ECONOMYNEXT – Sri Lanka is on track to make higher payouts on macro-linked bonds as dollar gross domestic product grows, but debt sustainability is maintained amid a strong economy, an International Monetary Fund report said.
Both the principal and coupons increase if dollar GDP expands above thresholds.
“Debt remains sustainable and debt indicators have improved relative to the Third Review, despite additional debt service from the Macro-Linked Bond (MLB) adjustment,” an IMF staff report issued after the completion of the fourth review said.
“The first MLB threshold is now expected to be triggered due to the stronger rupee that leads to a higher dollar GDP.
“That said, improved macroeconomic conditions more than offset the increase in debt service, resulting in improved debt indicators. All DSA targets remain respected.”
The projected average dollar GDP in 2025-27 is now US$98.7 billion compared to the first upper MLB threshold of US$94.0 billion.
Coupons could rise by 25-75 basis points depending on bond series, and principal would go up by 13 percent higher principal on the restructured Eurobonds, the report noted.
Monetary Stability
But debt to GDP would improve.
“This is primarily driven by the improved exchange rate and dollar GDP projections, as the stronger GDP offsets the higher debt service,” the IMF said.
“The projected debt-to-GDP ratio at end-2032 improved from 90.3 percent to 88.3 percent (compared to the DSA target of 95 percent), and the average GFN to GDP ratio in 2027-32 declined slightly from 12.73 to 12.66 (compared to the DSA target of 13 percent).”
There have been warnings that regardless of what politicians do to raise taxes, if the central bank narrowly targets its policy rate (single or mid-corridor rate) the exchange rate would collapse and Sri Lanka would default like Argentina.
Before the IMF’s Second Amendment to its Articles in 1978, (flexible or collapsing exchange rates) sovereign defaults were rare, when money in most countries had more credible anchors even when anchor conflicts triggered forex shortages, leading to stand-by agreements but not outright default.
Argentina routinely defaults after bringing debt down to 60 percent of GDP or below, with the BCRA trying to run credit cycles longer than the US by obsessively targeting a policy rate by repurchasing its own sterilization securities, analysts have pointed out.
Sri Lanka also started to rapidly go downhill after the end of a civil war, running in to BOP crises from the liquidity injections made to target a mid-corridor rate with excess liquidity from a variety of operation out of line with current dollar inflows, including dollar rupee swaps.
Forex shortages then led to a frenzy of foreign borrowings (as long as market access was there), and the ensuing stabilization crises then killed growth and pushed up interest costs, eventually leading to a Latin America style peacetime default with bloated foreign and domestic debt without a war.
Variation
Meanwhile the IMF said the current DSA baseline is based on no claw back assumption for other creditors with respect to the MLB features—consistent with the legal documents—but debt sustainability is preserved regardless as there was a sufficient buffer, the IMF said.
Sri Lanka has restructured most of the debt with only 0.8 billion remaining when the review went to the board.
Of that 250 million dollars were related to Hamilton Reserve Band-held bonds which were in litigation.
“The litigation entails risk to debt sustainability,” the IMF report said. “However, the risk is contained given the limited size of bonds under the litigation and the design of most favored creditor clauses on the new bonds: it does not apply to payment of any judgment which is final and non-appealable.:
After the stay of proceedings ended on January 15, Hamilton Reserves had renewed its motion for summary judgment, but the court granted Sri Lanka’s request for additional discovery.
IMF said debt sustainability risks would remain high in the next few years and it was “critical to fully complete debt restructuring and continue fiscal discipline.” (Colombo/July03/2025)
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