Overcoming the hurdle of restructuring sovereign bonds

A caution of alarm was raised last week, when the media disclosed that the private bondholders of Sri Lanka’s sovereign debt had expressed disappointment over the alleged lack of engagement with them by the Government. Heightening the fears, the private creditors are also reported to have vowed to exert pressure on the IMF to hold back the next tranche of funding to Sri Lanka if the Government does not hold constructive talks with them. 

As explained by this column last month, the continuation of the IMF program without hiccups is essential towards the recovery of the economy and moving towards normalisation. The administration is required to reach an in-principle agreement with private creditors when the second review of the IMF Mission takes place next June. The authorities entered into an accord with its bilateral creditors representing the Official Creditor Committee last November while a deal was reached with the Export-Import Bank of China separately, with regard to  $ 4.2 billion of outstanding debt.

Unlike the negotiations that were carried out with the sovereign creditors, striking a consensus with the private bondholders would be quite challenging. The total outstanding sovereign bonds are worth $ 12.55 billion and the bulk of them are held by international bondholders. One must also note that Sri Lanka’s banks too are owed about $ 1.5 billion worth sovereign bonds. 

A CEO of a top commercial bank recently pointed out that the local banks need to be cushioned from the full impact of an ISB haircut on the grounds that banks are vital for the growth of the economy. However, such a treatment requires the consent of other bondholders.

Sri Lanka has obtained the services of Lazard – financial advisor – and Clifford Chance – legal advisor – firms that are also associated with the debt restructuring efforts of Zambia. Zambia has been undergoing a complex, three-year-long debt-restructuring process since missing a $ 42.5 million payment on one of its international bonds in November 2020. Last November, the African nation suffered a huge setback after its official creditors, led by China, forced the country to suspend a deal that was reached with private sector bondholders, covering almost $ 4 billion worth of dollar bonds. Zambia’s painful experience highlights the gravity of the challenge Sri Lanka is facing.

The complexity of the task is further compounded by the lawsuit filed by the Hamilton Reserve Bank (HRB) in June 2022 against the Sri Lankan Government in a New York federal court. All the aforementioned intricacies clearly demolish naive arguments expressed by short-sighted politicians and various columnists – who have no understanding about the international financial architecture – about unilaterally defaulting the ISB-debt obligations. Some pseudo economists are under the impression that ISBs are like loans extended by loan sharks in Sri Lanka with no legal agreements or collaterals. 

Out of ignorance, few leftist columnists have said that private companies which lent to corrupt governments at high interest rates must face consequences from their risky lending by cancelling debt. That is such a junk observation which contravenes the principles of international finance. Asset managers, insurance and pension funds in the US and Europe are also holders of the ISBs owed by the Sri Lankan State, and those institutions invested in the sovereign bonds to safeguard the financial security of citizens in the investing states. Defaulting debt would adversely affect the interest of the working class and elderly citizens in Europe and the US. Such a course of action is wrong both morally as well as legally.   

Irrespective of which party that comes into power this year, the newly elected Government will have to deal with the challenge of reaching an agreement with private creditors. During such a course of action, the creditors could impose tough conditions with regard to public finances, which would involve cutting down expenditure on welfare and subsidies.