ANALYSIS: Sri Lanka Longer Dated Bond Curve at High-40s/Low-50s; 2022 Outstanding Debt $6.4B Excluding Repaid $500M Notes Due Jan. 2022; CAC Considerations Across Due 22s to Due 2030s; Current External Funding Lines Mapped

Editor's Note: The following story was sent on Friday evening. It is being resent for normal publishing hours. 

The Democratic Socialist Republic of Sri Lanka’s benchmark 7.55% $1.5 billion notes due March 2030, are indicated at 49/50.25, up from 48.75/50.25 on Jan. 14. The 2030 notes, which are widely held and traded in Asia, have been indicated at the level of 52.5/56, since Reorg initiated coverage in May 2020. Continue reading for more actionable insights on Sri Lanka's debt from Reorg's Asia Core Credit team, and request a trial for access to reporting and granular analysis on hundreds more stressed, distressed and performing credits in Asia. 

Meanwhile the $1 billion 5.875% notes due July 2022, were indicated at 74/76, on Jan. 28, up from 70/75 levels on Jan. 14., according to buyside sources.

Market sources have continued to flag the potential of Sri Lanka's debt curve being restructured, especially in the absence of an International Monetary Fund (IMF) program. In this piece, Reorg looks at parallels with other sovereign restructurings, as well as examining the Collective Action Clause (CAC) provisions for the USD debt stack. We also look at Sri Lanka’s myriad bilateral and multilateral funding arrangements in place which could help shore up liquidity.

As of January 2022, the Government of Sri Lanka had $6.9 billion of foreign debt outstanding, of which $500 million bonds were due on Jan. 18, Ajith Nivard Cabraal, Governor of CBSL, stated in a Jan. 24 interview with CNBC. As per Central Bank of Sri Lanka’ (CBSL) data, Sri Lanka’s revised gross USD reserves stood at $1.588 billion as of Nov. 30, 2021 excluding bilateral/multilateral lines.

It is interesting to note that Sri Lanka’s gold reserve in December 2021, dropped 54% to $175.4 million, as against $382.2 million of gold reserves in November 2021, as per CBSL data.

As per Jan. 19 Aljazeera report, the Government of Sri Lanka liquidated half its gold reserves to meet the international sovereign bond payments of $500 million that it settled on Jan. 18.

The government also availed several swap and credit lines from India to shore up liquidity (more on that below). CBSL’s official reserve as of Nov. 30, including the People’s Bank of China (PBoC) swap facility stood at $3.088 billion.

In the CNBC interview, Cabraal also stated that out of $6.9 billion of outstanding foreign loans maturing in 2022, most of loans are Sri Lankan rupee denominated, which have already been “negotiated for roll-over,” while the multilateral debts which are outstanding has been funded with “new receipts” coming in.

“The only area we do see some risk and concern in is the international sovereign bonds, of which we need to pay back $1.5 billion this year. We have already paid back $500 million this year, we have $1 billion to go,” Cabraal said in the interview with CNBC.

According to the same interview, Sri Lanka is looking for alternative sources of funds to pay back the $12.5 billion of international sovereign bonds payable over a period of 7 years. Government is also looking to monetise its assets. “In the last 2.5 years, we have reduced our exposure to international sovereign bonds by 17% and by July we will reduce by 23%,” the governor added in the interview.

Pre-emptive measures: CAC clause

Ahead of a potential restructuring, Reorg wishes to flag certain considerations ahead of a large Asian sovereign debt restructuring.

Back in 2001, when Argentina had declared a default, a lack of collective action clause (CAC) in its bond indenture had provoked a 15-year long legal battle between the government of Argentina and the minority creditors such as Elliot Management, founder Paul Singer. Singer and other hedge funds decided to holdout and fight against the government despite 93% of other creditors accepting a haircut on the offer. Read Reorg’s coverage of Argentina HERE.

Another twist in the tale, the Argentina bonds were under New York law, hence U.S jurisdiction applied. The U.S. federal judge had ruled that Argentina could not pay interest on restructured bonds unless it settled with the minority creditors. This resulted in Elliot Management receiving ~$2.4 billion for bonds with a face value of $617 million, which were purchased for an estimated value of $117 million.

