SRI LANKAN GOVERNMENT FINANCE-DOLLAR DEBT AND

UNCLAS SECTION 01 OF 02 COLOMBO 001633

SIPDIS

STATE FOR SA/INS
STATE PLEASE PASS TO USTR FOR FHUEGEL
TREASURY FOR DO/GCHRISTOPOLUS AND AKIFAYAT, GRAO
MANILA FOR USADB

E.O. 12958: N/A
TAGS: KTDB BEXP ECON EINV ETRD EFIN CE ECONOMICS
SUBJECT: SRI LANKAN GOVERNMENT FINANCE-DOLLAR DEBT AND
REFORM EFFORTS

Ref: (a) Colombo 001400


1. Summary: The Government of Sri Lanka (GSL) has
requested proposals for a financial facility of up to $350
million to finance the budget deficit. The funds raised in
this issue will ease pressure from the local money market
and interest rates. The proceeds will be part of a Rs 329
billion (approximately $3.4 billion) gross borrowing program
of the GSL for 2002. End Summary.

GSL to borrow $350 million
--------------

2. The Central Bank has requested proposals from
international investment banks and local banks to raise $350
million in long-term debt. The minimum tenor of the loan is
5 years and proposals are invited in the form of either a
syndicated loan, fixed rate bond or a floating rate note.
The closing date for proposals is September 6. The Central
Bank expects to borrow the funds during the last quarter of

2002. The funds will go to finance the GSL capital
expenditure and to retire existing short-term government
debt.


3. Sri Lanka will go for the debt issue, its largest ever
in international markets, minus a sovereign debt rating.
Although Sri Lankan officials have talked about seeking a
debt rating, Treasury Secretary Charitha Ratwatte told the
media a few weeks ago that the GSL would wait for the peace
process to take root, then will seek a rating. Investment
analysts in Colombo feel that Sri Lanka would likely get a
below investment grade of B+ or BB+, close to India's BB
rating, if it applies for a rating for long-term foreign
currency debt.


4. The last time the GSL raised a loan from the
international market was in 1997 when it raised $50 million
through a two year floating rate note. In addition, in late
2001 and June 2002, GSL raised a total of $250 million
through dollar denominated bonds sold in Sri Lanka. The
last tranche of this issue in June 2002 was priced at six
months LIBOR plus 193 basis points. The Central Bank is
confident of receiving favorable bids for the current debt
call. Citibank/Solomon Smith Barney, JP Morgan, HSBC and
Standard Chartered Bank are among those expected to submit
bids.


5. According to the Central Bank, the total gross borrowing
program of the GSL for 2002 is Rs 329 billion (or about $3.4
billion). The proceeds from the $350 million (Rs 33.3
billion) international debt issue will form part of the
borrowing plan, along with a $90 million dollar denominated
Development Bond issued in the local market in June. In
addition, the Government expects about $70 million (Rs 736
million) from concessionary foreign financing. The balance
will be raised mostly in the local rupee market.

Development of a long-term yield curve
--------------

6. The retirement of some rupee debt with dollar proceeds
is expected to improve market liquidity and further ease
pressure on the interest rates, which have fallen
considerably during 2002. In response to a reduction of key
Central Bank short-term discount rates and improved
liquidity, the entire Central Bank yield curve has shifted
downwards by about 300 basis points between January and
August 2002. Currently, short-term (3 month and 12 month) T-
bill rates are at 11-11.5% while long-term rates vary
between 13.3 percent for 4 year bonds and 14.4 percent for 6
year bonds.


7. In addition, the Central Bank has issued more long-term
rupee bonds and the yield curve has been extended up to 6
years. In a bid to develop further the long-term yield
curve, Central Bank is also expected to issue 12-year bonds
this year. The Central Bank is said to be keen on issuing
long-term debt in view of current low interest rate climate,
but the timing and the features of the issue have not been
decided yet.

Other financial sector developments
--------------

8. Meanwhile, the Prime Minster has appointed a Financial
Sector Reforms Committee (FSRC) to fast track financial
sector reforms. The Committee is reviewing key reforms
identified at a recent conference hosted with the assistance
of the IMF resident representative office in Colombo. The
conference results included a series of recommendations.
Some of the reforms considered by the FSRC are relaxation of
controls on foreign exchange and the capital account,
amendments to the banking act and monetary law act,
strengthening bank supervision, relaxation of the statutory
reserve ratio, development of debt instruments and the
creation of a long term yield curve.

New legislation
--------------

9. In a separate move to control public finances, the GSL
will introduce a wide-ranging Fiscal Management
(Responsibility) Act. The purpose is to promote greater
accountability and responsibility in all public offices. It
will place government spending under strict scrutiny and
will prevent finance ministers from giving out pre-election
subsidies and inducements to voters. If extreme
circumstances necessitate spending over-budget, the Finance
Minster has to table a statement in Parliament justifying
the action. Under the act, election manifestos of major
parties are to be referred to the Central Bank to assess the
long-term impact on government finances. The Central Bank
should also investigate and comment on all government
spending plans.


10. The law also would require the Finance Minister to
present to Parliament a financial position report annually
which will state GDP estimates and forecasts of other key
economic variables. The Finance Minister is also expected
to present to parliament a mid year GSL fiscal position
report as well as the annual budget statement. The GSL soon
plans to introduce several other laws or amendments to
current legislation concerning the financial sector
including regulations on monetary policy and banking,
finance companies, stocks and securities, mortgage, and debt
and loan recovery.
Amselem