SRI LANKA PLANS FIRST SOVEREIGN BOND ISSUE; MAY

UNCLAS SECTION 01 OF 02 COLOMBO 000550 SIPDIS STATE FOR SA/INS; MANILA FOR USADB; MCC FOR D NASSIRY AND E BURKE SENSITIVE, SIPDIS E.O 12958: N/A TAGS: EFIN ECON CE SUBJECT: SRI LANKA PLANS FIRST SOVEREIGN BOND ISSUE; MAY RETIRE DEBT AND FUND INFRASTRUCTURE ¶1. (U) Summary: For the first time, the Government of Sri Lanka (GSL) intends to raise funds through a sovereign bond issue. Traditionally, Sri Lanka has avoided large-scale borrowing from the international capital markets, relying on concessionary donor financing and local borrowing to fill its financing gaps. Sri Lanka has been forced to borrow from the markets since it chose to abandon the economic reforms program of a prior government and the related IMF- supported Poverty Reduction Growth Facility (PRGF),thus foregoing International Monetary Fund (IMF) and World Bank budgetary support. Central Bank sources say the new funds would go to retire high-cost commercial debt and fund infrastructure projects. End Summary. ¶2. (U) The GSL has appointed Citibank to raise between USD 500 million and USD 1 billion through a sovereign bond issuance. While this will be the first sovereign bond issue offered to the international market by the GSL (previously it had issued dollar denominated bonds locally to non- residents and banks),it is the third time the government will seek foreign currency borrowing since receiving its first sovereign ratings of BB-minus and B-plus (both sub- investment grade) from Fitch and Standard and Poors (S&P), respectively, in December 2005. The bonds will have maturities from 7 to 10 years. The interest rate is not yet known. According to Kapila Jayawardena, Chief Executive Officer of Citibank NA Colombo, who spoke with EconFSN in mid-February, the interest rate would be higher than the rate of LIBOR-plus-95 basis points (LIBOR-plus-0.95%) at which Citibank raised USD 100 million in the GSL's three- year syndicated loan offer in December 2005 as maturities of the new issue are longer. According to Jayawardena, the bonds will be rated prior to issuance and are likely to receive ratings similar to the GSL's sovereign ratings (Note: for rough comparative purposes, similarly ranked countries, such as Indonesia and Vietnam, have issued bonds with spreads ranging from LIBOR-plus-283 to LIBOR-plus-388. End Note). ¶3. (U) Citibank is in the initial stages of planning the bond issue. The bonds are likely to go on sale in May 2006 and will be marketed to financial institutions abroad, including banks and insurance companies. ¶4. (SBU) The government has not yet officially announced the intended use of these funds. Treasury Secretary P. B. Jayasundera told reporters on February 3 that he wants to test the market as Sri Lanka is bound to lose access to donor funds in the future due to rising per capita GDP (Note: Jayasundera leaves unstated that the GSL's options with donors are increasingly limited, due to GSL unwillingness to move forward on fiscal reform. End Note). Jayasundera also suggested the possibility of rolling over high cost debt, but failed to give specific details. Deputy Governor of the Central Bank Rani Jayamaha told EconOffs on February 9 that funds from the bonds would go to settle part of the government's expensive commercial debt including debt owed by quasi-government institutions such as the Ceylon Petroleum Corporation. They may also be used to fund infrastructure projects not funded by the donors. Domestic borrowing limits were also cited by Jayamaha as a reason for raising foreign funds. Parliamentary approval is needed to increase the domestic borrowing limits and the government does not want to seek parliamentary approval frequently. A US Treasury advisor posted in Sri Lanka may be asked by the GSL to become involved with this issuance. ¶5. (SBU) Comment: The GSL's first sovereign bond issue (along with the Nation Building Bonds opened to Sri Lankan expatriates (septel)) reflects substantial borrowing from international markets (about 4.5 percent of GDP) to fund increasing GSL deficits. The projected 2006 deficit has increased by 23 percent to Rs 247 billion (approximately $2.5 billion) equivalent to 9.1 percent of anticipated 2006 GDP. The increase stems from a sharp increase in both recurrent and capital expenditure. Further, Sri Lanka has not been able to draw concessionary funds previously made available from the IMF (about $350 million approved in April 2003 under a 3 year Poverty Reduction Growth Facility (PRGF) which ends on April 17, 2006) as it has abandoned its PRGF. The best use of new funds would be to retire more expensive COLOMBO 00000550 002 OF 002 debt and fund (growth-spurring) public investment, rather than pay for ever-increasing subsidies and the burgeoning civil service. Meanwhile, banking sources expect domestic interest rates to ease following the bond issue as foreign funding reduces government borrowing from the domestic markets. Only time will tell whether the market will purchase enough of these bonds to make a significant difference in need for domestic borrowing, and if it finds sufficient foreign sources, whether the GSL will have the fiscal discipline to actually reduce its domestic borrowing. LUNSTEAD