With cases like Argentina and Greece, and other countries, which have defaulted on their bond payments and faced severe consequences, CAC has readily been adopted as a preemptive measure in bond indentures.

A collective action clause (CAC) is included in some sovereign bonds. The clause governs the amendment mechanism applicable to the money terms of the debt, i.e. an amendment to maturity dates or coupon rates. The purpose behind the clause is to enable the sovereign to embark on a more orderly restructuring of its debt (emphasis added). It provides the sovereign with a cram-in mechanism to facilitate money term amendments to its debt and attempts to mitigate holdout creditor issues.

For comparison, under corporate high yield debt governed by New York law, the amendment of money terms usually requires either unanimous creditor consent or has a 90% approval threshold. The construction of CACs under Sri Lanka’s sovereign debt is different to these corporate note amendment provisions.

Overview of Sri Lanka CAC Provisions

Reorg has reviewed the terms and conditions of Sri Lanka’s $1.5 billion 6.2% bonds due 2027 ($1.5B Sovereign Bonds). The CAC clause for the $1.5B Sovereign Bonds is structured to include a three prong mechanism to facilitate modification/restructuring of the bond’s money terms.

This formulation of the CAC mechanism presents Sri Lanka with flexibility, depending on the type of restructuring it may wish to conduct, both in respect of the $1.5B Sovereign Bonds, but also other series of bonds which could under certain circumstances, be aggregated together for voting threshold purposes should a wider restructuring be required.

Depending on the details of any proposed restructuring Sri Lanka might launch in respect of its bonds, the sovereign may decide to use either one or a combination of the three prong CAC.

However, certain CAC prongs provide bondholders with more holdout opportunity than others.

Further below Reorg provides a granular review of the CAC, but at a high level an overview of the three prong CAC construct under Sri Lanka’s $1.5B Sovereign Bonds is as follows:

• Single Series: Amend the money terms of only the $1.5B Sovereign Bonds, using a single limb voting system. 75% approval threshold. This potentially has the most holdout risk for the sovereign given that a creditor need only purchase a position in the $1.5B Sovereign Bonds to block a proposed amendment/restructuring.

• Multi Series - Single Voting Limb: Amend the money terms of multiple series of Sri Lanka’s sovereign bonds using a single limb voting system which provides for one aggregated vote amongst all affected bondholders:
  
  
  
  • 75% in aggregate approval threshold. Potentially strong cram-in.
  
  
  • Uniformly applicable condition requires satisfying. This broadly means that affected bondholders must be either offered the same restructured terms or the choice to select from the same menu of restructuring options. Aims to promote equality of terms across the series to avoid one series of bonds being provided with advantageous terms at the expense of another affected series of bonds. Provides bondholders with protection, especially given the strong cram-in mechanism.
  
  
  
  

• Multi Series - Dual Voting Limb: Amend the money terms of multiple series of Sri Lanka’s sovereign bonds using a double limb voting system. Requires approval by affected bondholders voting together and then affected bondholders voting in their particular series of bonds:
  
  
  
  • 66.6% in aggregate series and 50% individual series approval thresholds. A majority of Sri Lanka’s bondholders affected by the proposed restructuring and taken as whole cannot force the terms on an individual series of affected bonds, if the majority of such individual series rejects the proposal.
  
  
  • Potentially creates holdout risk, should a creditor purchase a majority in a single series of affected bonds and reject the restructuring proposal. Conversely, provides additional protection for bondholders.
  
  
  
  

In respect of the amendments of multiple series of Sri Lanka’s debt this aggregated debt would include Sri Lanka’s other debt which contains the same, or substantially the same, CAC terms. For the purpose of the below, it is assumed for ease, that this consists of Sri Lanka’s other sovereign bonds.

Importantly in terms of restructuring considerations, the CAC construct provides the sovereign with the ability to cram-in dissenting bondholders should the relevant approval thresholds be met. The cram-in mechanism provides some mitigation against holdout creditor risk. However, the risk is not completely mitigated, especially in relation to amending/restructuring just the single series of the $1.5B Sovereign Bonds or when using the multi series dual limb voting construct.

