Emerging Issues in Sri Lankas Aid Relations

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Emerging Issues in Sri Lankas Aid Relations

• Deshal de Mel
• Institute of Policy Studies
• Sri Lanka

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Outline

• Aid in Sri Lanka Role and Context
• Traditional Financing - ODA - Remittances
  - FDI
• What Has Changed? - But expanding budget
  deficits and widening external resource gap -
  Fall in multilateral aid - Concerns of
  traditional donors (Human rights and security
  issues)Responses - New bilateral partners
  - Commercial borrowing - Liberalizing
  government bond market
• Implications
• Concluding remarks

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Aid in Sri Lanka Role and Context

• Supporting state development spending
• Current priorities public infrastructure
  roads, power sector, ports
• Also role in bridging external resource gap
• Aid disbursements in 2007 US 1028Mn (24 grants)
• Aid disbursements 3 GDP in 2007
• Exports 29 of GDP
• Remittances 7.7 of GDP
• But important role in development finance

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Traditional Financing of the External Resource Gap

• Government Primarily concessional loans,
  limited role of long term commercial borrowing
• Private short term commercial borrowing, FDI,
  Portfolio investment
• Remittances US 2.5 Bn in 2007 helped redress
  trade deficit of US 3.5 Bn

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Traditional Donors

• Aid dominated by Japan, ADB and the World Bank
  Over the last 3 decades have accounted for 80 of
  aid commitments

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What Has Changed?
1 US LKR 108
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Fall in Multilateral Aid
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Multilateral Aid Cont.

• Sri Lanka per capita income US 1650 less
  access to concessionary finance
• ADB In the past dominated by Special Fund
  Resources 30 year maturity, interest rate
  0.5Today more Ordinary Capital Resources
  12-20 Year maturity, interest rate LIBOR 0.6
• World Bank Until 2007 Bank loans at 0 interest
  0.75 service charge and 40 year maturity. Since
  2007, 20 year maturity, 10 year grace. Not yet
  IBRD funds.

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Other Factors Influencing Borrowing

• Nonetheless, more concessionary than commercial
  rates so why reduced borrowing?
• Other factors - Linkage between aid and
  conflict - Linkage between aid and economic
  reform - Administrative burdens and loan
  covenants
• Aid and conflict Concerns by donors regarding
  lack of progress in the peace process. But mainly
  bilateral donors Germany, UK and more recently
  Japan.
• In view of the linkage between donor support and
  progress in the peace process, the international
  community will monitor and review the progress in
  the peace process. Tokyo Donor Conference, 2003.
• A large sum of financial aid to Sri Lanka,
  currently provided by several foreign nations,
  including Japan, may be stopped due to the
  current situation in the country, Akashi,
  Japans special envoy to Sri Lanka, 2008.

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Other Factors cont.

• Aid and Economic reform
• The three-year arrangements under the PRGF/EFF
  facilities, amounting to 567 million for Sri
  Lanka, were approved in April 2003. Only the
  first disbursements, upon approval, have taken
  place thus far. The first reviews of the program
  were initially delayed because of lack of
  progress on key structural reforms namely, in
  the areas of tax administration and the
  restructuring of the state-owned Peoples Bank.
  During 2004, however, macroeconomic policies also
  deteriorated. IMF, Staff report
• With the prospect of continued uncertainty over
  both the reform and peace processes, the
  indicative program would not place Poverty
  Reduction Support Credits (PRSCs) at the center
  as proposed in the Country Assistance Strategy.
  Rather it proposes a core program of investment
  and analytical activities that would support the
  outcomes in the three thematic areas, while
  providing the option of adding policy-based
  lending in a higher case in the event of an
  improved framework. World Bank, CAS 2006

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Responses New bilateral Partners

• New bilateral donors specially China, India and
  Iran

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Responses - Commercial Borrowing
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Implications - New Bilateral Partners

• Conditionality labour, consultancy, sourcing
  eg. China specifies contractor, Indian line of
  credit for Indian products and services
• Lack of competitive bidding unlike multilateral
  aidThus despite low interest rates, expenses can
  be high
• Lack of transparency leaves room for corruption
• Political requirements eg. Oil block
  reservations for India and China
• Less emphasis on environment, re-settlement
  standards etc.
• All considered, bilateral aid can be more
  expensive

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Implications Commercial Borrowing

• Very expensive, short repayments
• US 500 Mn Commercial bond in 2007 8.5
  interest, 5 year repayment
• Liberalisation of Govt. treasury bond market (up
  to 5) US 337 Mn in 2007, maturity 2-11 years,
  average interest rate 14
• June 2008 US 150 Mn at US 6 Month LIBOR 2.5
  (5.69) per annum with 3 year repayment period
• Serious implications for government finances and
  debt sustainability

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Implications for debt sustainability

• Public debt 85.8 of GDP of which foreign debt
  37.9 of GDP
• Majority at concessional rates
• Thus far debt service has not been burdensome due
  to low repayment requirements
• In 2006, percentage of concessional debt was 93,
  in 2007 this had declined sharply to 83

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Implications cont.

• As the share of commercial debt increases, the
  burden on debt repayment is likely to increase
  substantially, creating more pressure on state
  finances
• In 2007 total debt service payments was
  equivalent to 32 of government revenue

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Sri Lankas estimated debt repayments
Source External Resources Department of Sri
Lanka
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Macroeconomic Implications

• Nature of repayments comparatively expensive
  and short cycles - implications for Exchange
  rate Balance of
  payments
• Nature of inflows one off disbursement
  impact on liquidity
  (interest rates) and inflation
  exchange rates
• SLs REER depreciated throughout 2007 from Rs.
  101 to Rs. 98 in July but then shot up from
  August (US 500 Mn bond) to reach 106.84 in
  December
• Negative implications for an economy with a weak
  currency and unstable macroeconomic environment

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Concluding Remarks

• In the context of increasing per capita income it
  is necessarily the case that access to
  concessionary financing will decline
• Requirements for financing of infrastructure
  remain high therefore alternative sources are
  needed

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Concluding Remarks cont.

• Urgent need to shift from dependency on foreign
  finance to fund development projects
• It is clear that government expenditure habits
  need to change in the face of changing external
  financing conditions
• Expenditure must be streamlined such that more
  domestic resources are devoted to development
  financing since foreign development finance is
  increasingly expensive

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