Barclays recommends investors to return to short-dated Lankan sovereign bonds

• Says immediate risk of default has eased off amid near-term improvement in liquidity position
• But maintains medium-term concerns on country’s debt sustainability

While maintaining its concerns over Sri Lanka’s medium-term debt sustainability, London-based Barclays Bank recommended investors to purchase the country’s short-dated International Sovereign Bonds (ISB), as the immediate risk of a debt-adjustment and default fears ease off following the expected near-term improvements in the liquidity position.

“Although Sri Lanka’s foreign reserves remain low (US $ 4 billion at end-May 2021), we think the immediate risk of a debt-adjustment event has eased. This is because Sri Lanka has secured a number of liquidity lines and loans with foreign central banks and agencies, which have eased funding pressures through near-term access to foreign currency,” Barclays advised its clientele in a credit research brief titled ‘Emerging Asia Sovereign Credit Sri Lanka: Making Ends Meet’, recently. 

Accordingly, the banking giant recommended its investors to purchase US $ 1 billion ISB maturing in 2022 and US $ 1.25 billion ISB maturing in 2023, which were quoted at US $ 85.0-86.5 and US $ 75.25-76.75, respectively.
In March, the Central Bank entered into a three-year US $ 1.5 billion bilateral currency swap agreement with the People’s Bank of China (PBoC), which is yet to be drawn out. In the following month, the China Development Bank (CDB) agreed to disburse a US $ 500 million loan to the country as a part of a US $ 700 million loan facility. The CDB is expected to disburse the balance US $ 200 million in the coming months. 

The government also secured US $ 500 million concessional loan in May from the Economic Development Cooperation Fund (EDCF) and Export-Import Bank of Korea that can be drawn down over 2021-2022, at 0.15-0.20 percent rates of interest with a repayment period of 40 years and a grace period of 10 years.

In June, Bangladesh Bank approved a US $ 200 million currency swap agreement with the Central Bank.
Further, the Central Bank announced resumption of talks for a US $ 400 million swap line with the Reserve Bank of India, which it would be able to draw down from August.

Meanwhile, state-owned Bank of Ceylon is expected to receive a US $ 115 million funding in the coming weeks from the CDB and Asia Infrastructure Investment Bank (AIIB).

Hence, Barclays expects the pressure on short-dated bonds that are trading at discounted prices to benefit from these developments while making a good entry points for investors for Sri Lankan ISBs. 

“We believe the front-end SRILAN bonds, especially the 6.25 percent 2021 and 5.75 percent 2022s, have been the key beneficiaries of the positive news flow around extra liquidity lines and loans being secured, which we think has reduced the risk of a debt adjustment event… We believe the relatively lower price points of the SRILAN 5.875 percent 2022s and 5.75 percent 2023s, which we view as short-dated bonds, offer good entry points,” it elaborated. 

Even if the government decides to seek a debt adjustment, Barclays expects that these short-dated bonds to receive the most favourable treatment and see the highest recoveries.

The multinational bank also downplayed the recent concerns arising from contingency liabilities of state-owned entities such as Ceylon Petroleum Corporation and the Ceylon Electricity Board. 

Sri Lankan banks increased their exposure to ISBs in recent months, taking the advantage of the low prices.
According to Barclays, domestic investors, mostly compromising of local banks, hold around US $ 2.23 billion of the country’s outstanding ISB issuance, including US $ 300-350 million of the ISB maturing late this month and 30-40 percent of ISB maturities up to 2023.

Overall, Barclays said this dynamic, combined with support from the IMF SDR flows estimated at US $ 780-800 million and the expected activation of an RBI swap line in August, as well as the recent bond price weakness, to have created good entry points for investors to make gains on short-dated SRILAN bonds.

Following the US $ 1 billion ISB maturity late this month, foreign debt repayment stands at US $ 1.4 billion for the remainder of the year.  

However, Barclays maintains medium-term concerns on the country’s debt sustainability, given the challenging external and fiscal position exacerbated by the pandemic. 

It pointed out that the rebound of key foreign exchange industries such as tourism would be critical for the country’s medium-term debt substantiality.  

“But questions remain about the sustainability of debt metrics, which will depend on the ability to boost economic activity in the next six to 12 months above pre-pandemic levels…  Recent liquidity lines only provide stop-gap relief; hence we maintain an Underweight rating. In this regard, we believe a return of tourism will be key to support external flows and economic activity,” it elaborated.