Sri Lanka Tests Post-Default Waters with New Dollar Bond: A Risky Step toward Market Re-Entry

Sri Lanka’s decision to issue a US$50 million Domestic Dollar Bond (DDB) next week marks the country’s first foreign-currency borrowing attempt since the 2022 suspension of external debt payments a move that signals cautious experimentation at a time when the nation remains locked out of the global capital market until at least 2028.

The issuance, managed by the newly established Public Debt Management Office (PDMO), is being framed by authorities as a pragmatic mobilisation of dollars already circulating inside the banking system. Yet the move raises critical questions about sustainability, risk exposure, and the broader roadmap for regaining investor confidence.

The bond auction, scheduled for 3 December, will offer one-, two-, and three-year maturities, with interest rates determined through competitive bidding. Although the minimum investment is set at US$1 million, participation is limited to domestically incorporate licensed commercial banks.Payments will be channelled to the Central Bank of Sri Lanka’s account at the Federal Reserve Bank of New York, signalling an attempt to instil procedural credibility and ensure settlement security.

The Government is attempting to diversify its funding sources after the 2022 default abruptly cut off access to global capital markets. Prior to the default, the country issued Sri Lanka Development Bonds (SLDBs), a mechanism suspended in February 2023 as part of the sweeping economic stabilisation programme.

SLDB holders later exchanged US$791.4 million of outstanding bonds for rupee-denominated Treasury instruments under the Domestic Debt Optimisation (DDO) initiative, a forced restructuring that weakened investor trust in sovereign dollar-denominated paper.

That history casts a shadow over the new DDB, raising concerns about whether banks—already strained by dollar liquidity requirements will view the instrument purely as a patriotic obligation rather than an attractive investment.

The issuance also marks the first major operational test for the PDMO, established in January 2024 under the Public Debt Management Act to centralise all debt-related functions previously split across various agencies.The PDMO’s expanded authority, including direct engagement with primary dealers and the formulation of new regulations, is central to Sri Lanka’s commitments under the IMF programme.

The country’s debt stock remains precarious even after completing 99% of its external restructuring, including International Sovereign Bonds, and restoring market access will depend on demonstrating credible, rules-based debt management.

A key question is whether the DDB represents a genuine borrowing strategy or a temporary measure to bridge near-term foreign-currency gaps. A Central Bank survey in August indicated domestic appetite for up to US$100 million in dollar instruments, prompting authorities to begin with a smaller US$50 million tranche.

While officials frame this as a controlled pilot, analysts caution that excessive reliance on domestic dollar borrowing could create fresh vulnerabilities, especially if foreign-currency inflows fall short of expectations.

The Government’s broader challenge is balancing short-term liquidity needs with long-term market credibility. Issuing a dollar bond domestically may help stabilise cash flows, but its success will ultimately depend on transparent execution, predictable repayment capacity, and whether investors interpret it as a sign of gradual recovery or a signal that external financing pressures remain unresolved.