US embassy cable - 02COLOMBO1633

UNCLAS SECTION 01 OF 02 COLOMBO 001633 
 
SIPDIS 
 
STATE FOR SA/INS 
STATE PLEASE PASS TO USTR FOR FHUEGEL 
TREASURY FOR DO/GCHRISTOPOLUS AND AKIFAYAT, GRAO 
MANILA FOR USADB 
 
E.O. 12958: N/A 
TAGS: KTDB, BEXP, ECON, EINV, ETRD, EFIN, CE, ECONOMICS 
SUBJECT:  SRI LANKAN GOVERNMENT FINANCE-DOLLAR DEBT AND 
REFORM EFFORTS 
 
Ref:  (a) Colombo 001400 
 
1.  Summary:  The Government of Sri Lanka (GSL) has 
requested proposals for a financial facility of up to $350 
million to finance the budget deficit.  The funds raised in 
this issue will ease pressure from the local money market 
and interest rates.  The proceeds will be part of a Rs 329 
billion (approximately $3.4 billion) gross borrowing program 
of the GSL for 2002.  End Summary. 
 
GSL to borrow $350 million 
-------------------------- 
2.  The Central Bank has requested proposals from 
international investment banks and local banks to raise $350 
million in long-term debt.  The minimum tenor of the loan is 
5 years and proposals are invited in the form of either a 
syndicated loan, fixed rate bond or a floating rate note. 
The closing date for proposals is September 6.  The Central 
Bank expects to borrow the funds during the last quarter of 
2002.  The funds will go to finance the GSL capital 
expenditure and to retire existing short-term government 
debt. 
 
3.  Sri Lanka will go for the debt issue, its largest ever 
in international markets, minus a sovereign debt rating. 
Although Sri Lankan officials have talked about seeking a 
debt rating, Treasury Secretary Charitha Ratwatte told the 
media a few weeks ago that the GSL would wait for the peace 
process to take root, then will seek a rating.  Investment 
analysts in Colombo feel that Sri Lanka would likely get a 
below investment grade of B+ or BB+, close to India's BB 
rating, if it applies for a rating for long-term foreign 
currency debt. 
 
4. The last time the GSL raised a loan from the 
international market was in 1997 when it raised $50 million 
through a two year floating rate note.  In addition, in late 
2001 and June 2002, GSL raised a total of $250 million 
through dollar denominated bonds sold in Sri Lanka.  The 
last tranche of this issue in June 2002 was priced at six 
months LIBOR plus 193 basis points.  The Central Bank is 
confident of receiving favorable bids for the current debt 
call.  Citibank/Solomon Smith Barney, JP Morgan, HSBC and 
Standard Chartered Bank are among those expected to submit 
bids. 
 
5.  According to the Central Bank, the total gross borrowing 
program of the GSL for 2002 is Rs 329 billion (or about $3.4 
billion).  The proceeds from the $350 million (Rs 33.3 
billion) international debt issue will form part of the 
borrowing plan, along with a $90 million dollar denominated 
Development Bond issued in the local market in June.  In 
addition, the Government expects about $70 million (Rs 736 
million) from concessionary foreign financing.  The balance 
will be raised mostly in the local rupee market. 
 
Development of a long-term yield curve 
-------------------------------------- 
6.  The retirement of some rupee debt with dollar proceeds 
is expected to improve market liquidity and further ease 
pressure on the interest rates, which have fallen 
considerably during 2002.  In response to a reduction of key 
Central Bank short-term discount rates and improved 
liquidity, the entire Central Bank yield curve has shifted 
downwards by about 300 basis points between January and 
August 2002.  Currently, short-term (3 month and 12 month) T- 
bill rates are at 11-11.5% while long-term rates vary 
between 13.3 percent for 4 year bonds and 14.4 percent for 6 
year bonds. 
 
7. In addition, the Central Bank has issued more long-term 
rupee bonds and the yield curve has been extended up to 6 
years.  In a bid to develop further the long-term yield 
curve, Central Bank is also expected to issue 12-year bonds 
this year.  The Central Bank is said to be keen on issuing 
long-term debt in view of current low interest rate climate, 
but the timing and the features of the issue have not been 
decided yet. 
 
Other financial sector developments 
----------------------------------- 
8.  Meanwhile, the Prime Minster has appointed a Financial 
Sector Reforms Committee (FSRC) to fast track financial 
sector reforms.  The Committee is reviewing key reforms 
identified at a recent conference hosted with the assistance 
of the IMF resident representative office in Colombo.  The 
conference results included a series of recommendations. 
Some of the reforms considered by the FSRC are relaxation of 
controls on foreign exchange and the capital account, 
amendments to the banking act and monetary law act, 
strengthening bank supervision, relaxation of the statutory 
reserve ratio, development of debt instruments and the 
creation of a long term yield curve. 
 
New legislation 
--------------- 
9.  In a separate move to control public finances, the GSL 
will introduce a wide-ranging Fiscal Management 
(Responsibility) Act.  The purpose is to promote greater 
accountability and responsibility in all public offices.  It 
will place government spending under strict scrutiny and 
will prevent finance ministers from giving out pre-election 
subsidies and inducements to voters.  If extreme 
circumstances necessitate spending over-budget, the Finance 
Minster has to table a statement in Parliament justifying 
the action.  Under the act, election manifestos of major 
parties are to be referred to the Central Bank to assess the 
long-term impact on government finances.  The Central Bank 
should also investigate and comment on all government 
spending plans. 
 
10. The law also would require the Finance Minister to 
present to Parliament a financial position report annually 
which will state GDP estimates and forecasts of other key 
economic variables.  The Finance Minister is also expected 
to present to parliament a mid year GSL fiscal position 
report as well as the annual budget statement.  The GSL soon 
plans to introduce several other laws or amendments to 
current legislation concerning the financial sector 
including regulations on monetary policy and banking, 
finance companies, stocks and securities, mortgage, and debt 
and loan recovery. 
Amselem