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Sri Lanka: Hope Amidst Turbulence

We initiate our coverage on Sri Lanka’s sovereign bonds (SRILAN complex) with an OVERWEIGHT recommendation. The SRILAN complex comprises SRILAN 19s, 22s, 26s and 27s. We believe Sri Lankan sovereign bonds (Moody’s: B1; S&P: B+) offer attractive yields in the market versus peers such as Vietnam (Moody’s: Ba3; S&P: BB-). Despite the sell-off due to the political chaos, we believe the sell-off was overdone.

We price the bonds on top of Vietnam sovereign bonds as the two economies are in a comparable state. It is evident that the yield of the Sri Lanka sovereign bonds (SRILAN 19s) is around 700bps above its Vietnamese sovereign bond peer with a similar maturity. This indicates that existing investors can still reap the rewards. Moody’s rating downgrade last week (20-November) also removed a near-term downgrade risk, in our view.

Sri Lanka’s growing economy has been hit by a political crisis. On 26-October-2018, President Maithripala Sirisena re-appointed former Prime Minister Mahinda Rajapaksa, ousting the incumbent Ranil Wickremesinghe. However, the parliament has been disrupted by the supporters of the latter, who have called the new appointment unconstitutional. Amidst uncertainty over the future course of action, the economy has dipped slightly in recent weeks.

The Sri Lankan Rupee has fallen c.13% over the last 12 months. Stock market returns have been bright, and the country is now looking to refinance its debt. The island nation has a debt of over USD4bn maturing in 2019, while sovereign bond debt is c.USD5.4bn. The government plans to raise nearly USD1bn through state-run banks. The government also has access to USD680m paid by China for the Hambantota port.    

Amidst continuing political unrest in the country, Sri Lanka’s sovereign bonds could potentially offer higher yields. These have also been driven by the prevalent global conditions. The Central Bank has already indicated that it is looking at alternative sources of funding since borrowing costs are spiralling.

Another viable option that could be explored according to the government is Swaps. They are already in talks with Qatar and China regarding this, and a deal is expected soon, according to the Central Bank Governor. Such a deal would help the country in meeting its repayment schedules. The government is also trying to keep rates down by intervening in the forex market and printing additional currency. Thus, Sri Lanka is likely to repay its bondholders despite political turbulence.