Sri Lankan bond proves fleet of foot

Sovereign takes advantage of strong credit market momentum to re-build foreign exchange reserves depleted by heavy debt re-payments.
Putting Sri Lanka's finances on a firmer footing
Putting Sri Lanka's finances on a firmer footing

The Democratic Socialist Republic of Sri Lanka took advantage of strong credit market momentum to execute a $1.5 billion bond deal on Monday, which should help re-build foreign exchange reserves depleted by heavy debt re-payments. 

Timing of the dual-tranche issue could hardly have been more fortuitous and emerging market investors piled in to an order book that closed at $5.5 billion mark, according to one banker. 

“This is just one of those deals where the stars were all aligned,” one syndicate banker commented.

“On a global basis, emerging markets are rallying, with Friday’s US non-farm payroll number underpinning credit spreads," the banker added.

“Investors are also a lot more positive about Sri Lanka now they think all the bad news has been priced in.” he continued. “There’s a new central bank governor who’s very well respected and the IMF package has boosted confidence.”

As a result, the syndicate was able to ratchet-in indicative pricing quite aggressively, particularly on the five-and-a-half year tranche, which saw guidance revised from 6.125% to 5bp either side of 5.8%.

Final pricing of this $500 million bond was fixed at par on a coupon of 5.75%, some 37.5bp inside of initial guidance. Bankers said the order book closed at $2.5 billion level, with the loss of a couple of price sensitive European accounts more than counterbalanced by an influx of US investors.

A total of 200 accounts participated with a split, which saw 35% placed in to the US, 37% into Europe and 28% into Asia. By investor type, 85% went to fund managers, 8% to pension and insurance funds and 7% to banks and private banks. 

The $1 billion 10-year bond was initially marketed around the 7.125% level before pricing was tightened to a range of 5bp either side of 6.875%. Final pricing was fixed at par on a coupon of 6.875%

Bankers said there was $3 billion in final demand. Distribution stats show that 200 accounts participated with a split of 62% US, 28% Europe and 10% Asia. By investor type, 91% went to funds, 7% to insurers and pension funds, plus 2% to banks. 

Sri Lankan spreads march inwards

The $3.5 billion Sri Lanka achieved this time round is far higher than the $3.3 billion order book it generated late last October when it raised $1.5 billion from a 10-year bond. 

The former deal was well timed from the government's perspective, coming off the back of a previous emerging markets rally. But it was disastrous for investors, coming ahead of a balance of payments crisis that saw Sri Lanka head to the IMF for a $1.5 billion Extended Fund Facility.

This was formally approved in early June.

All three rating agencies reacted to the balance of payments crisis by adjusting their ratings over the past six months. Fitch downgraded the sovereign from BB- to B+ in February, while Standard & Poor’s assigned a negative outlook to its B+ rating in March, with Moody’s followed suit with its B1 rating in late June.

Spreads on the previous November 2025 deal bottomed out in late February around the 86.5% level and have been on a rising trend since then as it became clear the IMF was likely to approve the country’s three-year deal. However, they only moved back through par again on Friday when the whole of the EM credit universe reacted positively to the latest US non-farm payroll numbers.

On Monday, many Asian EM sovereign bond prices rose by half to one point. Sri Lanka’s November 2025 deal jumped 1.25 points to a mid-price of 101.5% or yield of 6.63% by Asia’s close.

The sovereign also has a June 2025 bond outstanding, which was trading on a mid-yield of 6.495% at Monday's close.

This suggests fair value for the new July 2026 bond around the 6.84% level, or 1.5bp inside of where the deal priced. This level is based on a 13.5bp differential between the June and November bonds, which works out at 2.5bp per month.

Pricing on the five-and-a-half year tranche was slightly more generous, offering a 5bp to 9bp premium according to various estimates.

The syndicate pegged it at 5bp. But given there is 37.5bp on the curve between the sovereign’s June 2021 and June 2022 bonds (according to another broker’s quotes), this places a new January 2022 bond 9bp wider at 5.66%.  

One syndicate banker flagged what an impressive achievement it was to price an EM sovereign deal through its secondary curve without losing any demand. This underscores perceptions that Sri Lankan spreads will continue to perform.

It also marks a complete turnaround from just a couple of weeks ago.

Sri Lanka’s sovereign spreads may have been on an uptrend since late February but global bond markets have spent the past two weeks grappling with the post Brexit fallout. Sri Lanka is potentially one country that will be affected more than most, since the UK is its second largest export destination.

