All we are saying is give peace a price

Euromoney, October 2009

What’s peace worth – in basis points? Sri Lanka will provide something of an answer in the coming weeks as it tests the global investment community’s appetite for a $500 million bond.

Sri Lanka is back in the debt markets with a new story to tell. This year its 25-year civil war came to an end and the mood today on Colombo is peerlessly enthusiastic, as the country looks forward to economic growth unfettered by violence, a divided country, impeded supply (the war-hit regions of the north and east are where much of the country’s farming and fishing takes place) and military spending. The bond, which will be lead managed by JP Morgan, HSBC and RBS alongside local house Bank of Ceylon as a co-manager, aims to create a new, peacetime benchmark for the country, and to improve the cost of its funding.

There is nowhere so unemotional as the global capital markets, and it is an intriguing question to work out just how far inside existing paper, if at all, a new bond might price as a dividend for an end to conflict. There have been rumours of exuberant expectations from the government and the Central Bank of Sri Lanka, which will issue the bond on behalf of the sovereign, with talk in August that it was hoping to raise five-year funds at a yield of 7% – which would be dramatically inside the 8.9% yield at that time of its existing five-year paper, a US$500 million Reg S/Rule 144a issue launched in October 2007 (and which at the height of the financial crisis had gone as far out as 17%).  But those close to the central bank describe its leadership as pragmatic and willing to listen to the market, though clearly hopeful of a positive reception.

Neither the Central Bank nor the three leads were able to discuss the bond due to legal and regulatory restrictions, but Euromoney understands it will launch at an appropriate window before the end of the year and will be five or 10 years in duration depending on investor appetite at the time. Sri Lanka does have some sense of what reception it should expect, for it was taken on a non-deal roadshow across Europe, the US and Asia by HSBC and JP Morgan in July.

Uthum Herat, deputy governor of the central bank, says the reception on that roadshow was “very good. In the last 15 to 20 years, we have had one major underlying fundamental problem,” he says. “Whenever we spoke to investors, they would acknowledge that there was a great deal of potential in Sri Lanka, but they would say: there is one debilitating factor, and that is the war.

“Today we are in the happy position of being able to say: these are the underlying economic fundamentals of the country, and there is no war. That makes a huge difference.”

The message appears to have been getting through. Just weeks after the roadshow, in August, the central bank announced that an unnamed US fund manager purchased US$875 million of four- and six-year treasury bonds, which almost trebled foreign reserves in a single hit. This comes alongside an IMF standby facility that committed US$2.6 billion to Sri Lanka in instalments over the next two years, with about $325 million. Today, total reserves stand at around $4 billion.

That’s a far cry from earlier this year, when an outflow of foreign funds by managers hit by the financial crisis brought reserves to eight-year lows of around $1.2 billion – barely enough to cover a month’s imports. A closer look at the contribution of foreign money to government securities (foreigners can hold up to 10% of these securities) is starker still: Herath says that it went from US$750 million in July 2008 to just $19 million by February. “Pretty much everything had gone.”

Sri Lanka’s subsequent revival, underpinned by peace but supported by the IMF facility and more recently an outlook upgrade by Standard & Poor’s, has been impressive. It’s expecting to log 3-3.5% GDP growth for 2009 and Deputy Minister of Finance and Planning Sarath Amunugama tells Euromoney that “8% is quite doable” in the medium term. That’s the story the central bank will be putting to world investors who appear to be rediscovering appetite for high yield securities. The next edition of Euromoney, containing the full central bank and finance ministry interviews, will include a feature looking at Sri Lanka’s new proposition – and whether it stacks up.