(Continued from last week)
Sri Lanka’s net wealth as a country is $351b USD. Yes, that is the net wealth after the $50b of external debt is deducted. So, our gross wealth is $400b if you add back the debt, which creates a balance sheet for Sri Lanka of $400b of assets and $50b of debt. Now I am sure most of you reading this article did not know that. Have you ever seen a newspaper quote that figure? Have you ever heard an economist quote that figure?
As you can see, Sri Lanka is far from bankrupt on that measure. An organisation that has $400b of assets and $50b of debt is not bankrupt. Sri Lanka is in fact quite a wealthy country by that measure and is #58 in the world league of countries by wealth.
This view also answers the question about the United Kingdom’s external debt. The UK has an external debt of 345% of GDP totalling $9.3 trillion? Surely, they must be bankrupt right? But not so because you need to check out their net wealth. The UK’s net wealth according to Credit Suisse is $15T which means its net assets are $24T when you add back the debt. That is why the UK is not bankrupt – they have $24T of assets and $9T of debt. Any accountant knows that that is more than good enough.
Let’s then focus on the obvious next question. If Sri Lanka has so little debt compared with the UK, and our “country balance sheet” is so healthy, why do we get so much grief from the financial markets? Let’s look closely at the numbers again for the UK compared with Sri Lanka:
Sri Lanka’s debt to assets ratio is 13% compared with the UK at 62%. How is it that the UK is not in even hotter water than us? The answer is that much of the UK’s debt is seen by the markets as “secured debt” while SL debt is primarily seen as “unsecured debt”. Let me explain.
The UK as you all know has an open economy, it has a currency that is freely exchangeable, and a body of law (English law) and courts that are trusted by people around the world. (Full disclosure – I live in Edinburgh, UK).
It means that when external parties in other countries lend to UK’s institutions that debt is secured on assets owned by the UK institution that is doing the borrowing. If the UK borrower is unable to repay the debt, the lender will seize that asset, sell it and recover the debt.
This is the way loans work globally. Most importantly if there is a dispute between the borrower and the lender, the UK courts would resolve the matter and if necessary, the ruling could go all the way to the Supreme Court where a final ruling would be made.
The important thing to know is that this process is totally independent of politics, democracy, and government. It does not matter what the people of the UK think about the matter, the courts will rule in favour of the foreign lender if that lender is deemed to be in the right – no more questions asked.
Property rights in the UK are guaranteed by law and by the independence of the courts. Even more importantly all foreigners trust that system of law and the independence of the UK’s courts when it comes to matters of property.
I do not need to tell you that this is not true for Sri Lanka. The problem at heart is our perception of national sovereignty. We do not of course have a freely exchangeable currency (which means that the Rupee cannot be used to repay a foreign debt – unlike GBP can), and we do not have a system of property rights for foreigners, because we think Sri Lanka is for Sri Lankans.
That at the end of the day is a political judgment for the Sri Lankan people and the Government. We seem to think that foreigners owning land in Sri Lanka is unacceptable (contrast that with the UK and US where large swathes of the country are owned by foreigners, including by Chinese and Russian investors whom the West does not like that much).
Do we really value our national sovereignty so much more than the US does? And do we understand the downside of that choice we have made? Did we ask the people of Sri Lanka in an educated debate about the choice the establishment has made for them? Guess what – you cannot eat sovereignty. Sri Lanka really must rethink this in an open and clear manner.
Back then to the problem Sri Lanka has with its debts. As foreign lenders cannot be sure that we will not default on our debt (and all those people urging the Government to default are making matters worse), Sri Lanka cannot borrow and secure that borrowing against our assets in the way that a country such as the UK can. Please have no doubt that this is a mess of our own making. Sri Lanka can change the situation overnight by changing our laws to guarantee foreigner’s ownership of Sri Lankan assets, and by guaranteeing that foreign debt will always be serviced and repaid – by law.
6. Sri Lanka is a bit like a Scottish castle and estate
Let me give you a little example to explain the strange problem Sri Lanka has that I described in the last section. When I first came to live in Scotland in 1979 as a young PhD student, one of the intriguing aspects of Scottish Life was the way large parts of Scotland were owned by landed aristocrats. These estates could even include mountains and rivers and often a castle too. This is a legacy of Scotland’s feudal past. Now the interesting thing was that quite often the estate did not actually manage to pay for itself. The castle was sometimes in a dilapidated condition because the estate’s revenue was not enough to pay for its upkeep. The family that owned the estate was not bankrupt of course but they refused to sell some or all of the land as it had been handed down over centuries. As you can imagine the ordinary citizens of Scotland didn’t really feel sorry for these poor landowners.
