Key takeaways
There are a number of moving parts given the current economic uncertainty. Our calculations based on the available information and scenarios indicate that Sri Lanka will be in a position to start repayments in 2027 (5-year maturity extension), with bondholders taking a 25.0% - 35.0% haircut
We note that the Government’s willingness to drive fiscal discipline, any prolonged political tension could lead to a change in our calculations
The timing of the announcement of an IMF program is crucial in 2022. We expect this to materialise around September 2022
Following this, Sri Lanka will be eligible for funding lines from bi-lateral and multi-lateral partners, specifically supporting external and fiscal pressure
The first tranche through an IMF program will take longer, until Sri Lanka’s debt is more sustainable
We factor in the first inflow to take place around December 2022/January 2023 once more clarity on restructuring discussions and the 2023 budget policies are implemented
However, the political stability of the country plays a crucial part. Any further deterioration on the political front could see delays to both the IMF discussions and restructuring process
Until a formal program is announced, we expect the Govt to depend on short term funding lines like swaps and credit lines. We factor in a further USD 2.0bn in credit lines and funding in 2022 to ensure limited shortages of essential food items and fuel
We expect the USD/LKR to reach 350.00 – 370.00 in 2022 on our base case, and USD/LKR 420.00 – 450.00 by 2025
On rates, we forecast 1-yr Government bond rates at 22.0% - 25.0% by end 2022. We expect rates to peak around August 2022, ahead of an IMF program announcement
Outlook: Economy to stabilise by 2025; Structural policy changes key to recovery
We forecast total debt at 83% of GDP by 2027
Post IMF, the fiscal deficit at 7.7% of GDP in 2027
Int payments as a % of total revenue down to 28%
USD/LKR at 420.00 - 450.00 by 2025
What would a debt restructuring look like?
The debt re-structuring is separate to the IMF fund facility This will be conducted by the Government of Sri Lanka with the technical assistance of the IMF
Sovereign bonds are typically restructured through an exchange offer This sets conditions and deadlines for bondholder participation and exchanging the debt, usually providing cash flow relief
Historically, the IMF’s role in restructurings is to provide information and assess the debt sustainability of the proposed offer
There have been IMF lending programs where the restructuring process has taken place parallelly. We expect this to be in Sri Lanka’s case
We expect Sri Lanka would have to negotiate a grace period in repayment as well as a haircut on the capital to bring debt service to a sustainable level
Looking at past debt restructuring programs in the Caribbean, Jamaica concluded its program in about 2 years after losing International market access, while Antigua took as long as 20 years to stabilise its unsustainable public debt profile
Following a restructuring, the country’s gross financing needs and debt service ratios decline. However, this does not indicate significantly lower vulnerability to debt distress given elevated debt ratios like Sri Lanka
This is evident in Jamaica and Belize, where both countries went for a second restructuring within 5 years of the first program
In terms of Sri Lanka, we expect the entire restructure to take at least 9 months to be finalised i.e. for the restructure to commence from 2H 2023
In our view, Sri Lanka will look for cash flow relief, potentially taking 4-5 years to stabilise its debt profile in the event of a restructuring program
When will Sri Lanka’s debt be sustainable?
Our calculations show that Sri Lanka will be in a position to commence payment of its debt from 2027
While we assign a 20% probability that repayment can commence in 2025 , we see this being a tight option, with reserves expected to reach USD 3.9bn
This means that the maturity extension of debt looks to be at least 5 years
In terms of the ISBs, we factor in a 25.0% 35.0% haircut with a 5 year maturity extension