Once a bondholder meeting is arranged, which can be called by Sri Lanka or bondholders holding 10% in aggregate of the principal amount of outstanding $1.5B Sovereign Bonds, via a request to the bond trustee, the CAC provisions come into play.

Reorg provides an overview of the CAC mechanism for the $1.5B Sovereign Bonds below.

Single Series

Bondholders entitled to vote 75% of the aggregate principal amount of the outstanding bonds constitute a quorum for a bondholder meeting called to put forward a proposal to amend the money terms of the $1.5B Sovereign Bonds.

During any meeting any amendment of the money terms of the $1.5B Sovereign Bonds may be made or taken if approved by an extraordinary resolution or a written resolution. Respectively, these require approval from at least 75% of the aggregate principal amount of the outstanding $1.5B Sovereign Bonds.

Multiple Series Aggregation - Single Limb Voting

To amend the money terms in respect of two or more series of Sri Lanka’s sovereign bonds using the single limb voting mechanism requires the approval by an extraordinary resolution or by a written resolution. Respectively, these require approval from at least 75% of the aggregate principal amount of the outstanding debt securities of all affected series of sovereign bonds (taken in aggregate).

In addition, satisfaction of the uniformly applicable condition is required. Broadly this will be satisfied if the:

• Holders of all the affected series of Sri Lanka sovereign bonds are invited to exchange, convert, or substitute their debt securities, on the same terms or offered to select new instruments/ receive consideration from an identical menu of options; or


• Amendments proposed to the terms and conditions of each affected series of Sri Lanka’s sovereign bonds would result in the amended instruments having identical provisions (other than necessarily different provisions i.e. in respect of different currency of issuance).

Multiple Series Aggregation - Double Limb Voting

To amend the money terms in respect of two or more series of Sri Lanka’s sovereign bonds using the double limb voting mechanism requires the approval by an extraordinary resolution or by a written resolution.

To pass these resolutions requires approval from:

• at least 66.6% of the aggregate principal amount of the outstanding debt securities of all the affected series of bonds (in aggregate); and


• more than 50% of the aggregate principal amount of the outstanding debt securities in each affected series of bonds (individually).

Any modification proposed under the multi series two limb or single limb voting clauses may be used for some series only of the bonds and may be used for different groups of two or more series of bonds capable of aggregation simultaneously, according to the terms and conditions.

Foreign Disbursements, Grants

On Jan. 13, the Indian High Commission in Sri Lanka said in a twitter.com message that the High Commissioner met the governor of Central Bank of Sri Lanka (CBSL) and expressed India’s “strong support” to Sri Lanka in the wake of Reserve Bank of India (RBI) extending over $900 million facilities over the last week. This comprises a $500 million “deferment of Asian Clearing Union settlement” and a $400 million currency swap line.

Sri Lanka also signed a deal with the local unit of Indian Oil Corp (IOC), Lanka IOC, to lease 75 oil tanks, according to a Times of India report on Jan. 6. According to the new pact, Lanka IOC will have 14 tanks on a 50-year lease while its joint venture with state-run Ceylon Petroleum Corporation (CPC), the Trinco Petroleum Terminal, will develop 61 oil farms.

India also extended credit facilities amounting to $1 billion for importing food, essential items and medicine and $500 million for importing fuel from India, according to a Jan. 15 Indian Ministry of External Affairs report.

The credit lines follow a request from Sri Lanka during Finance Minister Basil Rajapaksa’s visit to New Delhi in December, for emergency financial assistance, including lines of credit for importing essentials and a currency swap, according to a Jan. 14 report in the Hindu.

This precedes a Jan. 9 speech by Sri Lankan President Gotabaya Rajapaksa during his meeting with Minister of Foreign Affairs of the People’s Republic of China and Member of the State Council Wang Yi, where the President pointed out that it would be a “great relief” to the country if the “attention could be paid on restructuring the debt repayments” (emphasis added) as a solution to the economic crisis that has arisen in the face of the Covid-19 pandemic, according to a transcript of the speech posted to the President’s website.

China is Sri Lanka's fourth-biggest lender, behind the capital market (for the USD bonds), the Asian Development Bank (ADB) and Japan, according to a Jan. 10 report on Channel News Asia. The same report quotes Chinese foreign ministry spokesman Wang Wenbin as having stated in response to President Rajapaksa that, "China has always helped Sri Lanka develop its economy as best as we can…We will continue to do so in future."