That is what Sri Lanka looks like from the outside. We are a rich country with a huge value hidden inside. But we do not know how to deploy it. We are stuck with out of date thinking about sovereignty, and we have not yet understood how to fully open our economy and take part in the capitalist success enjoyed by the rest of the world.
Switching back quickly to those poor Scottish aristocrats, they learned over time how to get out of their predicament. They learned to open their castles to the public, make sure there was a nice tea room that had expensive cakes and tea, and sell bits of the estate to fund improvements to the castle.
Think about what that means for Sri Lanka. We can easily get out of our debt hole tomorrow morning by (a) changing the law to secure foreigners’ debts and (b) by selling off some assets to repay those lenders that want their money back now.
7. Should Sri Lanka default on its debt?
Absolutely not. Only sovereign countries can even contemplate defaulting on debt and get away with it.
Let’s consider first what would happen in a normal debt scenario within a single country. If a UK borrower defaulted on his debt, the courts would ensure that his remaining assets are forcibly sold off to pay the debt and the borrower would be bankrupted. Once bankrupt that person would not be able to easily borrow again in the future. You get to be bankrupt only once. It is a pretty serious situation for any person to become bankrupt. If bankruptcy happens to a company, the directors of that company would be in a similar situation when it comes to any business they might attempt in the future.
Why is that different for a country? Well, a sovereign country could misuse its sovereignty to simply refuse to pay. There was a time when Western powers would send gunboats to sort out the situation, but these days lenders would simply cut-off that country, so it is not possible to borrow again in the future… for perhaps a very long time.
Be very clear that to refuse to pay our debt is simply a form of theft. We would essentially be stealing money from the lenders. That is why it is not a great idea, and that is why lenders will not forget what we did.
Now a legitimate question for you to ask me is this: I thought you said when we borrow, money lenders simply print the money and give it to us. So why is it such a big deal if we simply refuse to pay? A good question indeed. Yes, that is absolutely right that when you borrow money the bank creates money and lends it to you, and when you repay, the bank destroys that money. But here is the kicker… if you do not repay and default on your debt the bank has to destroy that loss out of its own money. So, all bad debt becomes a real loss to the bank. To not repay is to steal from the bank. That is why Sri Lanka must not do that.
8. So the way forward is to sell assets? What about the IMF?
Selling Sri Lankan assets is indeed one way forward. In total there are three ways out of our debt hole. But none of those involve the IMF. Let us first talk about the IMF option. It is firstly important to note that the IMF is a misnomer. It is not an “international” institution in that the world’s population owns it equally or that the world’s countries control it equally. It is essentially a Western institution whose primary purpose is to protect the interests of Western lenders. That does not make them bad – but we need to know why they exist and who they ultimately answer to.
There is a lot of noise in Western newspapers about the China debt trap. But be in no doubt that all debt is a form of trap. If you owe $1 to a bank and you are unable to repay that debt, the bank then controls you until you pay that debt (or your assets are dissolved to pay that debt and you are bankrupted).
That has always been true and will always be true. In the battle of the debt traps be aware that our choice here is a Western debt trap or a Chinese debt trap or an Indian debt trap. Debt is always a trap if you cannot repay it. Someone else dictates what happens to your assets at that point.
Let us talk a bit about China vs the West for a moment. Here is an interesting statistic that might surprise you. I mentioned the McKinsey study on national wealth earlier. China has now overtaken the US in terms of total national wealth according to the report. On a “purchasing power parity” (PPP) basis the report estimates total US wealth at $89 trillion in 2021 (that is the “net assets” position of the US as a whole), while it estimates China to be $201 trillion – which is more than double that of the US! Makes you think about where our borrowing should come from – but at the end of the day any debt that you cannot repay puts the country in a bad place and it doesn’t really matter whether it is China or the West that lends to us.
Back then to the IMF (or more accurately the WMF). The thing the IMF can do for us is to help us negotiate with our lenders and restructure our debt. If this results in a prolongation of the debt repayment timescale, well we can probably achieve that ourselves by talking to the lenders directly. We do not need the IMF for that.
