SL’s homegrown debt repayment plan may keep investors away: HSBC, Citi

• Point out short-term, ad hoc arrangements hardly give clarity on debt sustainability front
• Say CB’s six-month road map failed to provide much-needed “clarity and longevity”
• Citi estimates SL’s external financing gap to widen to US$ 3.9- US$ 6bn next year
• HSBC views IMF programme as best solution to address concerns on long-term debt sustainability

As the Sri Lankan government continues to resort to short-term ad hoc arrangements to service the country’s external debt obligations, two leading international investment banks warn that the lack of clarity on the debt sustainability front could keep both foreign and domestic investors at bay further worsening the country’s already weak external position.

“While ad hoc arrangements (like bilateral swaps and small ticket loans) are being made to service the debt, there is an urgent need for a long-term solution to roll over debt at a reasonable cost. Unless that happens, we believe the country’s external sector outlook will be clouded by debt repayment concerns and uncertainties every year,” HSBC Global Research cautioned in its latest report titled ‘Sri Lanka in need of a panacea’ last week. Sharing similar sentiments, Citi Research also said it didn’t think a homegrown strategy is sustainable in the long-term for the country, and suggested that the government may hold out for longer until mid-next year, after settling a US$ 500 million international sovereign bond maturing in January next year, before a possible reaching out to the International Monetary Fund (IMF). 

In particular, Citi highlighted that the six-month roadmap launched by the Central Bank early this month failed to provide much-needed “clarity and longevity” the global investors sought, hence, the country’s access to global capital markets remain restricted.

 “The roadmap announcement provides more detailed context for investors and stakeholders. But we think the plan contains somewhat less clarity and longevity than some investors sought,” it opined.

Citi estimated Sri Lanka’s external financing gap to widen to US$ 3.9 - US$ 6 billion next year without a debt-restructuring programme backed by the IMF.

“While we do not think a homegrown strategy is sustainable in the long-term, we think the likelihood has risen that the government will hold out for longer and repay the January 2022 bond, which can technically be done (ultimately a political decision), even though it would further erode Sri Lanka’s already weak external position,” Citi Research emphasised.

Meanwhile, HSBC warned that Sri Lanka could experience impediments on foreign direct investment (FDI) due to lack of clarity on long-term debt sustainability, further reducing anticipated foreign exchange inflows to the country. 
“The lack of clarity on the debt sustainability front may keep both foreign and domestic investors at bay,” it said.
Hence, HSBC viewed that an IMF programme as the best solution to address the concerns on long-term debt sustainability.

“An IMF programme could help on this front. Sri Lanka would be able to commit itself to structural reforms, gain access to new sources of financing, strengthen investor sentiment, and enable policy makers to focus on policies that help improve the growth potential of the economy,” it elaborated.

Going into detail, Citi suggested that a potential debt restructuring could include a combination of haircut, coupon reduction as well as a maturity extension, which would stabilise debt/GDP and reduce the debt burden to sustainable levels.

“...  we estimate they may face pressure to haircut coupon by at least 42-48 percent, with notional haircut of at least 10 percent, and maturity extension that ranges from 7 years for short-duration bonds to 20 years for longer-maturity bonds. 

Assuming 8.5 percent exit yield (consistent with a B- rated credit), we estimate the  ‘recovery value’ on dollar bonds in such a scenario could range between 55pts for long-end to 65pts for short-end. If we were to see higher exit yields, bond prices could easily trade below those levels,” it went on to note.

However, Citi cautioned on the downside risks on any attempt to restructure without the IMF.

“Excluding IMF and other associated extraordinary official financing, we think Sri Lanka has an annual external funding gap that could range from US$ 4-6 billion depending on its ability to mobilise private-capital inflows. The latter may be mobilised through a combination of market-determined exchange rates and substantially higher rates, a credible fiscal plan, and/or through a more concerted push for asset sales,” the report pointed out.