While Sri Lanka confirms expected default on sovereign debt repaymentsthere are high hopes for frontier markets such as Vietnam, a technical default by Sri Lanka on sovereign debt obligations will act as a wake-up call to many. Confirmation that Sri Lanka has exceeded the 30 day grace period formissed interest payments has seen debt rating agencies update their advice. Even though this move was not unexpected, confirmed by the Sri Lankan government last month, there will still be repercussions.


What does the future hold?


At this moment in time, Sri Lanka is in debt to international bondholders and creditors such as China, Japan and India to the tune of $51 billion. Some experts describe this as a "hard default", while the Sri Lankan government prefers to call it a pre-emptive move to reorganise their debts. 


Import-dependent countries such as Sri Lanka have struggled due to the pandemic, rising interest rates, high energy prices and uncomfortably levels of inflation. In addition, history shows that the Sri Lankan authorities borrowed heavily after a bloody civil war ended in 2009. As a consequence of the Covid pandemic, the loss of tourism also had a severe impact on the economy.


In talks with IMF


While the authorities talk with the International Monetary Fund (IMF) about emergency loan funding, the ongoing crisis has caused dangerous political unrest. Power cuts, a plunging currency and huge queues at the petrol stations seem to have lit the blue touch paper with violence across the island. We also saw the Cabinet, including the Prime Minister, resign en masse, making funding challenging in the short term.


The default interest payments in question relate to two $1.25 billion sovereign bonds, which mature in 2023 and 2028. The fact that the government was struggling to find sufficient funds to pay for $1 million worth of imports highlights the growing problem. We also have the issue of cross-default clauses in several bonds, which will bring forward somerepayment dates. However, at this moment in time, with Sri Lankan sovereign short-term bonds trading at around 45c to the dollar and longer-term bonds even worse, early repayment is not even a faint possibility.


Creditors forced into talks


It seems inevitable that creditors will have to take a hit on their Sri Lankan sovereign debt to get the country back on its feet. Interestingly, JPMorgan has been advising clients to go overweight on Sri Lankan bonds, expecting a short-to-medium-term recovery. So far, there has been limited contagion across other frontier markets, but one thing is sure, the financial impact of Covid will be with us for some time to come.


Long-term opportunities


At Global Investment Strategy Limited, we are renowned for our deep-seated knowledge of APAC markets, including frontier and emerging economies. While the Sri Lankan debt problem may take some time to resolve and move lenders to a more cautious approach, there are still opportunities in this area. Analysts are not expecting immediate debt problems with other frontier economies, but this is a fast-moving situation.

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