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Sri Lanka

Sri Lanka: CBSL commences creditor discussions; IMF Board agreement crucial

  • CBSL timeline for restructuring comes in-line with our views; IMF board approval a key factor to timeline

  • Central Bank Act ahead of IMF EFF a key positive; SoE guaranteed debt looks to be restructured

  • CBSL outlines realistic forecasts; expects economy to contract 8.7% YoY in 2022

Asia Securities
27 September 2022
Published byAsia Securities

CBSL timeline for restructuring comes in-line with our views expressed in April; IMF board approval a key factor to timeline

The first investor presentation to Sri Lanka’s private creditors took place on Friday (24th September). While the Central Bank outlined the current status of IMF discussions, an expected timeline for the conclusion of restructuring by end 3Q 2023 comes in-line with our views and timeline presented in April 2022, in our report titled “Debt Restructuring Outcomes; The Road Ahead”. A key positive following the call was the Government and Central Bank’s clear timeline for the restructuring process combined with better than expected macro stability by 2024 given the restructuring process at play.

Looking ahead, in our view, there is a high probability that restructuring talks could conclude by 3Q 2023 given the comparatively lower value of debt compared with other countries seeking restructuring at this point (eg: Zambia - USD 17.3bn of external debt, Argentina - approx. USD 44.5bn, Lebanon - approx. USD 30.0bn of ISBs). The lower level of complexity in Sri Lanka’s International Sovereign bonds also bodes well for this timeline.

However, the key factor at this point is that while discussions with the advisors of private creditors and official committees have commenced, the actual discussions and negotiations with private creditors can only commence following approval of the IMF agreement by the Board, likely to take place in December.

For the IMF approval, financial assurance from Sri Lanka’s bilateral creditors including China is required. According to our discussions with those involved with the restructuring, all bilateral creditor negotiations have already commenced at a technical level, with further discussions expected to take place in October. Furthermore, we note that the Government and its financial advisors have already commenced discussions with the private creditors who hold the ISBs on the status of debt restructuring based on the IMF’s debt sustainability analysis.

Central Bank Act ahead of IMF EFF a key positive; SoE guaranteed debt looks to be restructured

We also note that a Central Bank Act which strengthens the independence and accountability of the Central Bank is also a pre-requisite for the IMF approval. In our view, this is a key positive given the lower level of accountability by the Central Bank in recent years compared with other Central Banks globally. We expect the Act to be presented in October/November 2022, ahead of the 2023 budget reading.

The discussions also indicated a high probability of restructuring Government guaranteed State Owned Enterprise (SoE) debt, which at end April 2022 amounted to LKR 2.8tn (USD 7.6bn which the CB estimates has reduced to USD 5.5bn by end June). According to the Treasury, discussions with the IMF team on SoE debt are ongoing, with guaranteed SoE debt is under consideration, but not finalized.

In our view, while this will ease fiscal pressure on the government, the key factor would be the impact on the State banks with a potential guaranteed debt restructuring.

On the domestic debt, while this is still under consideration as previously indicated, our view remains that the impact on the financial system will be the key factor for a potential domestic debt restructuring.

CBSL outlines realistic forecasts; expects economy to contract 8.7% YoY in 2022

While the CB expects the economy to contract 8.7% YoY in 2022 (ASEC forecast: 7.5% - 9.0% YoY contraction), the forecasts indicate that a contraction of 3.0% in 2023 (we forecast marginal growth) is expected despite the low base effect. In our view, this mainly stems from the fiscal consolidation measures expected in 2023. This is reflected in the primary balance, which the CB expects to reach 0.7% of GDP in 2023.

What happens next?

In our view, the next few months leading to the IMF board meeting in December are crucial. While bilateral discussions are expected to continue at the President’s visit to Japan this week, we expect the momentum of discussions to increase as the Government’s fiscal consolidation plans finalise. We see the 2023 budget expected in November and Central Bank Act as two key pre-requisites to finalise discussions and get the necessary level of approval for the IMF agreement.

In terms of the upcoming budget, we expect steep measures to improve the Government’s revenue base. As such, we forecast the fiscal deficit to reach 8.9% of GDP in 2023, from approx. 13.0% of GDP in 2022.