Sri Lanka’s Debt Restructuring Deal: Economic Relief or Creditor Windfall?

Close on the heels of agreements with key bilateral lenders, the Sri Lankan government last week announced that it has reached debt restructuring agreements with commercial creditors (those who have bought the country’s International Sovereign Bonds (ISBs).

Of the country’s $37 billion external debt, ISBs amounted to $12.5 billion by the end of 2023, according to official data. According to a statement issued on July 3, investors agreed to take a 28 percent nominal reduction on the bonds’ principal. The deal also includes Macro-Linked Bonds (MLB), whose payouts are linked to economic growth and a potential governance-linked bond.

Sri Lankan economic analyst Dhanusha Gihan Pathirana told The Diplomat that while the government and the bondholders present the agreement as a 28 percent “haircut,” a reduction applied to the value of an asset, the bondholders can further trim it to just 15 percent, should certain economic conditions be met.

Pathirana said that this is one of the most disadvantageous debt restructuring agreements a developing country has signed. “This is considerably smaller than Zambia’s 18 percent and Ghana’s 37 percent haircuts,” Pathirana said. Like Sri Lanka, Zambia and Ghana too defaulted due to the impacts of the COVID pandemic, and had both entered into debt restructuring agreements after painful negotiations.

Under the agreement, Sri Lanka has to pay a low interest of about 3.75 percent until 2028, but from 2028, Sri Lanka must pay a weighted interest of 8.2 percent to bondholders if the GDP goes past $100 billion, Pathirana said, adding that given the current trends, i.e., the nominal GDP value has increased by about 14 percent in 2023, this is highly likely.  “This is a great deal for bondholders because the original interest rates were between 5 to 7 percent,” he pointed out.

History of Discussions

According to the government, the agreement is a culmination of discussions that have been taking place with the Ad-Hoc Group (AHG) from 2023. AHG, which includes some of Sri Lanka’s largest international holders of ISBs, controls about 50 percent of the ISBs held by foreign parties. They are represented by a steering committee advised by financial advisors Rothschild & Co, and legal advisors White & Case.

In a statement, Sri Lanka’s finance ministry said that the country is among “the first countries where debt restructuring was based on the IMF’s new Debt Sustainability Analysis (DSA) framework.” As per the DSA, Sri Lanka needs to achieve several targets to restore debt sustainability, including reduction of Public Debt to GDP ratio from 128 percent in 2022 to less than 95 percent by 2032, reduction of  Gross Financing Needs (GFN) as a percentage of GDP from 34.6  percent in 2022 to less than 13 percent on average during 2027-2032, and reduction of the percentage of foreign currency debt service as a percentage of GDP from 9.2 of GDP in 2022 to less than 4.5 during the period 2027-2032.

The ministry of finance also said that they had categorized external creditors into six groups, and that they needed to negotiate with them separately while ensuring equal treatment for all. These creditor groups are the Official Creditor Committee of official bilateral lenders (co-chaired by France, India, and Japan), who hold $5.8 billion of Lankan debt; the China Exim Bank ($4.2 billion); other Official Creditors (Kuwait, Saudi Arabia, Iran, Pakistan – $0.3 billion); ISB holders ($14.2 billion); China Development Bank ($3.2 billion) and other commercial creditors (under $0.2 billion). Sri Lanka finalized domestic debt restructuring last year.

While discussions with the bilateral creditors seem to be progressing, with the Official Creditor Committee and China’s Exim Bank agreeing to back the country, there were concerns regarding the discussions with the bondholders. The AHG believes that Sri Lanka and the IMF have underestimated the country’s GDP growth. In 2022, Sri Lanka’s GDP was $74.85 billion. Although the GDP declined by 2.3 percent in 2023, it is projected to grow by 2.2 percent in 2024 and 2.5 percent in 2025. The bondholders argue that Sri Lanka’s GDP will grow at a higher rate, enabling the country to pay higher interest rates on the new series of bonds it will issue during the restructuring of privately owned debt.

However, the two sides seem to have ironed out these differences in the last two months. The finance ministry says “AHG and Sri Lanka resumed restricted negotiations on the 27th – 28th of June in Paris,” a day after Sri Lanka signed agreements with the Official Creditor Committee (OCC) and Exim Bank of China. The Sri Lankan government insists that the AHG submitted a new proposal that addresses Sri Lanka’s concerns, i.e., the choice of baseline parameter, inclusion of downside risk, choice of trigger and share of upside.

The finance ministry says the agreement takes the baseline from the June 2024 second review of the IMF-supported program and would be applied as the choice of baseline parameter. To address the concerns over sharing downside risk, the two sides have incorporated additional downside scenarios, providing Sri Lanka with further debt relief in case of adverse macroeconomic outcomes. Regarding the choice of trigger, Sri Lanka had concerns about the Ad Hoc Group’s preference for a single trigger due to the risk of nominal U.S. dollar GDP increasing solely based on currency appreciation rather than real GDP growth. This could lead to higher payouts without a corresponding increase in government payment capacity. Therefore, a “control variable” capturing real GDP growth was agreed upon. Additionally, the upside thresholds and payouts were adjusted to ensure a more balanced share of upside between the creditor and debtor.

A Win for Creditors

Pathirana, the economic analyst, pointed out that while the government is portraying the agreement with bondholders as a victory in a bid to impress voters ahead of elections, it has agreed to increase the country’s ISB debt repayments to $19.6 billion in 2038, worsening the debt burden worse and setting the country to another default. According to the London Stock Exchange filing, the total amount of restructured debt is $14.43 billion, including $1.889 billion in overdue interest.

“The restructuring agreement provides for a 28 percent debt reduction on bonds originally valued at $12.55 billion. However, if Sri Lanka’s GDP grows beyond the conservative limits set by the IMF, the concessions could be reduced from 28 percent to 15 percent. This means the benefit of economic growth will accrue not to the people but to the creditors,” Pathirana said.

Drawing attention to the experience of other countries, Pathirana noted that “Ghana achieved a 37 percent debt reduction in 2023 and is negotiating for longer maturity dates. Zambia secured an 18 percent reduction and extended its maturities to 2030-2053. Ecuador and Argentina also managed to reissue bonds with extended maturities. In contrast, Sri Lanka’s agreement extends the maturity date from 2028 to 2038, which is relatively short.”

Pathirana says the bondholders extended loans to Sri Lanka at exorbitant interest rates, ahead of the developing country’s anticipated default, trapping the country in a cycle of debt, and yet do not bear substantial losses from debt restructuring.

“This dynamic not only unfairly burdens developing countries with high interest rates, but also risks creating a self-fulfilling prophecy where high interest burdens push sovereigns to default. Indeed, bondholders can be seen to triumph both before and after debt restructuring, while the countries negotiating their debt restructuring—and their citizens—wait in financial limbo,” Pathirana said.

Global debt justice organizations and scholars advocate for a new path, emphasizing the need for a government with the vision and strength to pursue debt justice. Holding predatory private creditors accountable requires significant political change.

President Ranil Wickremesinghe’s late-night agreement is not a victory but a dangerous deception that further entangles Sri Lanka in an exploitative global debt system prioritizing creditor profits over the country’s development and the people’s welfare. A radical political shift toward debt justice and accountability is urgently needed to break free from this cycle and build a sustainable future for Sri Lanka.