The Central Bank recently stated that the debt repayment obligation for 2024 is approximately US$6 billion, an exorbitant figure in the prevailing gloomy economic situation. Yet, it is a compulsory requirement that cannot be postponed in the current context unless a fresh restructuring process is agreed upon with lenders. According to Central Bank sources, the foreign reserves stood at US$3.5 billion, apart from the US$1.5 billion Yuan currency swap facility, by December last year.
Sri Lanka is grappling with the challenge of managing foreign debt obligations. In this context, the importance of boosting external reserves cannot be overstated for a country with ongoing diverse economic challenges.
The nation faces a set of unique and unprecedented challenges that warrant a comprehensive approach to economic management. The management of foreign debt and the strengthening of external reserves stand at the forefront of these challenges. Regrettably, none of the competing political parties seem to be giving due attention to this serious issue, perhaps because of the impending national elections. The public awareness of the situation and the repercussions of non-payment is almost nonexistent.
External reserves serve as a crucial buffer against economic uncertainties in Sri Lanka, just as they do in any other developing country. Economists opine that it is better to hold the foreign exchange reserves in a currency that is not directly connected to the country’s own currency to provide a barrier at times of economic disturbance.
By having a robust reserve position, the country can ease the impact of unforeseen events, such as internal conflicts, global economic recessions, or commodity price fluctuations, and stabilise its currency in times of crisis. Also, it helps keep the value of the domestic currency at a fixed rate.
Healthy reserve
A healthy reserve position also facilitates international trade by providing the foreign exchange for importing essential goods and services. This, in turn, ensures the smooth functioning of the economy and contributes to sustained economic growth.
Reserves are used to settle international trade and payments, in addition to foreign debts. When the country imports goods or services, the payments are made in foreign currencies, mostly in US dollars in Sri Lanka. Reserves provide the funds to fulfil these obligations without putting excessive pressure on the domestic currency’s value.
The staggering debt pile of US$ 52.7 billion has remained static since April 2022, after the temporary suspension of most foreign debts. The restructuring process is being discussed with creditor nations successfully, and the Government expects a favourable outcome. Although the plans are mostly agreed upon with most of the creditors, the final solution is yet to be arrived at.
Strengthening external reserves is directly linked to a country’s ability to honour its foreign debt commitments. Having an ample reserve position allows Sri Lanka to make timely interest payments, redeem maturing bonds, demonstrate fiscal responsibility, and enhance its credibility in the global financial markets. Servicing foreign debts properly is a key factor in the recovery of the Sri Lankan economy.
A sufficient level of external reserves provides the Central Bank with the flexibility to intervene in the foreign exchange market. This intervention helps stabilise the national currency, preventing sharp depreciation or excessive appreciation that could disrupt economic stability and trade competitiveness.
The current reserve of US$3.5 billion helps the Central Bank stabilise the once-out-of control exchange rate. A rise in external reserves can help prevent sharp fluctuations in the value of the national currency, ensuring stability and predictability for businesses and investors. The Sri Lankan rupee against the US dollar seems stable currently. However, the situation may change once the government resumes foreign debt repayments.
A solid reserve position fosters confidence among international investors and creditors. It signals to the global community that Sri Lanka is well-prepared to manage economic challenges, inspiring trust in the nation’s financial stability and potentially attracting foreign investment.
Among numerous economic issues, incoming foreign investments are a crucial factor in mitigating the current situation. At this juncture, the country desperately needs foreign investment to develop, organise, and navigate international markets.
A solid reserve position fosters confidence among international investors and creditors. It signals to the global community that Sri Lanka is well-prepared to manage economic challenges, inspiring trust in the nation’s financial stability and potentially attracting foreign investment. However, high-value FDIs seem to have dried up during the past few years, and the Board of Investment (BOI) has failed to attract significant amounts of foreign currency by way of investments.
The country confronts several challenges related to its foreign debt, which necessitate a proactive and strategic approach as repayments are to start this year.
Not only has Sri Lanka›s total external debt increased significantly in recent years, but the US$6 billion payment this year can lead to concerns about other essential imports such as fuel, LP gas, and essential food products. High levels of foreign debt can strain fiscal resources and pose challenges to meeting repayment obligations.
According to the Central Bank, the popular belief is that a depreciation of the Sri Lankan rupee against other foreign currencies would increase the foreign debt outstanding, debt service payments, and imported goods. On the other hand, it can also have a positive impact on the trade deficit and export earnings. Such a situation would also encourage domestic consumption, as consumers would use local goods instead, where indigenous trade can flourish.
However, at this point in time, the increase of the Sri Lankan rupee against other major currencies is a visible threat to servicing impending foreign debts with the limited external reserves available in the country. Currency fluctuations can have a significant impact on a country’s debt dynamics.
The maturity profile (the nominal amounts and their time left to maturity) of Sri Lanka’s external debt raises the possibility of refinancing issues. A concentration of loan maturities within specified dates may provide difficulty in repaying the debts, potentially leading to liquidity challenges.
Sri Lanka has multiple opportunities to increase its external reserves. Diversifying the export base by focusing more efficiently on value-added products and searching for niche markets for minor export crops can contribute immensely to obtaining extra foreign exchange that may mitigate the current shortage of reserves.
Tourism industry
The tourism industry shows signs of improving rapidly in the coming years. However, the country has the potential to improve the tourism industry further to become a major tourist destination in the region. Promoting tourism is compulsory through effective marketing, infrastructure development, and ensuring a safe and welcoming environment. This can significantly boost foreign exchange earnings.
In addition, the government must concentrate on efficient debt management, enhanced trade agreements in favour of the country’s external reserves, investing and promoting technology, and engaging in public-private partnerships for infrastructure projects that can bring in private sector investment and reduce the burden on public finances.
Building external reserves in Sri Lanka is a multidimensional attempt that involves strategic planning, introducing practical economic policies, and targeted foreign investments. The country’s specific economic issues, such as large levels of foreign debt and external vulnerabilities, need a multifaceted strategy to strengthen its economic shield.
As the country pursues economic resilience, building foreign reserves looms as one of the most vital components of a secure future. The execution of these policies needs a coordinated effort combining government agencies, the corporate sector, creditor nations, and other stakeholders to achieve a holistic approach to strengthen Sri Lanka’s current economic situation.
