Yesterday’s reserve print from the CBSL showed another momentous drop to US$1.6bn in November from US$2.3bn in October. This is equal to just one month of trailing goods imports, barely over two months of external debt service, and less than 30% of the US$5.4bn of external principal payments due over the next 12 months (with over US$3.7bn of external public sector amortizations in 2022, including eurobond payments of US$500mn in January and US$1bn in July). Further, of the US$1.6bn of gross official reserves, only US$1bn is liquid FX, leaving precious little to service debt and keep the economy running.
While the government seems intent on running reserves to zero to avoid default, the situation is becoming increasingly untenable. FX and goods shortages are already biting, and will only get worse if reserves continue to drop. While we have said that default was inevitable beyond July 2022 absent a sharp policy adjustment (see related reading), we thought that the government would pay its US$500mn eurobond maturity in January and were agnostic on its ability to pay the US$1bn maturity in July.
However, the ongoing collapse in reserves changes the calculus for Sri Lanka’s shorter-term bonds. Default now seems inevitable beyond January 2022, and it is looking less likely that the January maturity will be paid too. With the SRILAN 5 ¾ 01/18/2022s trading above US$90, they are pricing in just a c15% probability of default, but we think the probability has risen to at least 50% given the new reserve data. As such, we downgrade our recommendation on the SRILAN 5 ¾ 01/18/2022s from Hold to Sell.
While the SRILAN 6.85 03/14/2024s have now hit our target price of US$55, we maintain our Sell recommendation pending a more thorough review of developments. There could still be another leg down as markets digest the latest reserve data, which will be published in the more widely read weekly stats bulletin on Friday. Meanwhile, we still think that the shorter and longer ends of the curve are overpriced. As such, we retain our Sell recommendation on Sri Lanka’s eurobond curve beyond the July 2022s (which are still unrated).
Sri Lankan Eurobonds nearing fair value; retain Sell, December 2021
Sri Lankan budget falls flat (again), November 2021
Sri Lanka reserve crash in one chart, November 2021
Sri Lanka: Good and bad news for bonds, November 2021
Plummeting reserves push Sri Lanka closer to default, October 2021
Sri Lanka: Imbalances to remain despite policy shift, September 2021
Sri Lanka’s food and currency “emergency”, September 2021 (Malik)