The third research note published by the Verité Research Sri Lanka Economic Policy Group presents an analysis by Professor Udara Peiris, Oberlin College, USA, explaining four ways in which Sri Lanka would benefit if the government were to restructure its domestic debt. The analysis finds that, if the government were to act soon and restructuring is carried out early, economic policy goals could be achieved without needing to impose ‘haircuts’ on coupons or capital of domestic creditors. It would be adequate to simply reprofile its domestic debt, i.e. move repayments further into the future. On 12th April 2022, the Sri Lankan government announced a standstill on debt servicing to external creditors. Domestic debt was not subject to this standstill. Although, the real value of those domestic debts already has been considerably eroded by inflation, the cost to government of rolling over maturing domestic debt remains very high. It is currently paying around 30% annually for new loans. There is understandable concern about the implications of any domestic debt restructuring for the domestic banking system, the national economy, and pension funds. A follow-up analysis will be released to explain how the consequences can be constructively addressed. The current analysis focuses on the benefits of domestic debt restructuring. Provides a quicker path to debt sustainability and economic recovery. It is likely that the best debt restructuring package that the country can obtain from its external creditors will still leave Sri Lanka with severe problems of financial (in)solvency and debt sustainability. Assuming that Sri Lanka manages to negotiate a haircut on (International Sovereign Bonds (ISB)/Sri Lanka Development Bonds (SLDB) of 50% and a 25% haircut on multilateral/bilateral loans, the ratio of debt to GDP is still projected to rise to 136% by 2032. However, if the maturity of domestic treasury bonds were simultaneously extended by 10 years, the ratio of debt to GDP would rise to just 101% in the next 10 years. Provides a foundation for recovering macro-stability. Government’s debts are so large relative to the size of the national economy that the Central Bank is unable to tame very high inflation purely through monetary policy. The continuing high cost of rolling over government’s domestic debt will perpetuate the problem. The interconnectedness of fiscal solvency and inflation makes monetary policy less effective, even with high interest rates that have a negative impact on investment and growth. Domestic debt restructuring will provide a foundation for resetting these negative dynamics and achieving conditions conducive to economic growth, with reduced interest rates and reduced inflation. Achieves a more targeted and progressive sharing of the adjustment burden. The present path of quietly restructuring domestic debt through high inflation disproportionately hurts Sri Lanka’s wage-dependent working population and increases poverty. Reducing domestic debt through explicit restructuring allows the costs to be targeted progressively to those sectors of the economy that are most equipped to bear the burden of debt reduction. Reduces the risk of repeating the present debt crisis in the medium term. It is not unusual for countries that enter into insolvency and debt restructuring to fall back repeatedly into the same set of problems. The main reasons are poor governance, over-optimistic fiscal targets, and shallowness of the debt restructure. Currently Sri Lanka faces high risks in all three areas. If interest rates remain at current levels and the government’s highly ambitious targets for increasing revenue are not fully met, the country faces the prospect of a relapse into another debt sustainability crisis in the medium-term. An early domestic debt restructure can mitigate that risk – even though it cannot compensate for the continuing risks of poor governance. The Verité Research Sri Lanka Economic Policy Group was formed to contribute workable, analytically evaluated, durable solutions for economic recovery. The core group consists of four international and local economists. They are supported by an expanded team of local and international economists and researchers. The core group members are: Prof. Dileni Gunewardena, Prof. Mick Moore, Dr. Nishan de Mel, and Prof. Shantayanan Devarajan.