• Title of the article: The Desirability of Domestic Debt Restructuring

• Source: Verité Research
• Date published: 13/09/2025
• Link to the original article: https://www.veriteresearch.org/wp-content/uploads/2022/10/VR_EN_BN_Oct2022_Desirability-of-Domestic-Debt-Restructuring.pdf?

Restructuring of the domestic debt

      This is a very important process that Sri Lanka must go through to ensure that its economy is stable and healthy again. Sri Lanka is steering through one of the worst economy crises of its history with an alarming rate of debt-to-GDP ratio of approximately 121%. The foreign and domestic debt of government has led the country to the verge of financial collapses. Though there has been much emphasis on international debt restructuring, the much ignored but equally important restructuring of domestic debt is central to restoring macroeconomic stability, fiscal sustainability, and fair growth.

What is Domestic Debt Restructuring (DDR)?

The restructuring of domestic debt is a renegotiation of the terms of government debt owed to local creditors, such as the extension of maturity dates, or the repricing of interest rates or rescheduling of payments. This is in contrast with external debt restructuring which involves foreign creditors.

The domestic debt which is mainly in Sri Lankan rupees is currently approximately 59 percent of the overall public debt in Sri Lanka. The problem is in high interest rates (usually over 20 percent), the increase in debt stock through refinancing at high yield and the effect this has had on local financial institutions which are much exposed to government securities.

The Reason why Sri Lanka needs DDR?

• Improving Debt Sustainability:

 Studies indicate that restructuring of the external debt will not suffice, unless there is domestic debt restructuring, the debt to GDP ratio could increase to 139 percent within the next ten years. The extension of maturity of domestic Treasury Bonds at no reduction in the coupon can work the ratio to approximately 103, which is a much better and more manageable number.

• Macroeconomic Stability and Inflation:

The high interest rates on debt rollover stimulates the inflation and money growth. DDR would assist in lowering the cost of government borrowing, decreasing inflation rates, which are currently standing at more than 60 per cent and stabilizing the rupee.

• Strengthening Financial Institutions:

Sri Lankan banks and pension funds are heavily dependent on coupon income on domestic government bonds and therefore coupon reductions are not desirable because they provide a risk to the stability of the financial sector. The DDR strategies prefer to roll over maturities with regulatory cover to soften this shift.

• Prevention of Future Debt Crises:

It is common to see countries go through various debt restructurings unless fiscal discipline and credible policy frameworks are put in place. DDR can establish fiscal buffers to Sri Lanka to better absorb external shocks and minimize the probability of recurrence of crisis.

• Justice in the allocation of the crisis expenses:

 DDR provides a more specific and equitable solution to the reduction of the debt burden of the government than either increasing taxes or inflation which impact more on the middle and lower-income group.

Recent Developments and Government Measures

The Sri Lankan government has also been keen on negotiation with local creditors to agree on new repayment conditions and also attempting to restructure its external debts. Multilateral organizations such as the International Monetary Fund (IMF) also stress on DDR and reforms as a key to the sustainable recovery.

Based on the current research and findings:

• The government suggests the extension of the maturity of domestic Treasury Bonds to 10 years (reprofiling) without a decrease in coupons or the principal.
• The financial states of the banking sector and other financial institutions will need recapitalization assistance in the process.
• The success of the restructuring will rely on transparency and fair participation of the creditors.
• DDR will be needed in order to ensure that IMF standards are met and investor confidence is restored.

Global Context and Lessons:

Sri Lanka is not the only country that has been pursuing its domestic debt restructuring. To different extents, maturity extensions, coupon cuts, and face value haircuts have been utilized by countries like Greece, Barbados, Jamaica and Cyprus.

 Effective restructurings make it a rule not to include short-term treasury bills as this will cause market disruption.

Deep face value depreciation increases net present value (NPV) losses but could be required based on the state of the economy.

Challenges and Risks:

• DDR may request domestic creditors to suffer losses, and this will ultimately affect the country on its own.

• The DDR plan proposed by the government is expected to cut down debt servicing payments by approximately 1.5 percent of the GDP, whereas the IMF estimates higher cuts (approximately 15 percent) to make the fiscal sustainable.

• Maintaining the inflation regulation plus monetary growth to finance debt repayments is a complicated issue and demands both the fiscal and monetary policies.

 Conclusion

 A Path Forward Sri Lanka has a twin deficit issue, i.e. a fiscal deficit and, a current account deficit, which have been heavily financed by domestic debt. Devoid of restructuring this domestic debt and external restructuring, there is the risk of the country sliding into years of financial turmoil, inflation, and recurring debt crises. Restructuring of domestic debt through maturity extension and favorable financial sector interventions provides an effective route through which the economy can be brought to its senses and confidence is rebuilt and recovery is enhanced in an equitable manner. This process must be transparent, involve creditors and be accompanied by structural reforms to guarantee long-term sustainability. This is a hard road to go through, and with extensive DDR and profound reforms, Sri Lanka will be able to recover a strong economy that will be able to grow and flourish.