Sri Lanka bonds yields soar amid tax changes

ECONOMYNEXT – Sri Lanka’s bond yields rose sharply as the market took stock of two tax changes coming into effect from April, with auctions yields rising around 80 basis points for longer term maturities, dealers said.

A 10-year bond maturing on 01.09.2028 were sold at the action at a weighted average yield of 11.18 percent, up from 10.30/35 percent levels before the auction for the same maturity. The cut-off estimated at around 11.75 percent at least.

The auction has a settlement date of April 02.

On earlier auctions, investors bid at a so-called gross rate including a 10 percent withholding tax, and paid the debt office cash 10 percent lower after deducting withholding tax upfront.

From this auction, primary dealers bid at the ‘gross rate’ and also paid the cash to the debt office at the same rate with ‘up front withholding tax’ no longer deducted.

Many clients therefore demanded higher rates (a gross rate) than earlier, dealers said. Under the earlier system the Treasury ‘paid’ a higher rate, and collected 10 percent as taxes as a book entry.

However in another damaging tax change, the new administration drove individual investors out of bond markets into bank fixed deposits.

Individual investors were driven out the bond markets with high income tax rates (24 percent or higher) for interest, compared to only a 5 percent final tax for bank fixed deposits. Companies have to pay at their income tax rate.

Analysts had warned authorities that money will flow out of bonds into fixed deposits due to this tax differential, but the warnings were ignored. (Uncertainty roils Sri Lanka bond markets after tax reversals).

Many money market mutual funds had faced big outflows as a result of the tax differential.





While some individuals may get into government securities in the short term because they are more liquid, many are unlikely to return, dealers say, making for permanently higher rates for gilts.

On Thursday morning there were no active quotes in the secondary markets as dealers and investors took a wait and see attitude. Dealers are expecting the market to settle at higher rates as the tax effects become clearer.

But there were isolated quotes for 10.70/11.00 percent for the 2023 bond, dealers said. (Colombo/Mar29/2018)

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