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UNCLAS SECTION 01 OF 03 COLOMBO 001218 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS AND EEB/IFD/ODF 
MCC FOR S. GROFF, D. TETER, D. NASSIRY AND E. BURKE 
TREASURY FOR LESLIE HULL 
 
E.O 12958: N/A 
TAGS: ECON EINV EFIN KMCA CE
 
SUBJECT: SRI LANKA: GOVERNMENT REVIVES SOVEREIGN BOND ISSUE PLANS; 
OPPOSITION SEEKS TO BLOCK 
 
REF: A. 06 Colombo 550  B. Colombo 170 
 
¶1. (SBU) Summary:  The Government of Sri Lanka plans to issue the 
country's first international sovereign bond, in hopes of raising 
$500 million to fund infrastructure projects.  However, the main 
opposition United National Party has announced that a future UNP 
government would not honor the bonds, which it claims the country 
cannot afford.  UNP reps told us that their effort to sink the bond 
issue is primarily political though -- an effort to keep the 
government from being able to buy the continued loyalty of former 
UNP MPs who joined the government as ministers last January.  While 
markets will likely correctly view the UNP threat as a political 
move that would never materialize, the timing of the pending bond 
issue appears to be as bad or worse as sixteen months ago, when the 
government shelved an earlier plan for a $1 billion sovereign bond 
issue.  Sri Lanka has had little good news to reassure currently 
skittish international debt markets.  Nevertheless, market watchers 
say that the relatively small bond issue will probably appeal to a 
sufficient number of international investors who remain interested 
in diversifying their holdings of high-yielding emerging market 
debt.   End Summary. 
 
$500 MILLION BOND TO FUND 
INFRASTRUCTURE, "SET A BENCHMARK" 
--------------------------------- 
 
¶2. (U) The Government of Sri Lanka has revived plans for the 
country's first international sovereign bond issue.  The government 
seeks to raise $500 million, or more if demand is strong.  The 
government says it intends to invest the cash it raises in 
infrastructure projects.  It also expects the bonds to provide an 
interest rate benchmark for private Sri Lankan companies seeking to 
borrow in international capital markets.  This is the second time 
the government has prepared to tap international markets for a large 
bond issue (ref A).  In mid-2006 the government abandoned plans to 
raise $1 billion when advisor Citibank judged that the resumption of 
civil war made the timing inopportune. 
 
¶3. (SBU) The Central Bank of Sri Lanka, which will float the bond on 
behalf of the Government, has selected JP Morgan, Barclays Capital 
and HSBC as joint lead managers of the issue, from among twelve 
local and international banks that bid on the role.  According to a 
senior Central Banker, the bank plans an October road show to 
financial centers like New York, London, Frankfurt, Singapore, and 
Hong Kong to publicize the planned bond issue. 
 
OPPOSITION SEEKS TO BLOCK THE BOND ISSUE 
---------------------------------------- 
 
¶4. (U) The opposition United National Party has challenged the 
government's plan to issue the bonds.  UNP leader Ranil 
Wickremesinghe wrote to JP Morgan, Barclays, and HSBC August 24, 
stating that "the bond issue is in violation of the law" and that 
the "a future Government formed by the United National Party will 
not be able to honour the repayment obligations under this bond 
issue."  In the letters, Wickremesinghe charges that the government 
has not informed Parliament of its plans to issue the bonds; that 
interest payments on the bonds "will hamper the sustainability of 
Sri Lanka's long-term programme for servicing its existing public 
debt repayments"; and that the bonds may contribute to corruption, 
since planned "major infrastructure projects... have all been funded 
by bilateral and multilateral" lenders.  Wickremesinghe sent similar 
letters to U.S. Securities and Exchange Commission Chairman 
Christopher Cox and to Cox's UK equivalent, urging them to "consult 
with the banks concerned and bring to a halt the issuance of this 
sovereign bond." 
 
¶5. (SBU) A UNP economic advisor told Econoff, however, that if given 
the opportunity to do so in a future government, the party does not 
 
COLOMBO 00001218  002 OF 003 
 
 
in fact intend to default on the bonds.  The move, he said, is 
rather a political tactic in the UNP's strategy to bring down the 
Rajapaksa government.  The UNP believes that, if it can block the 
bond issue, it will be able to lure back former UNP members of 
parliament who joined the Rajapaksa government as ministers in 
January (ref B).  Conversely, the UNP believes that if the bond goes 
through, the government will be able to buy the continued support of 
those MPs by allocating much of the cash to the ministries they 
control.  The advisor stuck with the UNP's charge that the bond 
issue would violate the law, saying that it would cause the 
government's total outstanding debt to exceed a maximum established 
by Parliament.  One of the UNP ministers who joined the SLFP in 
January likewise told Ambassador that the UNP had made, but not 
followed through on, a similar threat to block the partial 
privatization of the national airline in the 1990s. 
 
