Echelon - June 2016

Who Runs First?

Sri Lanka’s debt addiction has got it into trouble many times in the past. In 2016 again, it faces having to turn over a large chunk of foreign currency loans just when conditions in the global markets for borrowers like it have taken a turn for the worse. Private portfolio managers, who now have options for higher yields from investment grade-rated issues, are punishing the irresponsible ones with refinance risks and higher prices.

Risk premiums for Sri Lankan bonds have steadily risen in the five years since 2010 when the country started frequently tapping international markets. Its 2015 $1.5 billion bond had a 4.81% risk premium over the US government bond with the same maturity. Premiums are over 100 basis points higher than five years ago.

It’s not unusual that lower middle-income countries tap international markets. However, Sri Lanka seems wholly ill informed about the discipline this requires. It has issued debt to anybody who would take some and now finds that not all who hold its bonds will refinance it at the same rates, subscribe to issue durations of its choosing or – in some cases – show any interest at all.

There are four types of lenders to governments – official ones like governments and the World Bank, non-banks like pension funds, banks including primary market participants and central banks. Being a relatively new issuer of bonds in international finance, it is strategic and prudent to have a mix of sources. The first to run are yield-hungry issuers who Sri Lanka has come to rely on heavily. At home, the worst places for a government to borrow from are banks and the central bank. These loans inevitably crowd out more productive ones to the private sector and trigger high inflation. Sri Lanka had fumbled in wisely choosing who holds its debt. It now has an opportunity for a fresh beginning with the IMF loan that has been announced.