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Thursday June 8th, 2023

Sri Lanka private creditors mull GDP-linked downside bond for debt re-structure

ECONOMYNEXT – An offer to exchange Sri Lanka’s defaulted bonds with a new sovereign security which will pay less if the island’s future economic growth is lower than expected, is under consideration among investors, sources said.

Sri Lanka defaulted on its external debt in April 2022 after printing money to target what state economists said was a ‘persistent output gap,” after growth fell in the wake of two currency crises triggered in the process of injecting liquidity to target 5 percent inflation.

Sri Lanka’s private and official creditors have to re-structure debt, that will bring the gross financing need (GFN) or the total debt rolled over and new deficit financing down to 13 percent of gross domestic product from 2027 to 2032, under an International Monetary Fund backed plan to get the country out of bankruptcy.

Of that foreign debt service is 4.5 percent of GDP.

However, many private foreign creditors believe that Sri Lanka’s projected growth of around 3 percent in the few years by the International Monetary Fund are too pessimistic, according to sources with knowledge of the discussions.

A lower GDP number would also squeeze the 4.5 percent foreign debt service ceiling, pushing foreign creditors to take deeper losses than they would take if actual growth was higher.

If the macro-economic framework particularly the GDP and the foreign exchange projections, are “reasonable” bondholders would close a deal very quickly, perhaps as early as June 2023, sources said.

If there are disagreements over growth projections, negotiations could drag on for “years” as creditors waited to see whether actual growth would be higher than projections.

A way out of the potential deadlock would be to issue a new bond linked to economic performance, generally known as a State Contingent Debt Instrument or SDCI.

“By tying the payments of restructured debt contracts to future outcomes, SCDIs may reduce conflicts over current valuations and facilitate more sustainable agreements between creditors and debtors,” according to an IMF paper in which Sri Lanka’s Senior Mission Chief Peter Breuer was a co-author.

In past sovereign workouts, an SCDI called a value recovery instrument (VRI) which will pay more if a country outperformance projections, have been used.

VRI are not bonds, but warrants and had been shunned by most bond investors. They were traded close to zero at the beginning and were not index eligible. As a result, bond investors had to sell them, perhaps ate a loss usually to hedge funds, reducing their attractiveness.

“Fixed-income investors have typically steeply discounted these “equity-like” instruments given their nonstandard designs, illiquidity, and idiosyncratic risk profiles; hence they have often provided poor value for their cost to borrowers,” according to the paper.

What is now contemplated by some bondholders is not a VRI but a bond, which will start out with more optimistic assumptions. Its cashflows will fall if actual growth falls to levels projected by the IMF.

“In Surinam and Zambia the difference expectations or projections by the IMF and creditors have led to a deadlock in the re-structuring negotiations,” the source said.

“I hope we will be able to avoid it and we can find a compromise.”

Over 75 percent of Sri Lanka’s current bond holders are estimated to be long term investors who had bought bonds close to par including at launch, according to the source.

“That is why they are not going to agree to silly economic assumptions,” the source said. “That is why also in case there is no way to bridge the gap between expectations, the re-structuring could last years.”

Public IMF projections show a growth of around 3.1 percent in the next few years. When Sri Lanka started flexible inflation targeting cum output gap targeting, the country’s ‘potential output’ was calculated at over 5.0 percent. (Colombo/Mar22/2023)

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Sri Lanka’s shares slip on profit taking and selling pressure

ECONOMYNEXT – Sri Lanka’s shares closed lower on Wednesday after four consecutive gains in previous sessions spiraled into selling interest and profit taking, an analyst said.

The main All Share Price Index was down 0.28 percent or 24.39 points to 8,722.06, this is the lowest the index has been since May 02, while the most liquid index S&P SL20 was down 0.40 percent or 9.92 points to 2,468.44.

“The market was gaining in the previous sessions and there is selling and profit taking present today, due to continuously being on green,” an analyst said.

In the previous sessions the market was seeing gains, due to lowered policy rates and low inflation stimulating buying interest and driving the sentiment up, an analyst said.

