Debt-hampered Sri Lanka at risk of running out of options


A thousand Sri Lankan Rupee note is seen in this photo taken on September 26, 2018. REUTERS / Dinuka Liyanawatte / Illustration

LONDON, Aug. 3 (Reuters) – Sri Lanka paid off a $ 1 billion bond last week, but alarming state of its finances suggest it may have been just one more step towards its first sovereign default.

All the telltale signs of the crisis are there: bonds at almost half of their face value, a debt-to-GDP ratio of over 100%, more than 80% of government revenue being spent on interest payments alone and barely enough reserves to cover a few months of expenses.

The chances of the island nation remaining on its own seem slim, especially with COVID-19 keeping the tourism industry on its knees and limiting the remittances expatriates return from abroad.

Reflecting the gravity of its plight, Colombo dollar-denominated government bonds are among the most distressed in the emerging market universe.

Yet last week’s bond payment underscored the government’s strong will to honor its debt and avoid the ignominy of a first sovereign default.

He’s also given him some breathing space – the next major payment won’t come until January, when he’s due to find $ 500 million.

But that’s followed by a billion dollars heavier in July and another billion before the end of 2023. Along with a staggering budget deficit estimated at around 11%, it could easily run out of rope.

“We always thought this was potentially heading for default,” said Sailesh Lad, of Axa Investment Managers. “And in the next 12, 18, 24 months, if nothing changes, we think it probably will.”

Most investors see an IMF program as the only way out of trouble, but the likelihood that it will require painful spending cuts means the government remains reluctant for now.

Instead, he seems to favor a confused approach. It relies on currency swaps with China and India – both of which are vying for influence in Sri Lanka – as well as an upcoming injection of $ 800 million in COVID crisis money from the IMF. Read more

In comments reported by local media last week, Minister of State for Money and Capital Markets Ajith Nivard Cabraal said Sri Lanka would proceed with the repayments through careful management of its existing reserves, as well. only expected entries.

Cabraal also said the decline in reserves, which halved them to less than $ 4 billion in the past 12 months, was temporary. It expects $ 2.65 billion in inflows over the next three months, in addition to a $ 1.5 billion currency swap with China, as well as refinancing of maturing loans in the rest of 2021.

Analysts are not convinced, however.

“We consider the expected increase in reserves to be overly optimistic,” said Esther Yong, head of fixed income research for Asia at Julius Baer. “The measures currently being taken are short-term in nature and are not a panacea for its low debt sustainability and external position.”

There is also uncertainty as to the terms that could be attached to any swap agreement and whether the flows will materialize.

With its strategic geographic location and one of the deepest ports in the world, Sri Lanka is an integral part of China’s Belt and Road plan, and Colombo hopes this will convince Beijing to provide more support.

“China can lend enough money for them to fend for themselves, but… are they willing to throw good money after bad?” Said Carlos de Sousa, emerging market debt portfolio manager at Vontobel Asset Management.

“My basic scenario is no, mainly because India does not seem willing to play ball.”

A worrying sign for Sri Lanka is that the muddled approach is rarely a lasting solution in struggling emerging markets.

Goldman Sachs analysts point out that since 2010, only three of the 13 countries where bond “spreads” have reached troubled levels for several months have managed to avoid a default.

And even if Sri Lanka changes course and opts for IMF aid, the dire state of its finances means that restructuring would almost certainly be necessary.

“Mathematically, it is very difficult for her to continue in the same direction,” said Mikhail Volodchenko, a Lad’s colleague at Axa. “For now, he’s filling the hole and surviving.”

Reporting by Tom Arnold and Marc Jones; Editing by Steve Orlofsky

Our standards: Thomson Reuters Trust Principles.

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