Sri Lanka’s external debt: Sri Lanka stumbles towards its first default on its external debt

Sri Lanka is sliding inexorably into default as the grace period on two unpaid foreign bonds draws to a close, the latest blow to a country rocked by economic pain and social unrest.

The island nation could be officially declared in default if it does not pay interest to bondholders by Wednesday, when the 30-day grace period for missed coupons on dollar bonds ends. That would be his first flaw.

The Sri Lankan government announced in mid-April that it would stop repaying its external debt to preserve cash for food and fuel imports as it grapples with a dollar crisis that has led authorities to implement capital controls and import restrictions. Days later, it defaulted on a $78 million coupon on its dollar bonds maturing in 2023 and 2028, leading S&P Global Ratings to declare selective default.

“Without a deal, there will be a formal default,” said Carlos de Sousa, fund manager at Vontobel Asset Management in Zurich. “Legally, it’s important. But for the markets, Sri Lanka is already de facto in default, so the price effect of such an event is unlikely to be significant.

Sri Lankan dollar notes due in 2029 fell 1.2% to 38.7 cents on the dollar on Monday, after hitting an all-time low of 37 cents on the dollar last week, indicative data showed. prices compiled by Bloomberg. According to JPMorgan Chase & Co, the additional return required by investors to hold the notes compared to US Treasuries is 37 percentage points. That’s well above the 1,000 basis point threshold to be considered distressed.

Bloomberg

While a default is widely expected by investors, it has significant implications. Many Sri Lanka bonds have so-called cross-default clauses, which result in the default of payment of the entire dollar debt in the event of non-payment of a single bond. On debt due in 2023 and 2028, the clause is triggered if any payment over $25 million is not honored.

“At this point, most bondholders who are unwilling or unable to hold distressed credit should have already liquidated,” said Patrick Curran, senior economist at Tellimer.

Sri Lanka has been rocked by power cuts, food shortages and a plummeting currency, which fueled protests and prompted Prime Minister Mahinda Rajapaksa to resign. His brother, President Gotabaya Rajapaksa, last week appointed a longtime opponent to lead the government in a bid to bring some modicum of stability to the country amid bailout talks with the International Monetary Fund.

Sunday evening, the country had not yet appointed a finance minister. The central bank governor has threatened to resign if political stability does not return soon. The monetary authority is due to review its policy on May 19.

“The Prime Minister’s departure was something that was really needed,” said Dean Tyler, head of global markets at London-based BancTrust, which sees the salvage value of the notes at between 35 and 45 cents on the dollar. “Hopefully this will start to clear the air and clear the streets.”

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