Sri Lanka’s inflation in the 12-months to May 2023 has eased to 25.2 percent from 35.3 percent a month earlier according to a revised Colombo Consumer Price Index calculated by the state statistics office.

The central bank cut the key policy rates by 250 basis points to spur a faltering economic growth as inflation was decelerating faster than it projected.

“There are gradual improvements in the market sentiment, with positive sentiments coming in from lowered policy rates and inflation,” an analyst said.

The market generated foreign inflows of 12 million rupees and received a net foreign inflow of 18 million rupees, due to low share prices and discounted shares followed by a dividend announcement.

The market generated a revenue of 554 million rupees, this is the lowest the turnover has been since May 10, while the daily turnover average was 1 billion rupees. From the total generated revenue, the banking sector contributed 120 million rupees, Diversified Banks contributed 115 million rupees and the Capital Goods Industry generated 78 million rupees.

Top losers during trade were Sampath Bank, Commercial Bank and Aitken Spence. (Colombo/June06/2023)

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Sri Lanka Treasuries yields plunge, 12-month down 318bp

ECONOMYNEXT – Sri Lanka’s Treasuries yields plunged across maturities at Wednesday’s auction with the 12-month yield falling 318 basis points, in one of the biggest one day falls, data from the state debt office showed.

The 3-month yield fell 244 basis points to 23.21 percent.

The 6-mont yield fell 339 basis points to 21.90 percent, along with the 12 months to 19.10 percent.

The short-term yield curve is inverted.

The central bank last week cut its policy rate 250 basis points in a signaling move but is not printing money to enforce the rate cut.

The debt office sold all 140 billion rupees of offered securities. (Colombo/June07/2023)

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Sri Lanka forex reserves rise US$722mn in May 2023

ECONOMYNEXT – Sri Lanka’s foreign reserves grew 722 million US dollars to 3,483 million US dollars in May 2023 from 2,761 million US dollars in April, official data showed as deflationary policy and weak credit reduced ‘above the line’ outflows.

Sri Lanka lost almost all its reserve in over two years as the central bank sold reserves and printed money to keep rates down (sterilized reserves sales) including borrowed dollars from India.

Gross official reserves fell to a low of 1,705 million US dollars in September 2022.

Sri Lanka’s central bank hiked rates in April 2022 to slow credit and also stopped printing money after it ran out of borrowed Asian Clearing Union dollars from India.

Sri Lanka’s gross official reserves are made up of both monetary reserves of the central bank and any balances of the Treasury account from loans or grants it gets.

The central bank’s net foreign reserves are still negative after busting up borrowed reserves to suppress rates. By April (before the collection of reserves in May) the central bank’s net reserves were negative by 3.7 billion US dollars.

In May alone 662 million US dollars were bought from the market, Central Bank Governor Nandalal Weerasinghe said.


No pre-determined level to stop Sri Lanka rupee appreciation: CB Governor

Borrowing dollars through swaps and busting them up, was invented by the US Federal Reserve as it was printing money and breaking the Bretton Woods system in the early 1970s.

Sri Lanka received a 350 million US dollar tranche from the Asian Development Bank and 331 million US dollars from the IMF to the Treasury for budget support.

The loans can be sold to the central bank by the government to generate rupees and spend. However, since credit is weak, not all the inflows go out of the country particularly as the central bank is conducting deflationary open market operations on a net basis.

By allowing the rupee to appreciate unlike in previous episodes of recovery in an IMF program, after a bout of money printing, the central bank is bringing down inflation – in some cases absolute prices – and restoring confidence and easing the ‘pain’ of ‘monetary policy’ or stimulus.


Why is Sri Lanka’s rupee appreciating?

Though exports are falling, tourism revenues are also picking up.

The budget support loans, tourism receipts less the reserve collected will widen the trade deficit. Building foreign reserves involves lending money to the US or other western nations and is similar to repaying foreign debt. (Colombo/June07/2023)

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