Sri Lanka and its sovereign bondholders have come to an agreement to exchange $14.43 billion in defaulted bonds and overdue interest for new instruments tied to future GDP growth, governance, and standard fixed interest bonds.
Bondholders have consented to an 11% haircut on $1.889 billion of overdue interest, as opposed to an earlier proposal, according to a filing with the London Stock Exchange.
Sri Lanka will swap $12.55 billion for bonds with an initial 28% haircut, which includes bonds with a state contingent factor (macro-linked bonds) connected to future dollar GDP growth.
The deal requires confirmation by the Secretariat of Sri Lanka’s Official Creditor Committee to ensure it aligns with their restructuring terms and IMF staff to confirm compliance with a debt sustainability analysis, as stated by the government.
The GDP-linked gains will be capped at 85% of the original principal, implying a minimum 15% haircut on the bonds, in an agreement with bondholder representatives (ad hoc group) who collectively hold about 50% of the securities.
Sri Lanka will also pay a consent fee of 1.8% on the original bonds, or $225 million, to persuade all bondholders to accept the deal.
The overdue interest will be converted into 4.0% bonds with a total principal of $1.678 billion, maturing between 2024 and 2028.
The $12.25 billion in bonds will be exchanged for bonds with a face value of $9.036 billion, maturing between 2028 and 2038.
This includes eight state contingent bonds whose haircut could improve from 28% to 15% if GDP grows faster than the conservative IMF forecast.
Coupons could rise to as much as 9.75% after 2033. The haircuts could increase up to 34.5%, and up to 40.4% after 2028, if GDP growth falls below IMF projections.
Sri Lanka is experiencing a strong recovery under monetary stability provided by the central bank through largely deflationary policies and currency stability so far.
Analysts have cautioned that the announced policy of ‘flexible’ inflation targeting with 5-7% inflation generation amounts to un-anchored discretionary policy, targeting a non-credible domestic anchor three times the level of stable countries, without a clean floating currency regime.
Such regimes in Sri Lanka and elsewhere, including Ghana, have led to sovereign defaults in the past, similar to money supply targeting without a clean float (primarily sterilizing reserve sales) observed during the Latin American sovereign default wave after 1978, regardless of fiscal deficits, revenue to GDP levels, or debt to GDP levels.
The macro-linked bonds represent a new mechanism where any gains would accrue to bondholders, unlike earlier mechanisms involving separate value recovery instruments (VRIs), which were traded separately and often ended up with hedge funds.
There will be two standard bonds of $800 million maturing in 2024 and 2035, which could be converted into bonds linked to governance or so-called environmental, social, and governance (ESG) securities.
Previously, bondholders had proposed that coupons would decrease if the government achieved certain governance benchmarks.