It would have also been difficult to complete a deal without a central bank governor. Arjuna Mahendran left the post at the end of June on the back of corruption allegations but his replacement, Indrajit Coomaraswamy, formerly director of economic affairs at the Commonwealth Secretariat, was not appointed immediately.

Domestic commentators have suggested there was a difference of opinion over Mahendran’s departure and Coomaraswamy’s arrival between the country’s president Maithripala Sirisena of the Sri Lanka Freedom party and his coalition partner and prime minister, Ranil Wickremesinghe, from the United National party.

This lack of cohesion has been portrayed as a ratings constraint at a time when Sri Lanka needs to implement deep structural reforms to adhere to the IMF’s targets. However, Frontier Economics lead economist, Shiran Fernando, suggests it is a sign of a country that is free to debate.

It also appears to be one open to pursuing corruption across the political spectrum given the former president’s son, Namal Rajapaksa, was also arrested as part of a corruption investigation on Monday by the country’s Financial Crimes Investigations Division.

“There are clearly different views among the coalition partners about how the economy should be run,” Fernando told FinanceAsia. “There’s a lot more political noise these days but that shows we have a democracy in action here now and that’s a good thing.”

Re-building reserves

Fernando believes the government is taking the right steps to improve the economy and feels a lot more confident about economic fundamentals than he did six months ago. “Even if only 60% of the IMF programme is implemented it will be received very positively,” he said.

Proceeds from the bond deal are being used to replenish foreign exchange reserves, which fell to only three months of imports coverage earlier this year. At the end of June, they stood at $5.2 billion, although last Thursday finance minister Ravi Kuranayake told parliament they have risen to $6.1 billion, equating to four months of coverage.

Alongside the bond deal, the government also has a $300 million loan in syndication, with an option to upsize it to $500 million. The five arrangers are: Citi, Emirates NDB, HSBC, Mashreq and Credit Suisse.

The government has previously indicated it will raise a total of $3 billion from the dollar bond and panda bond markets this year, suggesting a second deal will be on the way at some point soon.

Fernando says a further $4.7 billion in debt is coming due for re-payment between July this year and May 2017.

The coalition government has been faced with a debt hangover created by its predecessor’s infrastructure spending.

This was largely funded by commercial loans from China rather than longer-term and lower-cost concessional financing from multi-lateral institutions. The latter had been largely blanking the country because of the way strong president Mahinda Rajapaksa ended the country’s civil war with its Tamil minority.

In terms of financial metrics, the government is hoping to bring down its current account deficit to 5.8% by the end of the year compared to 7.4% in 2015. At the end of the first quarter it stood at 6.1%.

One of its chief policy goals concerns revenue collection, which currently stands at a lowly 11% of GDP.

“We need to get it to at least 14% to 15% of GDP,” Fernando stated. “It will take time but we are moving in the right direction.”

Fernando believes the currency will continue to depreciate over the course of the year, although he argues that most of the depreciation has already occurred. In 2015, the rupee fell 9% against the dollar, putting pressure on Sri Lanka’s debt servicing abilities.

As Standard & Poor’s flagged in its most recent ratings release, Sri Lanka’s debt servicing costs are second only to Lebanon among the sovereigns it rates. In 2015, the ratio stood at 39% of GDP.

The IMF says the country as a whole had $44.8 billion in external debt at the end of 2015, with central government debt to GDP ending the year at 76%.

In a bid to reform its state-owned enterprises, the government has recently taken responsibility for Sri Lankan Airlines’ debt, which accounts for roughly 4% of GDP. While this has added to the government’s contingent liabilities, Fernando says the prospective restructuring and possible strategic stake sale underlines the government’s commitment to structural reform.

All the rating agencies agree that Sri Lanka’s growth prospects are bright if it can push through reform. Late last month, Moody’s said Sri Lanka’s rating “is supported by the economy’s robust growth potential and higher income levels than similarly-rated sovereigns."

It concluded: “With the effective implementation of some of the fiscal policy measures and other structural reforms planned under the IMF programme, the government would be able to tap a significant potential revenue base.”   

Joint global co-ordinators for the new bond deal were the standard quartet of banks that lead Sri Lankan sovereign deals and all have a physical presence in the country: CitiDeutsche BankHSBC and Standard Chartered

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