VZCZCXRO4012
RR RUEHLMC
DE RUEHLM #0551/01 0960749
ZNR UUUUU ZZH
R 060749Z APR 06
FM AMEMBASSY COLOMBO
TO RUEHC/SECSTATE WASHDC 3046
INFO RUCPDOC/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUEHNE/AMEMBASSY NEW DELHI 9460
RUEHKA/AMEMBASSY DHAKA 9077
RUEHIL/AMEMBASSY ISLAMABAD 5966
RUEHKT/AMEMBASSY KATHMANDU 4000
RUEHCG/AMCONSUL CHENNAI 6511
RUEHLMC/MILLENNIUM CHALLENGE CORP

UNCLAS SECTION 01 OF 02 COLOMBO 000551 
 
SIPDIS 
 
STATE FOR SA/INS; MCC FOR D NASSIRY AND E BURKE 
 
SENSITIVE, SIPDIS 
 
E.O 12958: N/A 
TAGS: EFIN ECON CE
SUBJECT:  NATION-BUILDING BONDS: SRI LANKA TARGETS ITS 
CITIZENS LIVING OVERSEAS 
 
REF:  COLOMBO 550 
 
¶1.  (U) Summary:  In a move to raise funds from new markets, 
the Government of Sri Lanka (GSL) is targeting its citizens 
living overseas (who normally repatriate over USD 1 billion 
in remittances annually) to purchase patriotically-branded, 
Nation Building Bonds (NBB), by offering tax holidays and 
import duty concessions on vehicles.  The NBBs may become a 
success, as the GSL has already reported a good response 
from workers in the Middle-East.  The bonds appear to be one 
more way the GSL is trying to reduce its exposure to 
condition-laden, traditional donor financed concessionary 
debt.  End Summary. 
 
NBB - GSL LOOKING FOR FRESH FINANCING SOURCES 
--------------------------------------------- 
 
¶2.  (U) The 2006 GSL deficit (in nominal terms) is projected 
to increase by 23 percent to Rs 247 billion (approximately 
$2.5 billion), equivalent to 9.1 percent of anticipated 2006 
GDP (compared with 8.6 percent of 2005 GDP) (reftel).  This 
increase stems from a sharp rise in both recurrent and 
capital expenditure.  Traditionally, Sri Lanka has sought 
concessionary funds from international institutions such as 
the International Monetary Fund (IMF).  For example, Sri 
Lanka was offered the possibility of borrowing, through the 
IMF, approximately USD 413 million from a three-year Poverty 
Reduction Growth Facility (PRGF) and an Enhanced Fund 
Facility (EFF) arrangement approved in 2003.  Although the 
PRGF and EEF were scheduled to expire on April 17, 2006, Sri 
Lanka already abandoned these programs, having drawn only 
USD 59 million from them, when the previous Government 
(comprised of the same party as the current Government) took 
over from the more liberally-minded Government that 
initiated the PRGF in 2003.  The GSL must now seek new 
lenders. 
 
¶3.  (U) On February 4, the Central Bank floated foreign 
currency denominated "Nation Building Bonds" and invited Sri 
Lankan workers abroad to invest (Note: Sri Lankan 
expatriates typically remit over USD 1 billion per year. End 
Note).  The NBBs follow the pattern of bonds issued by India 
to its diaspora.  It is a much smaller issue than the 
recently announced sovereign bond issue which is expected to 
bring in up to USD 1 billion (reftel). Unlike the sovereign 
bond, NBBs do not target international financial 
institutions.  The Government hopes to raise a maximum of 
$250 million through this mechanism. The first issue of $25 
million is now open for subscription.  The state-owned Bank 
of Ceylon is the lead manager for the issue.  The issue is 
open for six months until August 2006. 
 
