Sri Lanka's Bond Restructuring

By Karin Strohecker

LONDON (Reuters) – Sri Lanka's restructuring of $12.55 billion in international bond debt is leading to new, untested instruments linked to economic growth and governance.

Observers describe it as one of the most complex bond restructurings. These bonds aim to offer additional debt relief if the economy struggles, while promoting improved governance.

Governance-Linked Bonds (GLB)

The governance-linked bond, the first of its kind, rewards Sri Lanka for transparency and effective economic management by reducing debt interest. To qualify for these reductions, Sri Lanka must meet targets, or KPIs, indicative of better governance:

1. Fiscal Performance: Exceed a baseline total revenue to GDP ratio set by the IMF projected at 15.3% for 2026 and 15.4% for 2027.
2. Transparency: Publish a “Fiscal Strategy Statement” on the finance ministry's website in both 2026 and 2027.

If successful, the bond coupon will reduce by 75 basis points from late 2028, saving Sri Lanka $80 million until maturity in 2035.

Macro-Linked Bonds

These fixed income instruments are tied to economic performance, a concept utilized by countries like Argentina and Greece. However, it’s notable that this is the first bond to permit payout adjustments for both economic growth and decline.

The adjustment will occur in 2028, where the upside leads to increased payments and the downside potentially reduces the principal owed. IMF data will inform the measurements and ensure that debt servicing only increases if there is genuine growth in real terms.

Rothschild, advisers to some bondholders, estimate that the downside could provide $2.1 billion in additional debt relief.

Market Integration

For broad acceptance, new bonds require ratings from major agencies (Moody's, Fitch, S&P) and eligibility for key bond indexes. Moody's has approved both structures, with others expected to follow.

Without ratings, major institutional investors may shy away, leading to lower liquidity and higher cost of debt for the issuing country.

Future Implications

The success of these bonds could serve as a blueprint for other issuers. Investors are keen to observe their performance and pricing complexities. Debt restructurings historically incubate innovative fixed income instruments; however, success in these does not guarantee their adoption in future bond markets.