As an initial step, the government said last week that it would seek a sovereign rating and has appointed Citigroup as its adviser on that process.
"I think, a bond issue would be sometime early next year after political uncertainty and elections have passed," said a Sri Lankan banker, who didn't want to be named.
For several years, Sri Lanka has considered issuing bonds in global markets. But it has delayed the move due to an ethnic war with Tamil Tiger rebels and political turmoil that led to numerous elections.
While there still is tension between the government and the rebels, relative peace due to a truce between the two parties since 2002 and foreign investor interest in the country's buoyant stock market, which has rallied 36% this year, make a bond issue more feasible.
The government so far has said that it wants to raise dollar-denominated funds but hasn't been specific about whether the raising would be in loan or bond form.
One reason why the government is keen to borrow in dollars rather than rupees is to avoid putting upward pressure on domestic interest rates, which are already high. The government's domestic three-year bonds currently yield 10.5%.
More generally, Sri Lanka's improving economy means that it will gradually have less access to concessional aid from donors, which is another reason why the government would want to start accessing international debt markets.
"The purpose of the fund raising is not to finance the budget deficit but to reconstitute the public debt portfolio and see whether any debt can be refinanced by relatively cheaper debt," Treasury Secretary P.B. Jayasundera told reporters Wednesday.
"If the markets are good we will use the ratings opportunity to mobilise capital," he said.
Market participants say that the government may raise between $200 million and $500 million by issuing bonds with a maturity of three to five years.
If they were to issue five-year bonds now, the securities would likely be priced at a spread of 250 to 275 basis points above the London Interbank Offered Rate, the participants say.
Last year, Sri Lanka's fixed-line operator, Sri Lanka Telecom, was rated B+ by ratings firms Standard & Poor's and Fitch Ratings after which the company issued $100 million of five-year bonds.
The telecom bonds were Sri Lanka's first offshore bonds and were priced at a spread of Libor plus 300 basis points.
A Fitch official in Colombo said recently that the rating on the sovereign could be similar to that for Sri Lanka Telecom or a notch higher.
The government has issued bonds and short-term bills in the domestic market and currently has outstanding debt of this kind valued at Rs. 1,200 billion or $11.9 billion, which equates roughly to 60% of the country's gross domestic product.
For dollar-denominated funds, the government has in the past borrowed from onshore banks using short-term loans and unrated bonds, which so far have proved cheaper than issuing long-term rated bonds.
The unrated bonds are effectively the same as loans from onshore banks.
Last year, it raised more than $200 million from onshore banks at a spread of around Libor plus 185 basis points and with a two-year payback period.
But bankers say that the government is keen on attaining greater visibility in global markets.
"It is always cheaper to go for a loan, but there is no international visibility," said an official at a foreign bank, who didn't want to be named.
A bond issue also might allow the government to raise money in greater volumes.
While the government might be able to raise a five-year loan at Libor plus 200 basis points from onshore banks, it may not be able to raise as much as $500 million.
An international bond issue would also provide a useful benchmark for Sri Lankan firms that might want to raise funds in global debt markets.
"A bond issue will raise the country profile and there will be a benchmark for other corporates in the country," said Rukshan Dias, the head of treasury at Standard Chartered in Colombo.
Also, investors will get a better sense of the risk premium they should charge for their investment in the island.
The downside to raising debt abroad is the higher cost of servicing it compared with local borrowings.
Sri Lanka's rupee has in recent years depreciated about 7% annually against the U.S. dollar, which adds to the interest cost of foreign-currency denominated debt.
But the current strength of the U.S. dollar makes an international bond issue a better bet, traders said. The Sri Lankan rupee is not expected to weaken more than 1%-2% this year from its current level of 100.70 against the dollar, they said. (Dow Jones)