Sri Lanka finally reached an agreement with its International Sovereign Bond (ISB) holders earlier this month after four rounds of discussions since last October.
It is expected that the finalisation of the deal will complete Sri Lanka’s debt restructuring if the comparability of treatment is ensured in the debt treatment of various creditors involved.
Agreement between SL and bondholders
Explaining the bondholder debt deal, Capital Alliance Ltd. (CAL) Head of Research Trisha Peries said that the deal had proposed a 28% haircut on the principal of the existing bonds of $ 12.5 billion, while a haircut of 11% had been proposed on the past due interest, which amounted to about $ 1.9 billion.
She noted that in the April proposal by the bondholders, they had not included a principal haircut on the past due interest. “There is an overall 25% coupon reduction based on the calculations by CAL, taking the entire timeline from now until 2038,” Peries said at a webinar held last week.
She added that prior to restructuring, coupons had averaged at 6.8% on a weighted basis versus currently at 5.1% based on the baseline scenario.
Moreover, she said that it was a step-up coupon structure which was anticipated and that there was a difference in treatment until 2027, from 2028 to 2032, as well as from 2033 onwards. “There is a five-year maturity extension where the payments for the existing bonds will start in March 2029 and last until 2038,” she said.
Peries also said that based on their calculations, the overall Net Present Value (NPV) reduction was about 52% based on the baseline scenario. “This is assuming a 12% exit deal that we have assumed within this, based on the discount rates that have been provided by international banks as well as the credit ratings of countries with the ‘BB+’ and ‘CCC’ rating scenarios,” she added.
Agreed-upon debt payments
According to Peries, Sri Lanka will begin principal payments from March 2025 onwards while the coupon payments will happen biannually.
She said that the debt service payments for ISB holders averaged about $ 720 million to $ 750 million from 2024 to 2028 and thereafter, as a result of the step up in the coupon and the maturities, the payments would increase to over $ 1 billion from 2029 onwards.
Sri Lanka has to make total payments amounting to $ 724 million by the end of 2024, which includes a consent fee of $ 225 million to be paid upfront upon finalisation of the debt restructuring agreement and maturity of $ 291 million and coupon payments of $ 208 million.
Peries stressed that the Joint Working Framework needed to be confirmed by the Official Creditor Committee (OCC) for comparable and equitable treatment in terms of the haircut and NPV losses of different creditors, as well as by the International Monetary Fund (IMF) staff to ensure that the debt treatment would reach the debt sustainability targets that have been laid out within the IMF programme.
Governance-Linked Bonds
Peries further said that in addition to the Macro-Linked Bonds (MLBs), there were also Governance-Linked Bonds (GLBs) which were for the proposed plain vanilla bonds and based on Sri Lanka’s performance on the qualitative and quantitative targets provided by the deal.
She said that quantitative targets were the IMF tax revenue targets for 2026 and 2027 while qualitative targets were yet to be mentioned. “If Sri Lanka achieves both of these, there could be a step down in terms of coupons of about 50 basis points,” she added.
Deal sufficiently addresses SL’s concerns: Fin. Min.
Following the publication of the Joint Working Framework earlier this month, the Finance Ministry said in a statement that the Ad Hoc Group of Bondholders had submitted a new proposal which made further adjustments to address Sri Lanka’s concerns on the four outstanding points in April.
It said that during the negotiations in Paris, further adjustments had been agreed upon in a Joint Working Framework, where the choice of baseline parameter – the IMF baseline from the second review of the IMF-supported programme in June – would be applied.
Inclusion of downside risk, where additional downside scenarios were included, provides Sri Lanka with further debt relief in case of an adverse macroeconomic outcome.
Another adjustment was the choice of trigger, where Sri Lanka had concerns regarding the bondholders’ preference for a single trigger due to a perceived risk of nominal US Dollar Gross Domestic Product (GDP) increasing only based on currency appreciation as opposed to real GDP growth.
In the absence of real GDP growth, there could be a risk of higher payouts being triggered without a concomitant increase in Government payment capacity. Therefore, a ‘control variable’ which captures real GDP growth as well, was agreed upon.
Finally, a share of upside was agreed upon, where the upside thresholds and payouts were adjusted to ensure a more balanced share of upside between the creditor and the debtor. The Finance Ministry said that the upside/downside trigger was calculated based on the average US Dollar GDP during the years 2025-2027.
In 2023, US Dollar nominal GDP was $ 84.4 billion. Taking Sri Lanka’s nominal USD GDP average annual growth in the last 10 years, it was 1.5% per year. Taking the last five years pre-pandemic (i.e. 2015-2019), it was 2.4% per year (in 2015 GDP was $ 79.4 billion and in 2019 it was $ 89 billion).
