From International Sovereign Bonds (ISBs) to Macro-Linked Bonds (MLBs) - Sri Lankan Debt Restructuring

Sri Lanka recently reached a landmark debt restructuring agreement with its ISB holders as part of efforts to stabilize its economy. These agreements are essential for ensuring long-term debt sustainability, speeding up Sri Lanka’s economic recovery, and allowing the country to return to international capital markets. Moreover, this deal is crucial for unlocking further funding from the International Monetary Fund (IMF) and other international development partners in the coming years.

In terms of the restructuring agreement, the ISBS holders will be issued MLBs in exchange for the ISBs.

What are Macro-Linked Bonds?

A Macro-Linked Bond (MLB) is a type of debt instrument where repayments are linked to the economic performance of the issuer—in this case, Sri Lanka. These bonds are typically tied to key economic indicators like the country's Gross Domestic Product (GDP), ensuring that the bond payments fluctuate in line with the nation’s actual economic outcomes.

From a legal perspective, the issuance of these bonds falls under the authority of the Ministry of Finance, which is empowered by the Public Finance Act and other related laws governing public debt management. The Ministry, in collaboration with the Central Bank of Sri Lanka, is responsible for inter-alia managing the country's public debt, to include planning, issuing, and servicing government securities such as bonds and treasury bills. An MLB is one such innovative instrument. These bonds are part of Sri Lanka’s broader debt restructuring efforts under the IMF-supported program through 2027.

The terms of repayment for these bonds are structured to adjust in 2028 based on the country's average GDP from 2025 to 2027 and real GDP growth from 2024 to 2027. If Sri Lanka’s economic performance exceeds projections, bondholders receive higher payments; if it underperforms, payments are reduced. This structure provides a flexible and sustainable approach to debt management, ensuring that Sri Lanka’s obligations are aligned with its economic capacity, while maintaining legal safeguards for both the issuer and bondholders.

Key outcomes of the restructuring -

Upfront Debt Reduction: Sri Lanka is set to benefit from a debt reduction of $3.2 billion, which could increase to as much as $4.6 billion if the economy performs worse than expected. If the economy performs exceptionally well, the reduction could decrease to $2 billion.

Reduced Debt Payments: Over the course of the IMF-supported program, Sri Lanka’s debt service payments will be reduced by $9.5 billion. The average maturity of the bonds will be extended by more than 5 years, and the average interest rate will be lowered from 6.4% to 4.4%.

Bondholder Concessions: Under the baseline scenario, bondholders have agreed to a 40.3% reduction in the present value of their bonds, calculated using a 1% discount factor. If Sri Lanka outperforms economic expectations, bondholders will still make a concession of 33%.