The depreciation of the rupee against major foreign currencies has resulted in the expansion of government debt in rupee terms by Rs. 131 billion in 2008 and accounted for 70 percent of the Rs. 130 billion foreign debt stock accumulated during the year, the Central Bank says in a report.

The bank’s report ‘Public Debt Management in Sri Lanka: Performance in 2008 and Strategies for 2009 and Beyond’, said of the overall outstanding foreign debt amounting to Rs. 1,615 billion as at end 2008, 43 percent of this, or Rs. 698 billion, is the result of the depreciation of the rupee.

"The annual increases in the outstanding foreign currency debt portfolio in local currency terms are very much higher than the net foreign currency borrowings during the year, due to the depreciation of the rupee against major loan currencies. The depreciation of the rupee has a serious impact on the country’s public debt management," the report says.

In 2008, the rupee depreciated by almost 30 percent against the yen (30.8 percent of the foreign currency debts are from Japan), 4.1 against the dollar and 1.6 against Special Drawing Rights (this is the unit of the IMF and other international institutions based on a basket of key international currencies.

While the Central Bank was faulted by many for depleting foreign reserves to maintain a stable exchange rate, thus triggering a balance of payments crisis, the bank’s Governor Ajith Nivard Cabraal told journalists at the launch of the report that the depreciation of the rupee had to be checked to avoid difficulties in meeting the country’s foreign commitments.

"Many looked only at the export sector. But there are other stakeholders as well. We were not blinded by a few numbers but looked at the bigger picture," Cabraal said.

The Central Bank has allowed the exchange rate to be flexible by limiting their intervention during the past few weeks which saw the dollar reach to Rs. 116 against the rupee, which many analysts claim is a precondition for the IMF US$ 1.9 billion standby facility.

In 2008, the total borrowings from domestic and external sources amounted to Rs. 559 billion and Rs. 130 billion respectively. Thereby, the debt stock increased by 689 billion during the year, within the Parliament approved borrowing limit of Rs. 708 billion.

As at 2008, outstanding debt amounted to Rs. 3,578 billion which was 81.1 percent GDP. The public debt to GDP ration has been declining over the past few years.

Total interest costs amounted to Rs. 212 billion.

The Central Bank says steps will be taken to contain public debt at a sustainable level and enhance the efficiency of the Treasury securities market.

"With the emerging issues in the domestic and global markets, it has become important to find alternative external funding to maintain stability of the domestic debt market, while meeting the government’s borrowing requirement at the lowest possible cost with a prudent degree of risk," the Central Bank said.

Not withstanding political rhetoric on the issue, external funding is crucial to carry out the development objectives of any country given the basic economic problem of scarce resources. The more debt a country is able to accumulate the better. But what really matters is the management of debt.

In its 2008 Annual Report the Central Bank warns that the government’s domestic borrowings could increase sharply in 2009.

"2009 will be a challenging one in terms of fiscal operations in the midst of the continuing global financial crisis and economic slowdown coupled with the need for accelerating the humanitarian and development activities in the newly liberated areas," it said.

It warns that government revenues could further decelerate if economic activities contract during the year.

The Central Bank observes that government borrowing from the banking system has far exceeded original targets, posing a major challenge to contain inflation.

"In addition, the higher domestic borrowings, especially to meet recurrent expenditures, pre-empts the available resources for public investment, thereby seriously affecting the future growth potential of the country, which is a huge opportunity cost compared to the benefits that can accrue to the country from capital investments in the future," the Central Bank says.

Total expenditure and net lending amounted to Rs. 996 billion, below the Rs. 1,044 billion target due to the lower than expected capital expenditure. Recurrent expenditure on the other hand over shot estimates by Rs.31 billion.

Given the importance of developing the Northern and Eastern provinces, after the war on terror comes to an end, the Central Bank goes on to say that government should adopt measures to minimize the revenue shortfall and control additional expenditure.