“Hypothetically, if USD GDP were to grow by 4% each year during the period 2024-2027, the resulting upside trigger, average USD GDP during 2025-2027, would be $ 95 billion,” the Finance Ministry statement said.
At a trigger of $ 95 billion, according to the Joint Working Scenario in June and subject to the control variable being satisfied, threshold three would be triggered, resulting in a nominal principal haircut reduced from 28% to 20%. At this threshold, the NPV effort at an 11% discount rate would be 35%.
The Finance Ministry said that the Joint Working Framework negotiated with the bondholders provided a fair balance of risk sharing and sufficiently addressed the concerns of Sri Lanka and the requirements of bondholders.
“The MLB structure, following the adjustments made through the evolution of the proposed instrument, enables the appropriate sharing of upside between creditors and the debtor, whilst also ensuring that in this process, the debt sustainability of the debtor sovereign is not compromised,” the authorities said.
SL’s deal with bondholders a test case for the world
Bloomberg said that Sri Lanka’s resolution with the bondholders was a test case for the world where the creditors were ready to walk away from 28% of their unpaid $ 12.5 billion principal, provided most of the rest got swapped into new bonds tied to the value of GDP.
It said that it was important to remember that two out of five sovereign debt recasts led to borrowers ending up as basket cases, returning for three or more rounds of relief. This happens as creditors squeeze more repayments than poor or middle-income nations can afford. Or, governments – having won a reprieve – go back to lax taxation and unsustainable spending.
Bloomberg also said that pegging debt servicing to output measured in dollars was problematic as the debtor might appear to be generating incomes to repay creditors when that was not the case.
“That’s because nominal GDP can just as easily get a boost from steeper prices as higher production. And the dollar value of goods and services can rise if the local currency appreciates. Both things happened last year,” it added.
Therefore, the authorities have persuaded the lenders to accept a second test where the creditors will be given their upside only if the cumulative real GDP growth between 2024 and 2027 turns out to be higher than the IMF’s projection of 11%. Conversely, Sri Lanka will get the promised downside protection only if growth is below 11%.
Additionally, the parties have agreed to incorporate features of a so-called GLB in that part of the debt will not be tied to GDP. How governance will be measured has not been disclosed. However, the Colombo-based Verité Research, which made the proposal, has suggested steps to curb corruption, strengthen banks, and improve tax collection.
“If the nation of 22 million meets these goals, creditors should accept a discounted coupon even on vanilla bonds. These are currently designed to offer a higher rate every few years, rising to 9.25% by 2033,” the Bloomberg report said.
Lessons learnt globally quicken SL’s deal
Speaking to The Sunday Morning, Frontier Research Macroeconomic Advisory Head Chayu Damsinghe said that the risk of the previous proposal by bondholders in April was that Sri Lanka could still fall into a recession, whereupon the currency could appreciate, causing the dollar GDP to rise, with the country still having to pay more.
He said that in terms of what the Government had originally proposed and the Joint Working Framework, Sri Lanka could avoid such a situation by having the real GDP. “It has avoided a loophole which was in the earlier proposal,” he added.
Addressing whether the deal agreed upon by both parties was ideal or not, he said: “Whatever the content, Sri Lanka, which is currently going through restructuring, as well as Zambia, Ghana, and Suriname, which have defaulted around this period and are currently restructuring, still do end up having many of their payments due after the restructuring in the second half of the 2020s and the early 2030s. It is neither positive nor negative; you still need to get through that period in the future,” Damsinghe said.
According to him, since it is a complicated negotiation, it cannot be determined at present whether the deal agreed upon by both parties will prevent such a scenario in the future. However, he said that the deal was in line with what he would have expected for a country like Sri Lanka at this point in the world market.
Damsinghe noted that the reason why Sri Lanka was able to get through the bondholders quicker than other countries which had defaulted earlier was because the same people were involved in this process globally. “Sri Lanka having better fiscal performance probably helped,” he added.
Bondholder proposal enough to meet IMF targets
Speaking at a webinar held on Tuesday (9) by CT CLSA Securities, former Governor of the Central Bank Dr. Indrajit Coomaraswamy said that the Joint Working Framework was structured in such a manner that it was intended to meet the IMF targets and that the authorities were simply waiting for IMF confirmation that it was satisfied that this package would meet those targets.
He noted that the IMF had rejected the proposal put forward by bondholders in March, saying that it was not sufficient to meet the targets. “Therefore, one would imagine the bondholders this time ensured that it would meet the targets. I think that this particular set of proposals is more than enough to ensure debt sustainability,” he added.