¶6. (SBU) The CEO of HSBC in Sri Lanka discounted the UNP threat as 
"silly... political tub-thumping."  He said there was no way a 
future UNP government would voluntarily default, and was confident 
that international markets would be unconcerned by the UNP position. 
 Other international bank and credit rating agency reps gave Econoff 
the same assessment.  (The Colombo-based JP Morgan representative 
told Econoff he could not comment on the impact of the UNP's letter 
to JP Morgan while his firm conducted due diligence preparations for 
the bond issue.) 
 
¶7. (SBU) As for the government's legal right to proceed with the 
bonds, the senior Central Banker told Econoff that in fact the 
government had notified Parliament, in its November 2006 budget 
proposal for 2007, that it planned "foreign borrowings up to one 
billion dollars."  Finance Ministry and Central Bank officials told 
EconFSN that Foreign Loans are covered under Sri Lanka's Foreign 
Loans Act and therefore do not need special parliamentary approval 
and that debt levels under the Fiscal Management Responsibility Act 
are only targets to improve transparency and accountability, not 
binding limits. 
 
S&P SAYS SRI LANKA CREDIT OUTLOOK "STABLE" 
------------------------------------------ 
 
¶8. (U) On August 9, Standard & Poor's Ratings Services upgraded its 
outlook on Sri Lanka's credit ratings from "negative" to "stable." 
(According to S&P, a negative outlook is used to signal that the 
rating may be lowered in the near future, whereas stable signals the 
rating is unlikely to change.)  S&P kept Sri Lanka's long-term 
foreign currency rating unchanged at B+, or four tiers below 
investment grade.   S&P attributed the improved outlook to "higher 
tax collections, strengthening of fiscal and macroeconomic 
coordination, elimination of fuel subsidies and revision of 
electricity prices" and "the limited impact on the economy from the 
renewed fighting." 
 
¶9. (SBU) The senior Central Banker told Econoff that JP Morgan had 
been influential in the S&P outlook decision, both by helping the 
Bank prepare for the S&P assessment and by convincing S&P during its 
deliberations that the Sri Lankan economy was in fact holding 
stable.  According to the Central Banker, Citibank had not been as 
helpful in preparing the bank for the April 2007 Fitch Ratings 
assessment, which ended with Fitch keeping its outlook at 
"negative."  The new local Citibank head acknowledged to Econoff 
that JP Morgan had beaten Citibank on "customer service," but 
maintained that Citi would have been a better choice than JP Morgan, 
Barclay's or HSBC to lead the bond issue. 
 
COMMENT: POLITICS ASIDE, TIMING FAR FROM OPTIMAL 
--------------------------------------------- --- 
 
¶10. (SBU) Aside from its political agenda, the opposition seeks to 
block this bond issue because it doubts the government will 
 
COLOMBO 00001218  003 OF 003 
 
 
productively invest the proceeds in infrastructure projects.  This 
is a valid concern on three levels.  First, as the opposition fears, 
the government may well use the funds to retain the loyalty of 
ex-UNP ministers by permitting them to pursue pork-barrel projects. 
Second, the government has said it intends to build infrastructure 
even where there is not currently a market demand (like the 
Weerawila airport), or which could be built more efficiently by the 
private sector (like an expanded oil refinery at Sapagaskunda). 
Third, the government is showing signs of being short on cash to 
bridge an apparently growing fiscal deficit, so it will likely use 
some of the bond funds for current, rather than capital, 
expenditures. 
 
¶11. (SBU) While markets will likely correctly view the UNP threat as 
a political move that would never materialize, the timing of the 
pending bond issue appears to be as bad or worse as sixteen months 
ago, when the government shelved its earlier sovereign bond issue 
plan.  Aside from the S&P outlook returning to stable, Sri Lanka has 
had little good news to reassure currently skittish international 
debt markets.  Nevertheless, market watchers say that the relatively 
small bond issue will probably appeal to a sufficient number of 
international investors who remain interested in diversifying their 
holdings of high-yielding emerging market debt. 
BLAKE