LNP – Sri Lanka’s sovereign bond yields rise after Moody’s downgrade

• Sri Lanka all set to settle billion dollar sovereign bond on October 4
• Analysts say downgrade could push Sri Lanka towards IMF bailoutÂ
• Rating action also comes while govt. gears for constitutional reforms   Â

While Sri Lanka is all set to settle a billion dollar sovereign bond maturing on October 4 and has repeatedly expressed its ability and willingness to meet all its upcoming debt obligations when they fall due, yields of Sri Lanka’s international sovereign bonds (ISBs) have reversed course in the wake the country’s sovereign rating downgrade by Moody’s Investors Service on Monday. Â

Moody’s downgraded Sri Lanka’s sovereign credit rating by an unusual two notches to Caa1 from B2, predominantly on the perceived weaknesses in the country’s institutions and governance, which appeared to have taken precedence over the typically assessed economic metrics, which in fact are making strong gains at present.

Foreign debt refinancing risks and the stretched budget deficit caused by the pandemic, from which Sri Lanka wasn’t spared among many other countries, also weighed in on the rating action.Â

As a result, the yields of Sri Lanka’s ISBs have slightly increased from their recent lows touched towards the first week of September, with the yields of the earliest bond maturity due on October 4 peaking to 187 percent on Monday as prices fell across the board, signalling that investors doubt Sri Lanka’s ability to settle the bond, said W.A. Wijewardena, an economist and former Central Banker.    Bond prices fall when the yields go up as they are inversely related.

“In the wake of ISBs of US$1.0 billion maturing on 4/10, Moody’s has ominously downgraded SL by 2 notches to Caa1; bid yield of this bond has peaked to 187 percent on 28/9, despite SL’s assurances that they’d be repaid as promised; SL has enough reserves to do so but market seems to have doubted it,” Wijewardena said in a tweet.  However, Sri Lankan government has lined up all payment transactions for the repayment of this bond maturing on October 4 and said the funds would be credited to the paying agent’s account on October 2.Â
“It is puzzling that Moody’s has downgraded Sri Lanka on the eve of this repayment, which seems similar to the previous premature and reckless downgrades by rating agencies in the immediate aftermath of the end of the internal conflict in 2009 and during the political impasse end of 2018,” the Finance Ministry said vehemently disputing the rationale behind the downgrade.Â

The rating action also came at a time when foreigners started returning to the government securities market as they added nearly Rs.1.8 billion worth of treasury bills and bonds into their holdings during the two weeks ended on September 16.Â

Meanwhile, the Colombo Stock Exchange which also remained lackluster with not much activity for five years, is also renewing records as its All Share Price Index ended 169.16 points or 2.89 percent higher on Monday to surpass the 6,000-point mark amid positive local investor sentiment. Some economic analysts say Moody’s rating action on Monday was aimed at pushing Sri Lanka to an International Monetary Fund (IMF) bailout, which could then impose their economic agenda premised on higher taxes and higher interest rates, reversing the economic gains that been made across the wider economy at present. The downgrade also struck just three weeks before the new government seeks a vote on its proposed 20th Amendment to the constitution abolishing the19th Amendment, which created a power struggle between the President and the Prime Minister driving the economy to its worst growth in two decades and compromised national security.

Sri Lanka has outstanding International Sovereign Bonds worth of US$ 15.5 billion issued via 14 issuances with maturities falling from October 4, 2020 to March 28, 2030. Sri Lanka’s sovereign bond yields which were hovering near their coupon rates or the primary issuance rates until early March started rising from the second week of the month since the identification of the first Sri Lankan COVID-19 patient and since have remained at elevated levels.

The negative rating actions by Fitch Ratings and Moody’s Investors Service in April also had a bearing on the yields.   The yields saw a dramatic increase during the weeks ended on April 3 and April 10 before starting to ease from end-May as investors regained confidence in Sri Lanka after the coronavirus related lockdowns were lifted.