Fitch says Sri Lanka foreign debt sales could start long-term trend

The recent increase in foreign bond sales out of Sri Lanka could be the start of a long-term trend for stronger entities attempting to overcome weak domestic liquidity, Fitch Ratings says.

Sri Lankan authorities are encouraging institutions to borrow offshore in a bid to bolster foreign-currency inflows. This could reduce near-term stress on the balance of payments and domestic liquidity, resulting in an easing of local interest rates.

For example, the Central Bank has permitted a 23% cap on annual loan growth for banks if additional financing is obtained offshore. The limit is 18% if lending is financed domestically.

The increased frequency of sovereign issuance across five- to 10-year maturities has also provided greater price discovery for investors, and created a benchmark for potential corporate issuers. The sovereign has sold a total of US$ 4 b in five transactions since 2007.

The 10.5x oversubscription of its 10-year US$ 1 b bond on 18 July highlights strong investor appetite, supported by the sovereign’s record of debt-servicing. Fitch Ratings upgraded Sri Lanka to ‘BB’ from ‘B+’ in July 2011.

Fitch...

“There is a cost benefit in sourcing external debt for most issuers, but risks need to be addressed - particularly in the absence of a deep domestic swap market. These risks centre on foreign currency, refinancing and the sovereign’s own credit profile,” Fitch said.

Commercial banks have the ability to mitigate associated risks to a large degree, as they cater to credit demand from exporters that generally lack the scale to tap global bond markets on their own.

Larger export-driven corporates that can borrow externally will also be able to manage risks, so long as external debt is maintained at a reasonable level in relation to the size and volatility of their external free cash flow. However, Sri Lanka remains exposed to volatile short-term capital flows given its persistent basic balance deficit. It may therefore be prudent for corporates to build in dollar sinking funds to meet repayments in the event of any unexpected blow to external free cash flow.

Issuers that do not benefit from external receipts, or do not directly cater to exporter demand, may need to hedge associated risks to a large extent in order to strike a balance between lower borrowing costs and balance sheet volatility.

Historically, a few local corporates and banks have actively sought and successfully sourced medium-term foreign funding, largely from multilateral agencies. But issuance has increased recently, with Bank of Ceylon (IDR: ‘BB-’) issuing US$ 500 m of five-year bonds in May 2012. Others are in the pipeline, subject to market conditions.