MP Mahinda Rajapaksa miscalculates the increase in debt and its causes

Fact Check

On 12 January 2019, The Island newspaper quoted MP Mahinda Rajapaksa making the above statement.

MP Rajapaksa makes two claims here:

1.The UNP government has borrowed the equivalent of 50 percent of the total national debt that was outstanding as at December 2014; and

2. If the current government is borrowing only to pay off previous debt, then the total outstanding debt in the country cannot increase.

An analysis of the data shows that MP Rajapaksa is incorrect about both these claims.

Claim 1:
Exhibit 1 shows, in both LKR and USD, the total domestic and foreign debt as at end of 2014 (end of Mr. Rajapaksa’s presidency) and also at the end of September 2018 (the latest month for which data was available at the time Mr. Rajapaksa made the statement). Our calculations show that the increase in total outstanding debt accumulated under the current government was 35.9 per cent of the total national debt as at December 2014, and not 50 per cent, as claimed by MP Rajapaksa.

Claim 1 is therefore false.

Claim 2:
The second statement would be correct, if debt was received at zero interest, and required only capital repayment. However, “paying off” previous debt involves not just paying off capital payments but also paying off interest payments. Unless the government has excess revenue after meeting its other obligations, interest payments have to be met by incurring additional debt. This additional debt then requires further interest payments, which have to be met through incurring further additional debt and so on. Therefore, contrary to what Mahinda Rajapaksa states, total debt does increase even if the government is borrowing only to “pay off” previous debt.

Therefore, claim 2 is also false.

Thus, we have categorised MP Rajapaksa’s statement as FALSE.

How much did debt increase due to borrowing to pay interest on debt that was outstanding as at 2014?

Exhibit 2 shows the interest costs incurred from 2015 to September 2018 in servicing the debt that was outstanding in 2014. This cost is estimated at LKR 2,059 Bn, which is 24.8% of the debt outstanding in 2014. Therefore, this is the amount by which total outstanding debt had to increase, by September 2018, even if the current government did not engage in any further borrowing to meet its other expenditures, but only borrowed to pay interest. Please see * references for the interest rate assumptions used in this calculation.

Continue reading to for a deeper analysis and to understand a potential means of making misleading claims about debt.

Much of the misunderstanding found in the media about increase in debt seems to be based on manipulating the consequences of currency depreciation on foreign debt, and reporting it as an increase in borrowing. Foreign debt is secured at much lower interest rates in foreign currency terms compared to debt in local currency. But if foreign debt was in-fact much cheaper, there is no good reason to borrow in local currency. However, the basic financial principle of “no-free-lunch” applies. In addition to the explicit interest cost, foreign debt also has an implicit interest cost that comes in through currency depreciation. Consequently, borrowing in currencies with relatively less depreciation (e.g. historically the Indian Rupee), will have relatively lower explicit interest rates.

If someone were to convert the foreign debt outstanding in 2014 to LKR at the 2014 rate, and compare that against the total LKR value of the foreign debt in 2018 at the 2018 LKR rate, they would get a higher number as the percentage increase in debt (in fact, the claim of a 50% increase in debt, as made by MR, can be constructed in this manner). But such a calculation falsifies the increase in government borrowings. Because, even if there was zero increase in USD debt, such a calculation would still present the debt as having increased significantly (in LKR terms), by using two different conversion rates to compare the USD debt in 2014 against the same amount of USD debt in 2018.
If the USD debt in 2014 had in fact been converted to LKR terms at that time, it would have incurred the much higher interest cost that applies to LKR debt, making explicit the interest cost that is implicit (through depreciation) in servicing debt in USD terms.

Exhibit 1: Value and Growth in Government Debt (2014 and Sept 2018)