Macro Analysis /
Sri Lanka

Sri Lanka's debt restructuring and the road ahead

  • Outlook: Economy to stabilise by 2025; structural policy changes key to recovery

  • What would a debt restructuring look like?

  • When will Sri Lanka’s debt be sustainable?

Sri Lanka's debt restructuring  and the road ahead
Asia Securities
22 April 2022
Published byAsia Securities

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

  1. We forecast total debt at 83% of GDP by 2027

  2. Post IMF, the fiscal deficit at 7.7% of GDP in 2027

  3. Int payments as a % of total revenue down to 28%

  4. 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