Sri Lanka weighs favoured creditor clause to speed up debt talks with IMF

Sri Lanka is considering using a special clause to expedite its debt-restructuring negotiations, according to people familiar with the matter, as prolonged talks risk delaying a crucial bailout from the International Monetary Fund.

The bankrupt nation is looking at introducing a “Most Favored Creditor” clause to assuage doubts among other creditors that China — which holds 52% of Sri Lanka’s bilateral debt — could be offered better terms. Such a clause would ensure the same terms are extended to all creditors even if an agreement with them has been sealed before a deal is reached with China.

“Viewed from the other end of the telescope, the MFC clause is intended to deflate any expectation on the part of other lenders that by delaying engagement in the process they may be able to secure a sweeter deal down the road,” Lee Buchheit, a veteran of over two dozen debt restructurings who has also been consulted by the Sri Lankan government, said by email without naming specific creditors.

Sri Lanka is pursuing pacts with commercial and bilateral lenders to meet conditions for the IMF to disburse a $2.9 billion loan.

The South Asian country is undergoing its worst ever economic crisis and has defaulted on its dollar debt to preserve foreign currency to pay for food and fuel.

“Authorities of Sri Lanka are working for getting financing assurance from all our bilateral creditors,” junior Finance Minister Shehan Semasinghe said in a text message when asked if Sri Lanka is considering including the MFC clause. “We will continue with our fair, comparable and a transparent policy with all official and private bilateral creditors.”

In response to a query on a MFC clause in Sri Lanka’s debt negotiations, Peter Breuer, IMF senior mission chief for Sri Lanka, said that board approval for Sri Lanka’s extended fund facility requires “assurances from official bilateral creditors to restore debt sustainability, and a good faith effort to reach a collaborative agreement with private creditors.”

The island nation expects the IMF program to start in January if debt assurances from China come through this month, central bank Governor Nandalal Weerasinghe said Dec. 6. Discussions with Beijing were delayed due to some “internal matters,” including an increase in Covid cases and the Chinese Communist Party Congress, Weerasinghe said.

If Sri Lanka introduces the MFC clause, it may be the first time that it is used in a debt restructuring involving China, the people said. Sri Lankan authorities have sought to answer an array of questions from China as Beijing isn’t familiar with this type of restructuring and tends to favor rollovers and an extension of maturities, they added.

Motivation for designing the clause was watching “very long” negotiation delays in some recent sovereign crises such as Zambia, Chad and Suriname, Mitu Gulati, a professor at the University of Virginia School of Law, said by email.

“Those delays seem to be at least partially caused by the emergence of new actors outside of the usual suspects (i.e., China, India, Chinese state-owned corps etc),” Gulati said. “To the extent that the same dynamics that caused the delays in the other contexts are also infecting the Sri Lanka negotiations, something like a more credible mechanism to assure parties that they are not being stupid in agreeing to terms early could help speed things up.”