Restructuring alone not enough to sustain SL’s debt gains: IMF

• Points out country faces a complex post-restructuring debt portfolio that requires stronger public debt management and continued fiscal discipline
• Asserts there is no room for slippage on fiscal front

Sri Lanka’s sovereign debt restructuring has eased the borrowing costs and restored investor access to financial markets. However, all is not rosy yet, as the country faces a complex post-restructuring debt portfolio that requires stronger public debt management and continued fiscal discipline, according to a new International Monetary Fund (IMF) working paper.

The domestic financing conditions have largely normalised, following the bond exchange. The treasury bill interest rates fell to around 8.5 percent by March 2025 and the authorities have begun issuing a substantial share of domestic debt in longer-term treasury bonds, a move the IMF said is critical for managing the refinancing risks and achieving a durable reduction in gross financing needs. 

The domestic debt operations implemented in September 2023 helped alleviate the immediate pressures, allowing private credit growth to resume and supporting the ongoing economic recovery.

Despite these improvements, the IMF cautioned that restructuring alone cannot ensure debt sustainability. 

“Continued prudent fiscal and macro policies and stronger institutions are essential and there is no room for slippage on the fiscal front,” said the IMF in a working paper titled ‘Sri Lanka’s Sovereign Debt Restructuring: Lessons from Complex Processes’, authored by Peter Breuer, Sandesh Dhungana and Mike Li.

The paper stresses the need for careful cost and risk analysis before signing new debt contracts, alignment of new borrowing programmes with the programme objectives and continued efforts to strengthen public debt management, given the country’s “more complex post-restructuring debt portfolio”.

Sri Lanka’s debt crisis, as the paper highlighted as well, emerged from a combination of policy missteps and external shocks, including lax fiscal policies, low tax-to-GDP ratios and external shocks, compounded by an overvalued exchange rate and international bond issuances in the 2010s that accelerated external debt accumulation. 

The Covid-19 pandemic further exposed balance-of-payments vulnerabilities, culminating in the country’s first default on external obligations in April 2022. The subsequent restructuring process was guided by an EFF-supported adjustment programme aimed at restoring medium-term external viability and debt sustainability, combining fiscal and external adjustments anchored in a realistic macroeconomic framework.

The restructuring process itself required careful balancing among diverse creditor groups, including international sovereign bondholders, bilateral and multilateral creditors and domestic financial institutions. 

The IMF paper noted that in the absence of an established coordinating forum among traditional and nontraditional bilateral creditors, a parallel approach was adopted to secure financing assurances for debt relief. An official creditor coordinating platform was later established to facilitate transparent information sharing and discussions of debt treatment parameters. However, concerns over transparency and comparability of treatment, as well as the introduction of innovative state-contingent debt instruments, prolonged the negotiations with the private creditors, which were concluded later in 2024.

While Sri Lanka’s domestic financial stability has been restored, the banking sector avoided a full-blown crisis, private credit growth resumed and fiscal operations stabilised. The IMF emphasised that safeguarding the hard-earned debt sustainability would require continued vigilance. 

The enactment of the Public Finance Management and Public Debt Management Acts were cited as important milestones in guiding the authorities towards wiser fiscal and debt decisions. The paper further noted that a sensible public investment programme, a sound procurement process and close monitoring of borrowing would help place public debt on a sustainable downward trajectory and mitigate the risk of future debt crises.

Sri Lanka’s experience offers lessons for other emerging economies navigating complex creditor landscapes, the IMF said. It went on to note that effective debt restructuring must carefully consider the impact of domestic debt operations on financial and social stability, clarity in applying comparability of treatment and the use of state-contingent debt instruments to assess sustainability.