Sri Lanka looks at reviving sovereign bond issue : CB Governor

Aug 10 (LBO) – Sri Lanka is looking at reviving a sovereign bond issue, which was shelved earlier this year, to raise medium term dollars, Central Bank Governor Nivard Cabraal said.

After getting a sovereign rating last year, (BB- from Fitch and B+ from S & P) Sri Lanka was planning to go to the markets and raise between 500 to 1000 million dollars through 7-year bonds, at the beginning of 2006, with the Citibank.

Treasury secretary P B Jayasundera later said they had shelved the Citibank deal, but Governor Cabraal now says the government is re-looking at the sovereign bond issue.

“We are considering all options and instruments,” he said. “We will choose the most appropriate method.”

Governor Cabraal said a sovereign bond issue would bring side benefits.

“When hard nosed investors buy these bonds it increases confidence in the country” he said.

In Sri Lanka the Central Bank’s public debt department is responsible for issuing debt on behalf of the treasury.

Quick dollars

The government has so far focused on issuing 2 to 3 year dollar bonds from the foreign currency banking units of local banks.

In June, the government raised 300 million dollars through the so-called Sri Lanka Development Bonds (SLDB), though 144.5 million dollars were re-issued.

Another 150 million dollar bond issue is due to close on August 18th.

Some market participants expect the government to accept bids up to 250 million dollars, repeating the experience in June when extra bids worth 100 million were accepted, though bids were originally called only for 200 million dollars.

The Bank of Ceylon which borrows through syndicated loans from time to time, and on-lends to government, is also expected to raise about 250 million dollars before the end of this year, a part of which is already reported to have been received.

It also lends it non-resident foreign currency deposits through to the government.

Faced with rising oil and other subsidies as well an intensifying conflict, the government has been trying to find ways to find money without raising domestic interest rates.

Dollars are also important to bridge a hole in the balance of payments which has been widening in recent months, resulting in a net outflow of central bank reserves.

Comfort Factor

A medium-term sovereign bond, though costly, would also help calm the foreign exchange markets at a time when conflict in the north and east is intensifying.

Analysts say it would also give fiscal space to absorb further increases in defense expenditure if the need arises, and the proceeds of the sovereign debt could be a valuable war chest for the country.

Dollar borrowings have several short term benefits such as less ‘crowding out’ of domestic savings or a temporary propping up of the currency as well as the putting less pressure on the government to print money.

But Sri Lanka Development Bonds have a floating rate, and also have to be re-issued every two or three years, which can be difficult if volumes build up.

However floating rates allow a borrower to benefit from falling rates in the future as well as exposing a borrower to rising rates.

Latin American countries like Argentina which resorted heavily to commercial dollar loans to bridge weaknesses in fiscal policy, fell into severe balance of payments problems later when it was unable to re-finance loans.

A medium term bond however will allow the government to escape re-finance pressure for 7-years or more.

Since 2005, Sri Lanka has found it difficult to qualify for low interest program loans from multilateral lenders such as the World Bank, because its macro-economic policy framework is weak on fiscal prudence and economic reforms, forcing it to rely more on commercial dollars.

Enormity?

Meanwhile dollar borrowings have run into a storm of protest from the opposition, with some critics calling it a national crime.

On Tuesday the central bank issued a statement saying dollar borrowings were not a ‘national crime.’

The statement also said dollar bonds have been issued in 2001, 2002, 2004 and 2006.

The statement said bonds have been re-issued at a lower risk premium of around 130-140 basis points, compared with 163-225 basis points two years ago.

But critics point out that this is a misleading statement because the benchmark London Interbank Offer Rate on which the bonds are based on, is now much higher than before.

Unlike rupees which can be repaid with domestic resources, dollar bonds have to be repaid in foreign exchange, and if economic or security conditions deteriorate, the government may find it difficult to refinance such debt, by resorting to the usual practice of printing money.

In addition, Sri Lanka’s chronic currency depreciation, brought by loose fiscal and monetary policy also increases the interest costs and the national debt burden of foreign loans.

Domestic debt on the other hand, falls as a percentage of GDP when inflation rises.

Borrowing large amounts of dollar debt can also push up the currency and hurt the competitiveness of the country.

But if dollar rates are nearing their peak now, having floating rates can actually benefit a borrower.

In that case, locking in for 7 or more years at current rates can be a costly mistake.