Sri Lanka’s Sovereign Debt Restructuring as It Presently Stands


President Ranil Wickremesinghe

Central Bank Governor, Dr. Nandalal Weerasinghe

Treasury Secretary Mahinda Siriwardena

By Manjuka Fernandopulle

What’s going on with the debt restructuring process? Three concepts are involved. The first is debt sustainability analysis (DSA). It estimates the resources available to repay the debt. Basically, it examines how the debt to GDP ratio can be reduced. It also informs creditors of the debtor nation’s resources to pay the restructured debt.

The variables calculated are GDP growth assumptions, revenues and expenditures under different scenarios. There is controversy over the growth rate assumptions. There is a theory of what is called the effect of over-indebtedness on GDP growth. Studies have shown that sovereign debt defaults have an overhanging effect on economic recovery and therefore previous assumptions about the behavior of the economy are no longer true. However, this may or may not be applicable in the case of the Sri Lankan economy given the resilience it has shown in recovering from past crises.

However, it should be kept in mind that this is Sri Lanka’s first sovereign default. The ghost of this defect will persist. The assumption that Sri Lanka will be bailed out or act rationally to avoid an economic collapse may no longer be considered true or even taken into account when risk calculations are made when investors’ decisions are made. It is estimated that 2022 and 2023 will see negative economic growth close to minus 10%. This will result in an increase in debt to GDP from the current 114%.

Second, the IMF’s policy on delinquent loans. The policy sets out the rules on how and when the IMF can lend in the event of a sovereign debt default. It requires the debtor country to prove that it attempted to negotiate in good faith and that the IMF must be satisfied with the financing it provides despite the default, this would not impair its ability to provide financing should an eventuality arise. . Under this policy, if there are arrears due to the IMF and the World Bank, the IMF does not provide financing until the arrears are cleared.

As a general rule, if the debtor country does not have sufficient resources to settle the arrears of the official lender, a bilateral lender will provide a bridge loan to settle the outstanding arrears. This happened during the debtor restructuring of Sudan which was concluded last year, where France provided a loan of 1.5 billion dollars to pay outstanding official arrears. The loan was repaid when Sudan accessed IMF financing. The IMF will look to the consent of bilateral debtors to verify whether there has been a negotiation in good faith. The IMF takes a somewhat liberal approach in applying the policy to commercial creditors, but will ensure that its funds are not used to bail them out. The policy derives from the content of Article VI of the IMF’s Articles of Agreement.

The third relates to the indicative debt scenarios being prepared by financial advisers. This is where the indebted country specifies the amount of debt relief sought and the methods of debt relief. Debt relief will be calculated in net present value terms.

Relief methods are maturity discounts, coupon adjustments or maturity extensions. For maturity hair to occur, creditors may insist on some sort of value recovery mechanism so that they can recoup lost capital if there is an advantage in the debtor’s economy.

The indicative “debt sicario” is akin to the sovereign debtor’s wish list. This is what he wants but not necessarily what he gets. The publication of the indicative debt scenarios marks the formal start of debt restructuring negotiations. Indicative debt scenarios are usually posted on a website to ensure full disclosure in accordance with US securities regulations.

The tough negotiations would center on how much foreign creditors are willing to subsidize domestic creditors to relieve Sri Lanka’s debt.

The composition of external debt in Sri Lanka is complicated. It consists of bond debt, multilateral loans, bilateral loans and bank loans. Bank loans and bond debt are taken into account.

From what I have gleaned from my discussions with bondholder advisers, I think they will push for domestic restructuring. The domestic quantum of national currency is about 50 billion dollars. They will want the burden of debt relief to be shared by domestic creditors. They believe that given the amount of domestic debt, a lasting solution can only be found if domestic debt is also addressed.

They will also insist on the transparency of the negotiations. This means that they will insist on full disclosure of what is offered to the Chinese and the principle of comparable treatment applied as the operational basis for debt restructuring. Comparable treatment ensures equity among creditors or that all creditors bear an equal burden of debt relief and that no group of creditors or creditors subsidizes the repayment of another creditor’s debt by granting debt relief.

Most likely, the Chinese will insist on confidentiality and privileged status. The Japanese will insist that Paris Club terms apply to the restructuring of China’s debt. The Bondholders Committee is advised by White and Case and Rothschilds. White and Case’s sovereign debt restructuring practice is led by Ian Clark. Ian Clark is a seasoned restructuring lawyer. He has been involved either on the sovereign side or on the creditor side, in all the sovereign restructurings that have taken place over the last thirty years. He currently advises Zambia, Suriname and Ukraine. In Zambia and Suriname, he is assisted by Lazard as financial adviser. In Suriname, bilateral creditors include both India and China. Creditors were offered value recovery instruments linked to the price of oil.

Ian’s philosophy is not to miss the wood for the trees. Therefore, I have the impression that he will look at the big picture rather than the detail. For him, it will be a question of creating an efficient economy which ensures the valuation of the assets of its customers. Thus, I believe he will adopt the best approach that will secure his customers’ payments while not inflicting unnecessary pain on the national economy.

It was this philosophy that he applied with Bruno Cuiffettelli of Hogan Lovells to complete Ecuador’s debt restructuring in six months with an exit yield of 8-10%. Ecuador is a major oil producer and a dollarized economy, but a serial defaulter. The need for internal restructuring has been avoided in Ecuador. Hogan Lovells successfully won a challenge from holdout creditors in New York

District Court for the Southern District.

Ian has also advised the bondholders committee in Lebanon and creditors in Iceland, Cyprus and Greece. He has the insight, experience and ability to show how bail-ins can be used to successfully ensure that creditors will have priority for payment while ensuring the financial stability of the national financial system. He advises essentially the same set of clients he has advised in Argentina, Ecuador and Lebanon.

(The author holds an LLM (University of Notre Dame, USA), LLM (University of Auckland), LLM (University of Colombo), LLB (Hons) (Hull) and is a lawyer with qualifications multi-jurisdictional law in international finance and sovereign debt, international commercial and investment arbitration, international taxation and Australian corporate restructuring and insolvency, international law and international human rights law with multi-faceted professional skills and experience.)


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