By Libby George and Uditha Jayasinghe
LONDON/COLOMBO (Reuters) – Sri Lanka’s knife-edge election on Saturday has raised doubts over when its long-awaited debt deal with bondholders will be finalised, if it keeps up with its IMF programme targets and even whether it results in a president inclined to change both.
Two of the leading presidential contenders, opposition leader Sajith Premadasa and Marxist-leaning parliamentarian Anura Kumara Dissanayake, have expressed interest in reworking Sri Lanka’s $2.9 billion International Monetary Fund bailout.
Sri Lanka has struggled since suicide bombings in 2019 hit its key tourism industry, worsening its over-spending and capping growth. Less than a year later, the COVID-19 pandemic and ensuing global food and fuel price spikes, combined with interest rate hikes, tipped its economy over the abyss.
In April 2022, Sri Lanka defaulted on its debt, sparking protests that forced out former president Gotabaya Rajapaksa.
Voters in the south Asian island nation of 22 million people, a tranquil tourist destination full of tea plantations and beautiful beaches, have since endured years of hardship.
However, green shoots have begun to surface under President Ranil Wickremesinghe, who took office in 2022.
“Everyone in Sri Lanka, be it the politicians, the upper class or middle class or lower class, they do see the economy is returning back to a steady, recovering track,” said Clifford Lau, a portfolio manager at William Blair.
“All this could only happen with the IMF deal being at the centrepiece of revamping the country,” Lau added.
Sri Lanka’s economy is expected to grow 3% this year, reversing last year’s contraction, while inflation, which peaked at 70% in September 2022, moderated to 0.5% in August.
Vital foreign reserves – once so low that Sri Lanka ran out of fuel and medicines – have bounced back to $6 billion.
“The government is outperforming its typical targets at the moment, but obviously policy continuity really depends on the outcome of the election,” said Patrick Curran of Tellimer.
Changing tack could be “immensely disruptive both to the economic recovery and to the restructuring,” said Curran.
Wickremesinghe, who is among 38 presidential candidates, trails in third place in opinion polls behind Premadasa, leader of Samagi Jana Balawegaya and Dissanayake, who heads the Marxist-leaning National People’s Power party.
Premadasa has called for alterations to the IMF programme and tax changes to cut the cost of living.
Lau said the potential disruption of reopening the IMF deal – and tinkering with targets required to release more money – would be so disruptive that he thinks it is unlikely.
A victory for Dissanayake, Citi analysts said, raises the risk of delays to IMF reviews which trigger the release of money, and a “high probability of debt deal renegotiation”.
Lau and other analysts said debt talks are almost certain to drag on for several months if one of the challengers wins.
Sri Lanka already signed a $10 billion debt rework with official creditors Japan, China and India in June.
But Colombo and its bondholders are in last-ditch formal talks to tweak a $12.5 billion debt rework proposal, after official creditors and the IMF objected to the “upside” scenario of a macro-linked bond – a debt instrument that would reward investors if the economy outperforms expectations.
Wickremesinghe, speaking at a rally on Wednesday, said government officials would meet with bondholders on Thursday.
“I have the ability to complete this process and make the announcement before 21 September,” he told a packed crowd.
However, a bondholder deal this week would be particularly tenuous, as a new government could seek changes or even scrap it in search of a better proposal.
“Additional delays to restructuring are likely if a new government comes to power and wants to rework the IMF program in a fundamental way,” said Chris Celio, senior economist and strategist with ProMeritum Investment Management LLP.
Without a deal, Sri Lanka is stuck in a perilous position.
“Sri Lanka remains officially in default and will remain so until this is over the line. Access to global capital is therefore much more constrained than it otherwise would be,” said Mark Ledger-Evans, portfolio manager with Ninety One.
Although the vote winner will also determine the timing of mandated parliamentary elections, another source of uncertainty, investors and observers say Sri Lanka’s fragile recovery could keep them from taking drastic steps.
And Tellimer’s Curran said revenue outperformance means the new government might even have room to tinker on the margins.
“But the risk is that they go a bit too far.”
(Editing by Karin Strohecker and Alexander Smith)
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