Be in no doubt that lenders’ real interest is to keep lending to us and continue to earn interest from that loan. That is how banks make money. The only reason they want us to repay now is because they are worried we may not be able to repay later. If the lender believes that we will absolutely repay, then guess what, they are no longer in a hurry to be repaid – more jam for them in interest paid.
So, debt restructuring is not where the IMF really helps. The IMF can help to make lenders take a “haircut”. What does that mean? A haircut has little to do with hairdressers but everything to do with making the lenders agree to lose some of the capital they lent us. Eg to agree that 20% of the debt need never be paid back and be written-off. This is of course a form of legitimised theft.
The IMF gets the lenders to agree to us “stealing” 20% of the loan in return for us paying back the rest of the 80%. As you can imagine, that’s not a nice place for the lenders to be in, and they will remember that and be far less keen to lend to us in the future. But in return for this official theft by us, the IMF usually imposes draconian rules on what the government must do to the domestic economy.
This as you can see is a lose-lose situation – and of course it needs to look like a lose-lose for the lenders to agree. The lenders lose some of their capital, the government is forced to follow the IMF’s diktats which are mostly rubbish (if they knew how to run a country, they would not be working for the IMF), and Sri Lanka goes a little bit deeper into a Western debt trap while Western politicians feel empowered to walk all over us.
Talk of losing sovereignty!
Even more crazy when you consider that Sri Lanka has its very own “Scottish castle” worth $400b that we refuse to mortgage or sell. Crazy crazy.
The IMF is absolutely not the way forward for Sri Lanka for one final massive reason. It is essential to understand the root cause of our debt problem which is of course Sri Lanka’s huge forex leak. I will talk about this in much more detail in the rest of this article but suffice to say here that if Sri Lanka did not have a persistent trade deficit (and current account deficit) we would not be in this situation. The years 2020 and 2021 were of course particularly bad for Sri Lanka due to Covid.
So although the IMF can give us short term debt relief, it will not fix our trade deficit. Sri Lanka quite simply buys much more in forex than we sell in forex. That’s the root cause of our long-term external debt problem. Going to the IMF will not fix that. The IMF will simply put a sticking plaster on our arterial wound and send us home – and Sri Lanka will continue haemorrhaging forex. The IMF will fully expect us to be back again in 2 years’ time asking for yet more debt relief. That is a debt-trap.
9. You said there are three ways forward that do not include the IMF. Were you serious?
Absolutely serious! We do not have to do them all – but they act over different timescales – so all three of these make sense. Here they are:
1. Fix our laws to give foreigners absolute ownership rights over Sri Lankan assets
2. Sell Sri Lankan assets
3. Fix our trade deficit with an industrial policy
The first of these is the quickest (but politically most difficult) thing to do. If our external debt can be secured against Sri Lankan assets that are guaranteed by law (and by that I mean it needs to be absolutely water-tight with an absolute constitutional guarantee that cannot be tinkered with by a future government), the pressure to repay our debt vanishes overnight. Here’s why:
Lenders make money by lending. They are not in a hurry to get their debt repaid if (a) the borrower continues to pay interest and (b) there is no risk whatsoever that the borrower will default.
Think about the US for a moment with its $22 trillion external debt. That is not just government debt but US institutional debt too. When will the US pay back all that debt? Actually never. There is no plan to repay any of that debt, but foreigners will continue to lend to the US. That is because if any of the US institutions default, the law provides recourse to the lenders to seize assets and recover the debt. That does not mean that individual debts are not being repaid. But as a total, US debt rises every year. Foreigners are happy to fund that because they can cash-in their loan anytime (e.g. by selling that loan to someone else) and they get interest payments while they hold US debt.
So here is the strange thing – not only do rich countries create more and more debt every year which they can never repay (and that debt circulates as “money” in the economy), if they ever tried to repay that debt the economies would simply have too little money and there would be massive deflation. It is crazy but true that economies need to create more and more debt to ensure there is enough money to run the economy. When Western banks did not create enough debt in the last few years (or in Japan’s case in the last 20 years), western central banks had to print money – famously known as Quantitative Easing to stop a deflationary spiral.