COMPLEX CONCESSIONS 
------------------- 
 
¶4.  (SBU) The GSL is offering interest rates similar to 
prevailing government bond rates in the US and the UK. This 
is quite significant, given how relatively low the rates are 
on USG treasuries and UK gilts, and considering the 
inherently higher risk premium Sri Lanka sovereign debt may 
be expected to carry, as indicated by its sovereign credit 
risk rating (currently sub-investment grade).  But the deal 
is significantly sweetened with tax and duty concessions. 
Under the NBB scheme, bondholders can reduce import duties 
on vehicles from over 100% to 25% of the vehicle's import 
value.  In order to be eligible for this reduction, bond 
purchasers must invest at least $50,000 in NBBs and the 
Cost, Insurance, Freight (CIF) value of the car can be up to 
20% of the value of the bond.  Therefore, a $10,000 vehicle 
that would typically cost a Sri Lankan a minimum $20,000 
(after import duties and other taxes) will cost only $12,500 
if $50,000 of NBBs are purchased. 
 
¶5.  (SBU) Expressing concern over the NBB's duty concessions 
on motor vehicles, Dr Rani Jayamaha, Deputy Governor of the 
Central Bank, told EconOffs that there will be opportunities 
for misuse.  She acknowledged that a straight-forward bond 
issuance would have been much more manageable. 
 
 
MARKETING WITH PATRIOTISM, BUT NOT SPECIFYING PROJECTS 
--------------------------------------------- --------- 
 
COLOMBO 00000551  002 OF 002 
 
 
 
¶6.  (SBU) When he first announced the issuance on February 
3, Finance Secretary P.B. Jayasundera did not specify how 
this extra debt burden would be used, beyond saying that the 
NBBs would be used for infrastructure projects.  Although a 
seasoned public finance expert, Jayasundera gave a 
surprisingly trivial (and false) justification for the 
issuance by saying "we don't need the money.  But there are 
some patriotic people out there who want to share in the 
national building process."  While the GSL has yet to 
publicly name specific projects, Central Bank Deputy 
Governor W.A. Wijewardena told EconChief that the bonds will 
be used for such infrastructure projects as construction of 
an airport in Hambantota (in the far south) as well as power 
sector and road development. 
 
¶7.  (SBU) An increasingly frustrated Jayasundera appears to 
be making strong efforts to wean Sri Lanka off concessional 
but condition-based donor debt.  Sri Lanka's efforts to 
obtain a sovereign bond rating (which they achieved in 
December 2005), its rejection of traditional IMF and WB 
financing facilities and its use of this latest scheme all 
speak to an effort to raise money, but with little or no 
strings attached. 
 
¶8.  (SBU) Since Jayasundera's February 3 announcement, the 
GSL has re-adjusted its NBB marketing strategy, although 
still playing on patriotism (or at least duty to country). 
Newspapers quoted Assistant Central Bank Governor Rose 
Cooray, kick starting a NBB marketing campaign in the Middle 
East, as saying "We want to tell the Sri Lankan expatriates 
of the country's expectations from its people toward 
national building." 
 
¶9.  (SBU) Deputy Governor Wijawardena also told EconChief in 
March that the GSL has received a good response for these 
bonds from Sri Lankan workers (typically blue collar) in the 
Middle East, although there has been less demand by Sri 
Lanka's professionals living abroad. 
 
¶10.  (SBU) In 2004, the GSL targeted the private market with 
its Sri Lanka Development Bonds (SLDB) of which there were 
USD 261 million outstanding at the beginning of 2005 
(provisionally USD 254 million at the beginning of 2006). 
Unlike the NBBs, only foreign individuals and companies and 
Sri Lankans living outside Sri Lanka are permitted to 
purchase the SLDBs; yet the SLDBs are listed as domestic 
debt.  The NBBs issued will have a further impact on the GSL 
debt structure, reducing its foreign concessional debt with 
debt of a more commercial nature. 
 
Comment 
------- 
 
¶11.  (SBU) In addition to the reftel sovereign bond issue, 
the Nation-Building Bond reflects substantial borrowing from 
international markets and an attempt to pursue non- 
traditional sources.  While the wisdom of issuing bonds with 
complicated incentive structures can be questioned, the cash 
raised could do some good if used to fund public investment 
that will benefit the economy, and not pay for ever- 
increasing subsidies or the ballooning civil service.  This 
appears to be one more step down the GSL's path of reducing 
its dependence on donors, in favor of commercial borrowing, 
in an effort to throw off what Jayasundera sees as overly 
restrictive donor conditionality.  End Comment. 
 
LUNSTEAD