Colombo stumbles towards its first default on foreign debt

COLOMBO • Sri Lanka is sliding inexorably into default as the grace period on two unpaid foreign bonds nears an end, the latest blow to a country rattled by economic pain and social unrest.

The island nation could be formally declared in default if it fails to make an interest payment to bondholders before tomorrow, when the 30-day grace period for missed coupons on US dollar bonds ends. That would mark its first default.

Sri Lanka's government announced in mid-April it would stop paying back its foreign debt to preserve cash for food and fuel imports as it struggles with a dollar crunch that has led officials to implement capital controls and import curbs.

A few days later, it failed to service a US$78 million (S$109 million) coupon on its dollar bonds due in 2023 and 2028, leading S&P Global Ratings to declare a selective default.

"Without an agreement, there will be a formal default," said Mr Carlos de Sousa, a money manager at Vontobel Asset Management in Zurich. "Legally, that matters. But for markets, Sri Lanka is already de facto in default, so the price effect of such an event is probably not going to be significant."

Sri Lankan dollar notes due in 2029 were down 1.2 per cent to 38.7 cents on the dollar yesterday, after touching an all-time low of 37 cents on the dollar last week, indicative pricing data compiled by Bloomberg showed.

The extra yield investors demand to hold the notes over US Treasuries is at 37 percentage points, according to JPMorgan Chase & Co. That is far above the 1,000 basis-point threshold to be considered distressed.

While a default is widely expected by investors, it has important implications. Many of Sri Lanka's bonds have so-called cross-default clauses, which drag all the outstanding dollar debt into default if there is a missed payment in a single bond. On the debt due in 2023 and 2028, the clause is triggered if any payment that exceeds US$25 million is not met.

"At this point, most bondholders who are unwilling or unable to hold distressed credits should already have cleared out," said Mr Patrick Curran, a senior economist at Tellimer.

Sri Lanka has been rattled by power cuts, food shortages and a currency in free fall, which fuelled protests and pushed prime minister Mahinda Rajapaksa to resign.

His brother, President Gotabaya Rajapaksa, last week appointed long-time opponent Ranil Wickremesinghe to run the government in a bid to bring a modicum of stability to the country amid bailout talks with the International Monetary Fund.

BLOOMBERG