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RR RUEHLMC
DE RUEHLM #0450/01 1300459
ZNR UUUUU ZZH
R 090459Z MAY 08
FM AMEMBASSY COLOMBO
TO RUEHC/SECSTATE WASHDC 8095
INFO RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHNE/AMEMBASSY NEW DELHI 2009
RUEHKA/AMEMBASSY DHAKA 0873
RUEHIL/AMEMBASSY ISLAMABAD 7866
RUEHKT/AMEMBASSY KATHMANDU 6047
RUEHKP/AMCONSUL KARACHI 2342
RUEHCG/AMCONSUL CHENNAI 8473
RUEATRS/DEPT OF TREASURY WASHDC
RUEHLMC/MILLENNIUM CHALLENGE CORPORATION

UNCLAS SECTION 01 OF 02 COLOMBO 000450 
 
SENSITIVE 
 
SIPDIS 
 
STATE FOR SCA/INS AND EEB/IFD/ODF 
 
E.O 12958: N/A 
TAGS: EFIN ECON EINV KMCA CE
SUBJECT: SRI LANKA: GOVERNMENT SEEKS LOWER BORROWING COSTS BY 
ALLOWING FOREIGN INVESTORS TO BUY TREASURY BILLS 
 
REF: COLOMBO 366 
 
¶1.  (SBU) Summary and comment:  Seeking to reduce government 
borrowing costs, Sri Lanka opened ten percent of its short-term 
local currency Treasury bill market to foreign investors.  The 
Central Bank calculates, accurately it appears after the first day 
of trading, that offering the 3-12 month debt instruments to foreign 
buyers will bring down the interest rates it pays -- currently 
around 19% -- by increasing the number of potential buyers of the 
debt.   The move comes a year and a half after Sri Lanka first 
allowed foreign buyers to buy Rupee-denominated Treasury bonds, 
which have maturities of over a year.  The Treasury bills may prove 
easier to sell than the longer term bonds, as foreign buyers will be 
more comfortable with the shorter-term exposure.  By limiting 
foreign purchases to ten percent of both the overall bill and the 
bond stock, Sri Lanka is protecting itself against sudden large cash 
outflows -- the hot money problem that drove the 1997 Asian 
financial crisis.  Nevertheless, with the government unable to rein 
in its persistent budget deficits, the move also reflects a 
continuing effort to find new buyers for government debt.  This is 
exactly why credit rating agencies have recently expressed concerns 
about Sri Lanka's sovereign creditworthiness.  End Summary and 
comment. 
 
¶2.  (U) Sri Lanka on May 6 began allowing foreign investors to buy 
up to ten percent of the total stock of its Rupee-denominated 
Treasury bills.  The move paralleled Sri Lanka's opening a year ago 
of ten percent of its Treasury bond market to foreign buyers. 
Treasury bills have maturities extending up to one year, while 
Treasury bonds have maturities of one to five years.  The move will 
allow the Central Bank to sell up to about Rupees 300 billion ($2.8 
billion) of Treasury bills to foreign investors; about Rupees 1.1 
trillion ($10.5 billion) in bonds are open to foreigners.  Yields 
currently range from 18.5% (3 months) to 19% (1 year) to 15.5% (5 
year) -- some of the highest nominal interest rates in the region. 
The nominal rates are high because inflation in Sri Lanka has been 
above twenty percent for over a year. 
 
¶3.  (SBU) The Central Bank said in a press release that the 
objective of the current move was to "widen and diversify the 
government debt market and enhance competition in the Treasury bill 
market."  A Central Bank research department source told EconFSN 
however that the primary reason for the liberalization was to reduce 
the government's cost of borrowing. 
 
¶4.  (U) Analysts say foreign buyers are increasingly reluctant to 
invest in longer term instruments due to Sri Lanka's persistent high 
inflation and fears that the Sri Lankan Rupee could lose value 
against the dollar over the longer term.  They predict Treasury 
bills will likely be easier to sell than bonds.  If the Rupee 
remains relatively stable, the 18% interest rate will be attractive 
to hedge funds and other investors with an appetite for emerging 
market exposure.  The Central Bank expects the Rupee to remain 
stable in 2008 on the strength of Sri Lanka's currently comfortable 
reserves and positive balance of payments.  The Rupee has held 
steady at around 108 to the US dollar so far this year. 
 
¶5.  (U) On May 7, in the first Treasury bill sale since the opening 
of the market, yields on three-month Treasury bills fell by 42 basis 
points to 18.09%.  Yields on other maturities also declined, with 
one-year bills falling by 21 basis points to 19%.  According to the 
Central Bank's public debt office, foreign investors subscribed to 
Rs. 500 million worth of Treasury bills, out of a total of Rs 8.6 
billion sold in the day's auction.  Central Bank sources expect 
yields to come down further in the next few weeks. 
 
¶6.  (U) The opening of the debt market came not long after warnings 
by international credit rating agencies regarding Sri Lanka's 
sovereign creditworthiness.  Fitch Ratings cited debt worries as a 
key reason for its April downgrade of Sri Lanka's rating from BB- to 
B+, four levels below investment grade (reftel).  Standard & Poor's 
also recently revised its outlook on Sri Lankan debt to negative 
(indicating a likelihood of a rating downgrade in the future) and 
this week included Sri Lanka along with Indonesia and Vietnam among 
Asian emerging market countries to "keep an eye on" because they 
might be tempted to borrow excessively to cope with worsening 
economic conditions.  S&P said of Sri Lanka: "The rising share of 
external debt, estimated at about 49 percent of total, and within 
that, the proportion of more expensive and shorter-maturity 
 
COLOMBO 00000450  002 OF 002 
 
 
commercial funds, is gradually eroding what has so far been a 
relatively favorable debt profile." 
 
¶7.  (U) Locally, primary market dealers expressed mixed sentiments 
about the Central Bank's allowing foreign investment in Treasury 
bills.  Ajith Fernando, former Chairman of the Primary Dealers 
Association, told EconFSN that, while the move could be regarded as 
further liberalization of the capital account, it could lead to a 
drain on foreign exchange as bills matured and foreign investors 
converted their proceeds into dollars and withdrew from the market. 
Other primary dealers speaking to newspapers also cautioned about 
the need to manage the outflow of funds at maturity.  Fernando 
predicted the market opening would likely stabilize the Treasury 
bill market in the short term, though he felt it premature to 
comment on the likely volume of foreign buying of the bills. 
 
¶8.  (SBU) Comment:  By limiting foreign purchases to ten percent of 
both the overall bill and the bond stock, Sri Lanka is protecting 
itself against sudden large cash outflows -- the "hot money" problem 
that drove the 1997 Asian financial crisis.  Nevertheless, with the 
government unable to rein in its persistent budget deficits, the 
move also reflects the government's continuing effort to find new 
buyers for its debt.  This is exactly why the credit rating agencies 
are watching carefully and why investors may be more comfortable 
with short-term debt. 
BLAKE