The Democratic Socialist Republic of Sri Lanka made a highly successful return to the international bond markets on Thursday with a $1.5 billion bond issue, attracting record-breaking demand despite tight pricing relative to secondary market levels.
The final order book stood at $11 billion, which was not only a record for the single-B rated country but was also strong by the standard of recent emerging market deals, which have benefited from high liquidity thanks to robust emerging market fund inflows.
By contrast, Sri Lanka’s last $1.5 billion two-tranche international bond deal in July 2016 attracted a $5.5 billion peak order book.
But timing is everything, and the B1/B+/B+ rated sovereign chose it well. The deal hit a clear market in a quiet week marked by two public holidays in Hong Kong.
More importantly, it also came one day after the IMF announced it had reached a delayed staff level agreement to disburse the next tranche of funds as part of the country’s three-year Extended Fund Facility (EFF).
This may give the sovereign’s secondary market spreads additional momentum. They performed well in April after a difficult March when IMF-related fears caused a four point sell-off from peak to trough. As a result, Sri Lanka was the worst performing country component of Markit's iBoxx ADBI index, down 9bp over the course of the month.
But the government’s benchmark 6.875% January 2026 bond has re-bounded two points since a March 12 low point and was trading around the 105.5 level to yield 6.04% when the new deal was announced Thursday morning.
This provided the main comparable for the new 10-year Reg S/144a offering, which was priced at par on a coupon and yield of 6.2%. It had initially been marketed around the 6.25% level.
The new bond offered a 16bp premium for a 10-month maturity extension over the July 2026 bond, which was in turn was trading at a 27bp premium over the sovereign's July 2025 bond.
China makes its mark
One of the most notable aspects of the new transaction was its syndicate. A regular quartet of banks — Citi, Deutsche Bank, HSBC and Standard Chartered — were present. But the central bank’s funding team also added three more.
One was emerging market’s stalwart, JP Morgan. The two most striking additions were Chinese: Citic CLSA and ICBC International.
Their inclusion is partly testament to the growing pulling power Chinese investors have over Asian bond deals — although their buying interest is still very heavily oriented towards offshore bond deals by their own country’s borrowers.
But Citic CLSA has deep roots in Sri Lanka thanks to CLSA, which established broking links there in 1994 and currently owns 25% of local broker CT CLSA.
For ICBC, the bookrunner’s slot marks another symbolic step forward in its internationalisation plans. It won its first international sovereign mandate in November 2015 when it led a $1.5 billion deal for the Republic of Angola. Sri Lanka’s deal marks its first for an Asian sovereign, excluding China.
However, the decision did not appear to alter the distribution statistics in Asia's favour, with US investors taking 58% of the total compared to 22% in Europe and 20% in Asia. By investor type, a total of 500 participated with asset managers allocated 83%, banks 9%, insurers and pension funds 5% and others 3%.
Proceeds from the deal are being used to replenish Sri Lanka’s depleted foreign exchange reserves, which stood at only $5.6 billion at the end of March, below the IMF’s $7.5 billion EFF stipulation. The missed target was one of the main reasons delaying an agreement to disburse the next tranche.
“Low FX reserves are one of our main concerns as well,” said Lakshini Fernando, an economist at Asia Securities in Colombo. “However, this bond deal and a syndicated loan, which is also in the market, will go some way to replenishing them again. We’re also watching the Hambantota Port agreement very closely since it will have a material impact if and when it closes.”
Bankers believe the syndicated loan is likely to total $750 million, although the government has not yet confirmed the final amount.
Where the Hambantota Port is concerned, the government signed a framework agreement with China Merchants Ports Holdings on December 8. Its hand had been forced by the need to re-pay a $1.12 billion China Exim bank loan to build the port, which is currently generating very little business.
Sri Lanka and China then laid the foundation stone for an adjoining 1,235-acre Sri Lanka-China Logistics and Industrial Zone in January.
But a final agreement between the two sovereigns has yet to be signed, with Sri Lanka attempting to increase its own eventual ownership from 20% to 40% and boost its profit sharing arrangements. Bankers are still hopeful the deal will close by the end of the first half and believe China will make the payments in three tranches.
The agreement and development of the SEZ will also pave the way for increased foreign direct investment (FDI), marking a key turning point in the country's economic fortunes.
In recent years, Sri Lanka has had a dismal record relative to comparable sovereigns such as Bangladesh and Vietnam. In 2016, it managed to attract just $300 million FDI; a figure that was quietly released amid a mass of other data releases.
The country also needs to do more to improve tax collection, which has hovered around 11% of GDP for some years. A second IMF stipulation covers an income tax bill, which has to be submitted to parliament by June.
Economists say it should help to boost GDP over the short-term. Consensus estimates put GDP at 4.9% in 2017, below Asia ex-Japan’s 5.8% average. One reason for the poorer-than-expected performance is an ongoing drought, the worst in four decades.
“There's been a lagging effect of about five months since December.” Fernando commented. “It’s possible to see what impact it’s having on the inflation figures, even though the government has imposed price controls. The country’s had to import more rice to curb the shortage, which is likely to have hit the foreign exchange reserves as well.”
In April, inflation stood at 6.9% and the currency has also been under a little bit of pressure, falling against the dollar from the 150 level in the fourth quarter of 2016 to an average of 152 in the first quarter of 2017.
In addition, the central bank also came under fire at the beginning of year after printing money to roll over debt maturities. It caused foreign investors to sell-off local Treasuries, an ouflow which gained in momentum in the run-up to the Federal Reserve’s last interest rate hike in March. .
“It’s been very encouraging and could push GDP growth just above 5% this year,” Fernando added. “The fourth quarter data demonstrated the trend very clearly. Industry accounted for 29% of GDP, of which construction was the main driver in the sector, recording a 19% year-on-year increase."
Fernando estimated this could help the fiscal deficit fall to 4.9% in 2017, compared to 5.6% in 2016.
This story has been updated since first publication with final deal statistics.