Even though Sri Lanka is nowhere near as rich as the West we could join the same benign pool of money creation if we (a) make the Sri Lanka Rupee fully convertible and (b) guarantee property rights independent of nationality.
If we did this tomorrow, our debt problem would be permanently and immediately banished. But just doing part (b) would solve our immediate issue. It would remove the urgency for lenders to be repaid. They would be happy to simply delay repayment while we pay interest, knowing that their capital is bullet proof and safe. They will also understand that Sri Lanka has entered a new era of fully joining the world economy, and that would mean the $400b of assets will appreciate a lot faster in future. A very virtuous circle to get into.
10. You said there are three ways forward that do not include the IMF. Were you serious?
As we discovered earlier, Sri Lanka as a country has a balance sheet with $400b of assets and $50b of external debt resulting in a net assets position of $350b.
As I said in the previous section the first easy way out of our debt dilemma is to simply change the legislation around the ownership of Sri Lankan Assets.
An alternative is to sell parts of our “Scottish Castle”. For example, sell prime beach property to a foreign hotel chain and give them freedom to develop it. Sri Lanka plans to sell property in Colombo Port City as far as I understand it. Totally right too, and we should be doing that asap. Economynext says that the initial land sales for just 20 plots of land are estimated at $5b.
Let’s take a few minutes to consider the Port City project. There is a lot of nonsense written about it being a China debt trap and a waste of money. Just a little moment please. The land reclamation project cost Sri Lanka $0.9b which created land worth $5b in phase 1 and a total sellable land value of $15b. All those people who have complained about this project – how many of you have invested $1 and got back $15 a few years later? This was a totally brilliant project in my opinion and only the government could have done this. Some people think that this type of idea should be left to private companies – well really? Could a company have simply created an island off the Sri Lankan shore with no government help?
In the longer term once the Port City is fully built the total amount of wealth created by it will probably exceed $100b (my estimate). And you know what, we could do it again one day in the future and have a second island, and then a third.
The beauty of Port City is also the ability to set the property laws to be investor friendly like I said in the section above. So, I accept that Sri Lanka may not want to free-up property laws across the whole of the country and make our Scottish Castle fully part of the world economy – fine. But please Sri Lanka, do get that right for Port City. We must make sure that ownership rights are absolutely guaranteed by law, independent of the nationality of the owner.
11. Tackling Sri Lanka’s persistent trade deficit
Sri Lankans apparently like the good life. And so, they should! If we want to buy an iPhone or a Mercedes Benz and we can afford it, we should be able buy it just like the rest of the world. But here’s the rub – we also as a country need to sell things back to the rest of the world! Otherwise, we have a trade deficit and a negative current account balance which means a persistent forex problem. That is where Sri Lanka is today.
Take a quick look at the current account balance for Sri Lanka. The “current account” of a country covers all forex movements – not just the trade deficit, but it captures money remittances and all foreign exchange movements.
You can see the problem – we have a sea of red ink. Sri Lanka is constantly spending more forex than it earns, and so has to borrow forex to pay for imports. This obviously cannot keep going forever – the country will simply have bigger and bigger debts to pay.
Now fixing the trade deficit is not easy and will take time. Unlike financial engineering with asset sales and property freedom that I outlined above, fixing the trade deficit takes a lot more effort and much more time to achieve. But once we do that, we are finally out of the foreign debt problem – and permanently so. The Sri Lankan establishment talks about self-sufficiency in turmeric or in rice. That is crazy. We need to be self-sufficient in forex. That’s all. Once we have done that, we can buy whatever we want – a Mercedes Benz, or maybe even as much turmeric as we want ..!
As the famous Scottish Economist Adam Smith wrote in his Wealth of Nations published in 1776, countries must focus on their competitive advantage.
We really must learn from Adam Smith, and from Singapore a country that is a perfect example of how to focus on competitive advantage. Guess what – Singapore does not need to worry about turmeric – they just buy what they want. Singapore has had a current account surplus of around 20% of GDP for nearly 30 years. See:
Once you have a permanent positive forex situation the country has true sovereignty. There is no need to worry about external debt. It does not mean you do not have debt – in fact Singapore has an external debt of 501% of GDP secured against its many assets ($3.3T gross).
So how do we become Singapore? Sri Lanka needs to start selling to the world what the world wants to buy. Tea, rubber and coconut alone will not do it.
To be Continued