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Thilina Panduwawala is an economist at Frontier Analysis and writes a Sri Lanka-focused e-newsletter. Chayu Damsinghe is head of macroeconomic advisory at Frontier Analysis.
Sri Lanka’s plans to incorporate macro-linked bonds as a restructuring sweetener for collectors that must swallow some harsh losses has garnered a whole lot of consideration lately, together with from MainFT. Rightly so, as a result of they’re fascinating devices.
Briefly, the proposals hyperlink repayments to Sri Lanka’s GDP efficiency through the IMF program, which stretches till 2027. The headline haircut and coupon price on the macro-linked bonds apply if Sri Lanka solely reaches the IMF’s easy-to-reach (for complicated causes) development benchmarks, with lowered haircuts and better coupons if the financial system does higher than the IMF envisages.
However the MLBs are nonetheless a sticking level, based on an indirect authorities’s assertion in April. Studying the main points of the bondholder proposal, it’s straightforward to see why.
Of their March 2024 proposal, the creditor committee of bondholders had instructed that all restructured Sri Lankan bonds might be MLBs, apart from the Previous Due Curiosity (PDI) bonds. The MLBs would have a one-time single check primarily based on Sri Lanka’s common nominal GDP in US greenback phrases for 2025-2027, with 4 upside situations and two draw back situations of their up to date April proposal.
Sri Lanka’s personal March 2024 proposal carried two main nuances on MLBs in comparison with the plan lined out by bondholders.
First, the Sri Lankan authorities proposed that solely 27 per cent of its restructured bonds can be variable MLBs, with the remainder being commonplace, plain-vanilla bonds. Second, it proposed a extra complicated adjustment check than that proposed by bondholders, involving each US greenback nominal GDP and actual GDP development through the IMF program interval.
What distinction does two variables as a substitute of only one linking to GDP make? A world of distinction. (zoomable model)
Each inflation and trade price actions can clearly nominal GDP denominated in US {dollars}, inflicting vital deviation from actual GDP development.
That is what occurred to Sri Lanka in 2023, as the previous rose to $84.4bn from $77bn in 2022, as 17 per cent inflation and a 11 per cent foreign money appreciation offset the two.3 per cent actual GDP contraction. This $84.4bn GDP is already larger than the $84.2bn “IMF baseline scenario” common for 2025-2027 used within the bondholders’ MLB situations.
The IMF clearly underestimated Sri Lanka’s capability to see foreign money strengthening post-crisis. Even utilizing IMF assumptions for a median actual GDP development of 2-3 per cent and 5 per cent inflation, a decrease depreciation path may give Sri Lanka a median nominal GDP of over $90bn for 2025-2027 — triggering the upper compensation situations.
Six straight quarters of present account surpluses and multilateral loans drove the Sri Lankan rupee’s appreciation. Whereas a fast restoration in tourism and remittances have helped preserve these surpluses going, weak imports are a vital issue. In different phrases, the foreign money is surprisingly sturdy due to weak home demand. Home political financial elements additionally imply that policymakers are fairly eager on foreign money stability, as you may see in latest statements by the central financial institution and authorities.
By including actual GDP efficiency as a second variable, Sri Lanka’s personal MLB proposal tries to keep away from a situation the place an appreciated rupee alone forces larger repayments to bondholders, particularly if the appreciation is in apply attributable to a weaker financial system. Given the austerity wanted to stick to the IMF programme, that’s fairly possible.
Right here’s what the totally different compensation schedules would appear like if the Sri Lankan rupee goes above 400 to the greenback by 2027 and pushes up nominal NGDP to above $96bn, however IMF actual development forecast turns into actuality.
Whereas the federal government proposal strikes to the primary upward situation, the bondholder proposal strikes funds to the very best upward situation.
The bondholders appear to have continued with the one-time, single check of solely utilizing common greenback GDP for 2025-2027 of their negotiations since April. This admittedly makes it more likely for the bonds to be index-eligible — which might be a boon for the bonds — however runs the numerous threat of Sri Lanka having larger debt repayments later.
However the MLBs will not be structured to regulate repayments downwards for GDP contractions after 2027. So you might have a state of affairs the place complete repayments on all present exterior money owed rise to about $4.5bn from 2029 onwards (even assuming no extra borrowing), after which any subsequent recession or sharp devaluation would trigger exterior repayments to as soon as once more smash by means of the 4.5 per cent of GDP ceiling dictated by the IMF for the 2027-32 interval.
From 2027 onwards, the true check for the MLBs will likely be Sri Lanka’s capability to refinance the rising repayments — IMF assumes over $1bn in debt issuance from that time — specifically if repayments go over $4.5bn by 2029. Failure to refinance would deplete Sri Lanka’s FX reserves and threat a return to the darkish days of 2022.
If debt sustainability actually was the precedence then the macro-link bonds can be tied to Sri Lanka’s FX earnings or FX reserves throughout 2029-2032
However given the complexity of such an MLB, bondholders would profit from a minimum of reconsidering Sri Lanka’s proposal for a two-limbed MLB that hyperlinks to each nominal greenback GDP and actual GDP development. In any case, the very thought of MLBs is at stake right here, along with Sri Lanka’s future.
