Mixed forecast for Lankan sovereign debt performance

The announcement of the failure to agree on a new follow-up funding package by the International Monetary Fund (IMF) has led to a slide in investor sentiments and country’s sovereign bond prices from 1 to 1.25 points, according to a US banking giant.

Evaluating the Lankan macroeconomic environment in the aftermath of IMF engagement failure, JP Morgan asserted that the impact on the economy was largely psychological at least in the short term.

“Since the announcement early last week, Sri Lanka’s sovereign bond prices have fallen 1-2.5 points and Sri Lanka’s sovereign Emerging Markets Bond Index Global (EMBIG) spread has risen 25 basis points while the EMBIG spread has been basically unchanged,” the bank stated.

JP Morgan is of the view that the disappointment from the lack of a follow up program was not because of the financial resources IMF would have brought along. This is because planned follow up program would most likely to be spread over 1-2 years, unlike a typical Stand-by-Arrangement which has a longer tenure.

Further the intention of the authorities of such a program was also not to finance the fiscal deficit or the balance of payment hole. It’s understandable given the US $ 7 billion external reserve position, which is equivalent to four months of imports.

However the IMF mission Chief John Nelmes from Washington, USA maintaining a slightly different view to JP Morgan opined that although anything above three months of imports was adequate as a rough rule of thumb, ‘a ratio of international reserves to short term debt that is maturing in less than a year’ was another yard stick commonly used to measure the status of external reserves.

Typically the external reserves have to be 100 percent of the short term debt, but in Sri Lanka this ratio remains below 100 percent end of 2012.

Though Sri Lankan bonds have underperformed the EMBIG this year (of which the trend intensified last week due to turning down a followon IMF program), JP Morgan is still of the view that Lankan bonds will outperform the Emerging Markets in the Asian region this year.

Maintaining largely a positive view on the progress made in the macroeconomic front despite the slow growth as a response to monetary tightening in 1Q’12 the bank said, “With macro-economic imbalances narrowing, growth having bottomed, and inflation expected to roll-off, we continue to overweight sovereign bonds and we recommend buying on the dip”, it said.

However JP Morgan’s speculations on Lankan bonds are dramatically different from Standard Chartered Bank which holds an underweight position on Lankan sovereigns where they expect the high-beta sovereigns of Sri Lanka to under perform over the next 6-12 months.

At the beginning of the year, Central Bank Governor, Ajith Nivard Cabraal ruled out the possibility of issuing a sovereign bond this year after successfully issuing four bonds to the tune of US $ 3.5 billion after its maiden bond issue in 2007 of US $ 500 million which was redeemed from the proceeds of last year’s US $ 1 billion bond.

However in the backdrop of an expected budget support from IMF at concessionary rates proving futile, a Treasury official is reported to have said the government might opt for another sovereign bond issue this year if otherwise the country will have to resort to high cost commercial borrowings as analysts pointed out.