The Sri Lankan government said in an Oct. 28 statement responding to a Moody’s downgrade of its long-term foreign currency issuer and senior unsecured debt ratings to Caa2 from Caa1
that the credit ratings agency had “failed to recognise” the medium to long term funding arrangements that the government is finalising with various bilateral sources and which are due to be materialised in the new term, such as credit lines of several billion U.S. dollars from India and its Middle Eastern counterparts to procure petroleum, an arrangement for a large forex loan from a Middle Eastern nation as a bilateral long-term loan, as well as proposals received for a syndicated loan arrangement that are presently being evaluated at present.

The government at the time further noted that a “substantial amount of funds” is expected from an already lined-up prioritised project loan related inflows to the government, and recent discussions on bilateral currency swap arrangements with several central banks are also expected to provide the country with additional support in the near term.

Bilateral Trades

Separately, various media reports stated that the board of the Bangladesh Bank will lend $200 million to $250 million from Bangladesh’s reserves to Sri Lanka for three months as part of a currency swap arrangement at LIBOR + 100bps to 200bps, as also reported.

On May 10, the Government of Korea agreed to provide to Sri Lanka $500 million concessional loans at the rate ranging from 0.15% to 0.2% from Economic Development Cooperation Fund of Korean Export Import Bank, according to a press release issued by the Ministry of Finance, Government of Sri Lanka. The loan will have a tenor of forty years with 10 years’ grace, the announcement states.

Regarding Sri Lanka’s relationship with the IMF, Reorg has reported the current government’s stance of not seeking the international financing body’s assistance. CBSL Governor Cabraal reiterated that stance in a Jan. 24 interview with CNBC stating that Sri Lanka “doesn’t need an economic lifeline” from the IMF.
This is in contrast with 2020, when the Sri Lankan government had requested around $800 million over the following two years from the IMF under the Rapid Financing facility, according to an April 29 2020 Moody’s report. This is in addition to the existing $1.5 billion extended fund facility signed in 2016 which was to conclude in mid-2020.
Apart from the above mentioned facilities, according to Sri Lanka’s budget report for 2022, the total foreign financing disbursements rose by 16% to $1.602 billion in the first eight months of 2021 compared to corresponding period in the previous year. The World Bank accounted for almost 56% of the disbursements, while Asian Development amounted to 40% of the total disbursements. Bilateral ODA financing accounted for almost 16% of the disbursements, with Japan accounting for 30% the total bilateral disbursements followed by China with 25%. Meanwhile, China Development Bank extended $800 million of commercial loans during the first 8 months of 2021, according to the Government of Sri Lanka’s budget for 2022.

Disbursements of Foreign Loans and Grants from January to August 2021, as per Budget 2022, is given below:

Budget

At the Budget 2022 presentation in November, finance minister Basil Rajapaksa had said it was important to discuss the country’s foreign reserves, management of the foreign exchange rate, and the country’s current debt position and acknowledged that its foreign reserves were being “challenged”, with the frequent fluctuations in the Rupee, which lead to the imposition of certain restrictions on the use of foreign exchange.

Rajapaksa also noted that annual earnings from tourism of almost $5 billion had not been available in the last two years, and foreign direct investment inflows had not been adequate, while worker remittances inflows have also been limited. “The gap between the export income and the import expenditure is not simply a national challenge during the past several decades, but it is an unsolved economic problem,” Rajapaksa had said.

The minister also said in the same speech that the government will cut its budget deficit to around 8.8% of gross domestic product in 2022. The deficit target for 2021 was revised to 11.1%.

According to tradingeconomics, Sri Lanka’s gross domestic product is projected to be $83 billion for fiscal year ending 2022, marginally up from $81 billion from year ending 2021. As per the Government of Sri Lanka’s projections, central government debt as a percentage of GDP for the financial year ended 2022 is estimated to be 101.7% down from 102.8% estimated for the financial year ended 2021. Total revenue for year ending 2022, is estimated to be 12.3% (as a percentage of GDP), with total expenditure standing at 21.2% for the corresponding period.

– Poonam Bansal, Nidhi Pandurangi