt distress,” Prof. Volz noted.

According to the International Monetary Fund (IMF), 60% of low-income countries are at high risk of, or already experiencing, debt distress, while some estimates suggest that 135 countries in the global South are critically indebted.

Also speaking at the event, Lee Buchheit, an expert in sovereign debt restructuring, said that the principal challenge that Sri Lanka will face in conducting this debt restructuring in this difficult global environment will be to co-ordinate the various creditor groups and to coordinate individual creditors within those groups.

In April, the Central Bank of Sri Lanka announced the suspension of $ 51 billion in external debt payments, which has led to the country seeking an Extended Fund Facility (EFF) from the IMF, along with a debt restructuring process, for which it had hired leading financial and legal advisory firms Lazard and Clifford Chance LLP to support.

There are four major creditor groups involved in Sri Lanka’s foreign debt, bondholders, bilateral creditors – including Paris Club members and other nations such as China and India – and multilateral lenders such as the IMF, World Bank, and Asian Development Bank.

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