Domestic dollar bonds to support SL’s liquidity after debt restructuring: LRA

Sri Lanka’s recent regulatory measures to introduce Domestic Dollar Bonds and widen investor participation represent “two coordinated phases of a domestic foreign currency funding strategy” aimed at strengthening liquidity and supporting sovereign debt management after the country’s restructuring, according to the Lanka Rating Agency (LRA).

The agency said regulatory actions taken in October 2025 and January 2026 together form a structured mechanism to mobilise foreign currency already circulating within the domestic financial system while easing pressure on external funding sources.

In October 2025, the Cabinet approved the issuance of Domestic Dollar Bonds, U.S. dollar-denominated sovereign instruments issued locally and initially restricted to licensed commercial banks. 

According to the agency, “the primary objective was to create a formal channel through which the Government could mobilise foreign currency already circulating within the domestic financial system,” reducing near-term reliance on external markets and supporting short-term reserve stability.

The strategy was broadened on January 30, 2026 when authorities amended the Export Earnings Repatriation Rules to allow exporters and other eligible foreign currency holders to invest repatriated proceeds in Domestic Dollar Bonds.

The change effectively links trade-generated foreign exchange to sovereign financing while expanding the available investor base. As the rating agency noted, the amendment “broadened participation by permitting exporters and other eligible private foreign currency holders to invest repatriated export proceeds,” thereby diversifying the domestic pool of dollar liquidity available to the government.

Taken together, the two regulatory measures establish a domestic funding mechanism capable of mobilising foreign currency resources while strengthening near-term liquidity management within the broader post-restructuring framework.

However, the agency cautioned that Sri Lanka remains within the speculative credit category following the 2022 sovereign default and subsequent debt restructuring process. This means yields on the bonds will continue to reflect “elevated but gradually stabilizing credit risk,” compensating investors for sovereign, liquidity and macroeconomic risks embedded in the country’s fiscal and external position.

From a debt structure perspective, the agency said Domestic Dollar Bonds increase the government’s domestic foreign currency liabilities while reducing immediate dependence on international capital markets. Unlike international sovereign bonds, the instruments remain within the local financial system, limiting exposure to global market volatility.

At the same time, the concentration of foreign currency liabilities domestically creates exchange rate risk. A significant depreciation of the Sri Lankan rupee would increase the local currency cost of servicing and redeeming these instruments, the agency warned, underscoring the importance of disciplined issuance limits. Funds raised through Domestic Dollar Bonds are expected to support external debt service obligations, reinforce gross official reserves and manage short-term foreign currency financing needs within Sri Lanka’s broader fiscal consolidation and reform programme.

According to the rating agency, the instruments “function predominantly as liquidity management tools rather than long-term structural borrowing sources.”

From a market perspective, the agency said the pricing structure of the bonds is likely to attract interest from exporters with stable U.S. dollar inflows. For such companies, the instruments provide an opportunity to earn a sovereign-backed dollar return within the domestic financial system while deploying surplus foreign currency in a regulated investment avenue.

However, participation may vary depending on exporters’ liquidity cycles. Firms with tighter working capital requirements may remain cautious about allocating funds to fixed-tenor instruments, particularly given the limited depth of a secondary market.

For licensed commercial banks, the bonds could offer improved returns on surplus foreign currency holdings, though investment decisions will likely be balanced against liquidity coverage requirements, maturity mismatches and overall sovereign exposure concentrations.

Overall, the rating agency said the evolving regulatory framework “materially strengthens Sri Lanka’s ability to mobilise domestic foreign currency resources and diversify sovereign funding sources.”

Nevertheless, its sustainability will depend on strict issuance ceilings, continued macroeconomic stabilisation, credible debt management practices and sustained investor confidence in the government’s repayment capacity.

While the current yield range may remain attractive, the agency said investor participation will ultimately depend on fiscal discipline and the resilience of the country’s external sector.

source: Daily Mirror