This post has been authored by Manisha Rikkula, the Research Analyst Intern at Arthashastra Intelligence.

Over the recent months, Sri Lanka is witnessing massive inflation and economic slowdown.  This was in addition to the downgrading of debt service positioning from international rating agencies. It has amassed an external debt of more than $45 billion, or nearly 60% of its nominal GDP (2020), compared to India\’s 20%. The Sri Lankan government is on a tight rope to channel resources to correct the economy as against servicing its debt. In wake of this, a comparison of India’s external debt position to that of Sri Lanka offers insight into the need to revisit debt sustainability in India.

External Debt in India is classified under seven heads namely, multilateral, bilateral, IMF loans, Trade Credit, Commercial Borrowings, NRI Deposits, and Rupee Debt. \”Sustainable debt\” is defined as a level of debt that permits a debtor country to satisfy all its present and future debt service commitments without resorting to additional debt relief or rescheduling, avoiding the accumulation of arrears while allowing for acceptable economic growth. One way to achieve this is by bringing the net present value (NPV) of external public debt down to about 150 percent of a country’s exports or 250 percent of a country’s revenues

The major indicators of debt sustainability are:

1. The ratio of debt to GNI

It is the ratio of the total outstanding external debt at the end of the year to GNI. India\’s external debt to GNI was highest during 1991-92 (30%), thereafter it was below the range of 20%. On the other hand, Sri Lanka\’s debt stock was on increased from 39% in 2011 to 71% in 2020.

2. Short term debt as a percentage of total external debt:

Short-term debt is a debt of maturity of less than a year. The short-term debt as a percentage of total external debt is around 20% on average for both India and Sri Lanka. This indicates that approximately 80% of debt is long-term debt.

3. Short term debt as a percentage of total reserves:

This is a pure liquidity indicator that is defined as the ratio of the monetary authorities\’ stock of international reserves to the stock of short-term debt on a remaining-maturity basis. It\’s a good measure of reserve adequacy. It is a measure of how rapidly a country would be obliged to pay its debt if it were to cut off from external borrowing. The short-term debt as a percentage of total reserves in 2020 in India was at 17.5 %, while in Sri Lanka it was 148.23%. Since 2011, this ratio has started increasing in Sri Lanka. This portrays that Sri Lanka has a huge debt burden that is way beyond its reserve capacity.

Major Reasons for mounting debt in Sri Lanka:

• Overnight policy change of banning chemical fertilizers.
• Not diversifying dollar revenue, tourism was the main source of USD to Sri Lanka which got affected due to Covid and terror attacks.
• Falling into China’s debt trap – more than 10% of its debt is sourced from China.
• Expansion of commercial loans over the last seven years.

Conclusion:

Developmental needs advocates for low-interest foreign loans, whereas borrowing costs and the risks associated with external dependency and liabilities, argue against external debt. The comparisons on debt indicators reveal that India is better placed than Sri Lanka in debt servicing. However, reducing the dependency syndrome, diversifying the revenue bases, improving tax buoyancy, and aiming for higher growth rates should be a focus.

References:

1. Jain, T., 2006. External Debt Scenario in India: Issue of Debt Sustainability. Available at SSRN 1087384.

2. https://www.theguardian.com/world/2022/jan/10/sri-lanka-appeals-to-china-to-ease-debt-burden-amid-economic-crisis

3. https://www.livemint.com/news/world/sri-lanka-economic-crisis-what-we-know-so-far-11648883629841.html