ECONOMYNEXT – Sri Lanka’s domestic banks are in talks with the government seeking repayment of their sovereign bonds in rupees, sources said though there are concerns over the likely impact on the exchange rate from such a move.
Out of 12,550 million dollars of sovereign bonds outstanding, about 1,750 million dollars of bonds are held by resident investors, the bulk of which are banks.
When a dollar asset is repaid in rupees, the banks have a negative foreign exchange position against the deposit liabilities called the net open position which has to be covered by purchasing dollars from the market.
By exchanging a rupee security, banks are hoping to reduce or avoid a haircut on the ISB holdings as they did in the case of Sri Lanka Development Bonds.
When Sri Lanka Development Bonds were repaid in rupees without a haircut, the central bank also provided some dollars in August 2023.
As a result, there are concerns that such a move could impact the exchange rate and the ability to collect reserves, if similar process is followed for ISBs, according to one source.
Banks have already provided for about 50 percent of their exposure to sovereign bonds and the dollar net open position has also been closed to that value.
There are several alternative options that could be taken, another source said.
To collect dollars banks have to curtail domestic credit and channel rupee inflows to purchases.
The SLDBs were exchanged for bonds paying 1 percent above an average policy lending rate.
Foreign investors in bonds have indicated that they may agree to local banks being repaid in rupees, provided any foreigner who wants is also given the same change and that any such deal conforms to parameters set in an International Monetary Fund debt analysis, the sources said.
Any repayment in rupees would reduce the future foreign debt service volumes, analysts say though there are outflow risks if there are significant foreign holdings in rupee securities.
Sri Lanka’s private banks have a separate advisor to foreign investors.
A deal was already reached with foreign investors involving new dollar denominated bond with a haircut that could reduce to 15 percent if the economy performed well.
State Minister for Finance Shehan Semasinghe said engagements with local banks are continuing through advisors but he could not comment on the substance of the talks. (Colombo/July26/2024)