Sri Lanka is among the first countries where debt restructuring was based on the IMF’s new Debt Sustainability Analysis (DSA) framework – the Sovereign Risk and Debt Sustainability Framework for Market Access Countries (MAC-SRDSF).
According to Sri Lanka’s DSA as per the MAC-SRDSF model, the following targets would need to be achieved in order to restore debt sustainability in the country:
- Public debt-to-GDP should reduce from 128% of GDP in 2022 to less than 95% of GDP by 2032.
- Gross Financing Needs (GFNs) as a percentage of GDP should reduce from 34.6% in 2022 to less than 13% on average during the period 2027-2032.
- Foreign currency debt service as a percentage of GDP should reduce from 9.2% of GDP in 2022 to no higher than 4.5% of GDP per annum during the period 2027-2032.
Questions remain on ISB deal
Speaking at the webinar, World Bank Lead Economist and Programme Leader for Sri Lanka, Nepal, and the Maldives Gregory Smith said that there were a few questions left in the bondholder deal, particularly about the GLBs where one or two of the plain vanilla bonds would be converted to a governance bond and where details of the triggers were needed for those bonds.
“At least in my opinion, it looks as if the bondholder deal is enough for the IMF to accept it from a DSA perspective,” he said.
Smith added that it was interesting how the official creditors looked at the deal, since a few years ago, comparability of treatment was very much a notional thing and was agreed upon among human beings, a practice which had shifted in the last five years.
He noted that bilateral creditors did not mind taking a maturity extension as long as there was no haircut, while private creditors would not mind taking a haircut as they wanted quick cash flows. However, Smith said that there was a question of whether the comparability of treatment would be assessed using the IMF baseline or the probabilistic approach.
“My view is that the Paris Club tends, at least from recent papers, to think about the comparability of treatment in an NPV sense using various discount rates – not just the 5% in IMF and World Bank DSAs, but also discount rates that are a bit higher – towards the 11% the Ministry of Finance published, which the bondholders were most likely to use,” he said.
As a whole, he said that there was enough there for the OCC to accept the deal on the comparability of treatment, but noted that “it really depends on their methodology”.
SL still has massive debt interest burden post-restructuring
Smith said that Sri Lanka still had a massive debt interest burden post-restructuring, given that the DSA, published in 2022, had not required a large debt reduction, partly because it was on the foreign exchange and growth forecast.
He said that when the economy did better than expected and outperformed the targets, the mileage needed to get to the debt targets was much smaller. “The people haven’t been able to change that in the last 18 months, so I think this deal reflects the DSA and therefore it must be commended,” he added.
He said that the caution had to do with the fact that when a country was coming out of restructuring with 50% of revenue taken by debt interest payments, it was on a ‘knife edge’ – which was the term the IMF had used.
In March, IMF Senior Mission Chief for Sri Lanka Peter Breuer told reporters in Colombo that Sri Lanka’s path to debt sustainability was on a knife edge path although there were green shoots in the economy.
Therefore, Smith said that it was going to be incredibly hard for Sri Lanka to perform this balancing act, while on the other hand it might be able to outperform on growth.
Standard Chartered Bank
Standard Chartered sees a high probability of Sri Lanka getting a principal haircut of less than 20% for the GDP-linked bonds as the nominal GDP is expected to grow.
Accordingly, Standard Chartered expects gradual and modest rupee depreciation versus the US Dollar, projecting the US Dollar to be at Rs. 390 as of end-2027.
As a result, the GDP projection of the 2024 GDP is expected to be in the $ 89-91 billion range and nominal GDP above $ 96 billion as of end-2027.
“We therefore assign a high 75% probability of the average 2025-2027 nominal GDP being above $ 92 billion,” Standard Chartered said.
The average 2025-27 nominal GDP threshold is specified as US Dollar 88.6 billion (IMF forecast) and the upward adjustment on repayments kick in if average nominal GDP crosses the thresholds of $ 92 billion, $ 96 billion and $ 100 billion.
Citibank
Citibank favours selling Sri Lanka’s restructured dollar bonds before the election if they reach fair value in the range of 60 cents on the dollar.
According to Bloomberg, Citibank analysts state that positive economic developments and demand for the bonds – as there aren’t many high-yielding sovereign bonds available in Asia – would raise the price of the bonds.
Therefore, Citibank said that it favoured selling Sri Lanka’s restructured US Dollar bonds before the election if the fair value of the restructured bonds were in the range of 60 cents on the dollar.