• Warns of potential flaws in IMF debt sustainability analysis (DSA)
• Calls for stricter debt constraints and a revised restructuring approach

Sri Lanka is making a mistake by going forward with the existing international bondholder deal as the country more broadly shows the problems created by a flawed debt sustainability analysis (DSA), a sovereign debt expert said.

According to sovereign debt expert and Senior Fellow at US based think tank Council on Foreign Relations (CFR) Brad Setser, Sri Lanka’s new government is making a mistake by going forward with the bondholder deal announced by the previous government just before the election.

“Sri Lanka more broadly shows the problems created by a flawed IMF debt sustainability analysis,” he said on social media platform X, adding that the market access DSA was not ready for prime time.

He added that the fact that Sri Lanka wasn’t in the “common framework” is in fact significant but rather because it was judged on the market access debt sustainability framework.

Setser said that the framework didn’t constrain debt service to revenue or the net present value (NPV) of external debt, and set generous limits on the total amount of public debt: 105% of GDP in 2028, 95% in 2032.

He added that the bonds though pushed back against the low GDP forecast in the baseline, and got a structure that gives more upside to the bonds if Sri Lanka 2025-2027 GDP is above the IMF forecast (it will be -- the “base case” has a GDP of $ 90 billion and GDP is currently ~ $100 billion) resetting debt service up based on higher levels of GDP without resetting the debt to GDP target (which has as high balled as GDP was low balled in the programme) creates very high odds that Sri Lanka will be back in default in 2028 or 2029.

“When it had to re-access markets that meant the bonds could rally to par as conditions improved, and the country had a realistic path to returning to the markets to do more than just raise money to finance the early amortisation of its previously restructured bond,” he said.

Setser said Sri Lanka’s restructuring did not go off track because of processing or being outside the common framework, “it went off track because the IMF didn’t set out constraints on key debt variables and the IMF somehow concluded Sri Lanka had a very high public debt carrying capacity,” he said.