In a bid to address the substantial challenge of restructuring $12 billion in overseas debt, Sri Lanka’s private creditors have put forth a comprehensive proposal. This proposal includes the introduction of a novel bond type designed to facilitate repayments in the event of future economic pressures, as revealed by two undisclosed sources familiar with the matter.
Sri Lanka, with its population of 22 million, experienced its inaugural foreign debt default in May 2022, triggered by a severe shortage of foreign currency, leading to the nation’s most severe financial crisis since gaining independence from Britain in 1948.
The proposal, transmitted on October 2, envisions a write-down (haircut) on both the principal amount and interest, according to the anonymous sources, who opted to remain unnamed due to the confidentiality of the negotiations. Furthermore, it introduces the issuance of regular sovereign bonds and a unique financial instrument known as Macro Linked Bonds (MLBs). These MLBs will automatically reduce coupon payments, commencing in 2027, should Sri Lanka fail to meet specific economic targets linked to its International Monetary Fund (IMF) program.
At present, there has been no response from government representatives, nor from the creditor committee’s spokesperson regarding the proposal.
The comprehensive proposal incorporates two distinct options for creditors, with one combining MLB notes with regular bonds, and the other featuring regular bonds coupled with a Value Recovery Instrument (VRI), according to one of the sources.
The inclusion of MLBs is aimed at ensuring eligibility for indexing, a feature that typically enhances liquidity for the instruments. This proposal holds significant weight for Sri Lanka, which, as per the terms of a $2.9 billion IMF bailout secured in March, must secure debt restructuring assurances from bondholders and major bilateral lenders, including China, Japan, and India.
Notably, the proposal introduces the concept of step-down bonds, with the MLBs’ step-down payments linked to indicators such as Sri Lanka’s gross financing needs (GFN) to gross domestic product (GDP) ratio and debt to GDP ratio. For instance, if the GFN/GDP ratio surpasses 4.5% in 2027, coupon rates will automatically decrease.
Crucially, this debt restructuring proposal aligns with the parameters outlined in the debt sustainability analysis produced by the IMF as part of the economic program.
The proposal has also been shared with the IMF and the Paris Club secretariat. It marks a groundbreaking approach to debt restructuring, as step-down bonds have not been previously used in such contexts.
As discussions between bondholders and the government continue, facilitated by financial and legal advisors, trading of the country’s securities remains unrestricted.
