• Says Muddle Through, IMF program and Debt Restructuring are possible outcomes in the near-term
• Opines SL’s debt sustainability challenges to keep spreads wide
• Suggests longer-term stability requires structural reforms

World famous investment banking, securities and investment management firm Goldman Sachs has reviewed three options for Sri Lanka’s current and medium-term debt crisis. In an analysis released last week of Sri Lanka debt sustainability challenge, Goldman Sachs said Sri Lanka has one of the highest dollar bond spreads among EM sovereigns and political uncertainty and the significant impact of COVID-19 led to a worsening of the country’s external vulnerabilities and multiple-notch credit rating downgrades. 

“The question of Sri Lanka’s near-term debt sustainability now appears more pressing. Over the next 18 months, Sri Lanka has $ 2.5 billion in dollar bond maturities falling due, equivalent to 55% of its gross FX reserves, one of the highest levels in EM,” Goldman Sachs said.

In its analysis, Goldman Sachs has explored three potential scenarios for how Sri Lanka can handle its external financing needs in the near term. 

“We do not take a view on the likelihood of these scenarios, but assess what the likely market reaction would be to the different outcomes,” it said. The three options are as follows.

1. Muddle Through: Under this scenario, the country is able to meet its external funding needs until at least early 2021 without entering into a new IMF program, by relying on the drawdown of announced bilateral and multilateral facilities. Goldman Sachs expects Sri Lankan bond prices to continue to trade within the price ranges from March 2020 to now, with market moves dictated by news flow and investor sentiment

2. IMF program: The most recent IMF package was extended in 2016, and expired in June 2020. It expects Sri Lanka’s dollar bonds to perform well should the Government engage with the IMF. For example, if Sri Lankan spreads reprice to 800bp, prices for the longer-dated bonds would likely rise to above 90

3. Debt Restructuring: This may be needed if Sri Lanka is not able to muddle through and does not go to the IMF. Goldman Sachs’ earlier work on sovereign defaults would imply an NPV haircut of around 40% on external commercial debt. This suggests downside risk to the shorter-dated bonds, with longer-dated bonds closer to fair value

Goldman Sachs said the ultimate goal for the Government should be to return to a sustainable debt trajectory. 

“Structural reforms are needed to diversify the economy and current account, and to put the sovereign back on a more stable footing,” it added.

The firm said achieving a significant reduction in public debt-to-GDP over the next several years is going to be a challenging task. The fiscal and current account adjustments required to accomplish that in isolation – i.e., without a significant increase in export revenues and/or funding from stable new external sources – would likely necessitate painful domestic adjustments that may be politically challenging. 

However, in an environment where there is a sustained boost from external growth drivers, an improvement in external competitiveness driven by structural reforms, and increased funding from non-debt creating sources (FDI and equity inflows), a gradual reduction in public debt-to-GDP to more sustainable levels could be achievable over a longer time horizon, Goldman Sachs added. 

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