NEW YORK (BLOOMBERG) - The Sri Lankan government's decision to halt debt payments in the face of growing political turmoil has sent investors scurrying to figure out just how much they might recover on US$12.6 billion (S$17.2 billion) of foreign bonds - and whether there is profit to be made.

With the nation battling power shortages, growing political unrest and a currency in free fall, the bonds were already in a downward spiral as the government edged closer to its first default since achieving independence from Britain in 1948.

Now that the authorities are declaring a halt to payments on its foreign debt, investors are assessing if the worst has already been priced in.

The outcome is far from certain, with Sri Lanka rocked by mounting calls for President Gotabaya Rajapaksa and his brother, Prime Minister Mahinda Rajapaksa, to resign, complicating the outlook for whether it will be able to strike a deal with the International Monetary Fund (IMF).

But with some of the bonds hovering around 40 cents on the dollar, analysts say investors could come out ahead as the island renegotiates its obligations.

"Let's hope that the political situation is clarified soon, so that the government can focus on the economy instead of politics," said Mr Carlos de Sousa of Vontobel Asset Management in Zurich, who said investors could receive 60 cents on the dollar in a quick restructuring. "If it takes longer, then the recovery will be considerably lower."

On Tuesday (April 12), the government said that all outstanding payments to foreign holders, bilateral creditors and institutional lenders will be suspended until it can restructure its debts.

The unprecedented step was taken to prevent a further drain on its dwindling foreign exchange reserves to pay for essential imports, such as food and fuel.

Sri Lanka has coupon payments due as soon as April 18, though the Finance Ministry said it requested that payments due while it sorts out a restructuring are capitalised.

The step sent bonds maturing in July down three cents on the dollar on Tuesday to a record low of 46 cents, while US$1.5 billion in debt due in 2030 traded near 39 cents.

The extra yield investors demand to hold Sri Lankan government notes over US Treasuries has risen to 34.63 percentage points, according to JPMorgan Chase and Co data, well past the threshold for distressed debt.

Debt options

For some, the Finance Ministry's plan echoes Ecuador's US$17.4 billion restructuring in 2020, when that country pushed out payment dates, struck an accord with the IMF and exchanged its bonds for new securities to lower its debt burden.

Nomura Holdings analyst Nicholas Yap said Sri Lanka could opt to swap existing notes for longer-dated bonds with lower coupon rates and some reduction to the principal.

Barclays analyst Avanti Save said Sri Lanka could roll all of its debt into a new bond with a final maturity in 2037 and semi-annual amortisations starting in 2027. In that case, coupons could be in the range of 4 per cent to 5 per cent, lower than the average coupon of 6.6 per cent on the outstanding dollar-denominated international bonds.

The steep drop in the price of Sri Lanka's debt led Tellimer to upgrade the eurobonds on April 8 to hold from sell, estimating that the securities had dropped below the amount investors are likely to recover.

In a note Tuesday, Mr Patrick Curran, a senior economist at the firm, said it may be a "long road" to any resolution but that the "balance of risks is now skewed marginally to the upside".