Sri Lanka’s proposed macro-linked bonds (MLBs) are not really MLBs but act as standard fixed-income instruments after 2027 providing no help in the event of future shocks, a global sovereign debt expert said.

According to Brad Setser, Senior Fellow US-based think tank Council for Foreign Relations(CFR) and an expert in sovereign debt restructuring said that proposed MLBs will act as standard fixed income instruments after 2027 which provide no help in the event of future shocks.

“The new bonds thus aren’t true state-contingent instruments,” he said in a blog post for CFR.

Setser said that the final restructuring terms are just left open until just after Sri Lanka’s IMF programme ends, and the creditors and Sri Lanka have agreed that the final terms will largely be a function of Sri Lanka's dollar GDP between 2025 and 2027. 

“Payments after 2027 aren’t linked to real GDP growth, tourism inflows, or the price of Sri Lanka’s oil imports,” he said, adding that theorists who extol the advantages of state-contingent instruments shouldn’t be fooled.

He added that bond traders still need to worry about the risk that the payments will reset up based on Sri Lanka’s economic performance between 2025 and 2027 — a period when risks are low because Sri Lanka is more or less fully funded by the official sector. 

Therefore, he said that good performance over the next few years creates more risk of trouble after 2028, as external debt service ratchets up during a period when Sri Lanka is expected to be back financing in the international bond market with a debt to GDP ratio of around 100%.

“The new bonds are thus structured to game the IMF's fiscal targets and increase the return bondholders get out of Sri Lanka’s debt exchange rather than to insulate Sri Lanka against future risks,” he added.

Further, he said that the innovation in the macro-linked bonds is that the terms of the exchange are not fixed until after Sri Lanka’s current IMF programme has expired.

 “if all follow the IMF’s (relatively conservative) macroeconomic and exchange rate forecasts, the bondholders get the base case bond — so $ 12.5 billion in bonds with an average coupon of around 6.5% are swapped into $ 9 billion of new bonds with an average coupon of around 6%, and past-due interest (PDI) is settled with a modest discount. In the base case — with GDP averaging $89 billion over the next year — there is a little bit of true debt reduction, as the coupon on the new bonds is below the coupon on the old bonds,” he said.