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Lanka default swaps begin trading

TOKYO — Credit-default swaps tied to Sri Lanka’s debt began the first day of trading quoted at the second-highest level among sovereign contracts globally.

The government, which faces a worsening civil war, sold $500 million in debt overseas for the first time yesterday. The price of the swaps is about a percentage point higher than for similarly rated Pakistan, whose army is fighting pro-Taleban militants in the northwestern region bordering Afghanistan.

“The bond just came out so people are still sizing each other up,” said Desmond Soon, who helps manage $300 million of debt at Pacific Asset Management Co. in Singapore. Both Pakistan and Sri Lanka “are quite headline-risk driven.”

Five-year credit-default swaps tied to the debt fell to 360 basis points as of 3:50pm in Singapore from 375 basis points this morning, according to prices from JPMorgan Chase & Co. The price to protect a $10 million investment in the notes from default is equivalent to $360,000. Ecuador has the most expensive default protection for a sovereign at 674 basis points.

Credit-default swaps tied to Pakistan’s foreign debt rose 4 basis points to 273 basis points yesterday, according to prices from London-based CMA Datavision. The debt of both South Asian nations carries the high-risk, high-yield credit ranking of B+ from Standard & Poor’s, four levels below investment grade.

First overseas sale

The Sri Lankan government sold its 8.25 per cent notes due in October, 2012 at a yield 397.2 basis points higher than US Treasuries of similar maturity yesterday, according to Bloomberg data. Merrill Lynch & Co. quoted the notes at an 8.25 per cent yield yesterday.

“Unless Sri Lanka comes up with repeat issues, the CDS are not going to be very liquid,” said Dilip Parameswaran, head of Asia credit research at Calyon.

The government will boost spending on defense and public security by 20 per cent to a record next year. More than 70,000 people have been killed since conflict between the Liberation Tigers of Tamil Eelam and the government started in 1983, according to the Defense Ministry. The rebels want a separate homeland in the north and northeast of the island.

The central bank forecasts Sri Lanka’s economic growth will slow to 7 per cent this year after reaching 7.8 per cent in the first quarter last year, the most in at least three years. “Any country which did not have any strife would have been happy with” the 6.4 per cent expansion in the second quarter, central bank governor Ajith Nivard Cabraal said on Sept. 14.

Asia swaps widen

Contracts on the iTraxx Asia Ex-Japan High Yield Series 8 Index of 20 borrowers, including the Vietnamese government and India’s Tata Motors Ltd., rose 4 basis points to 224 basis points, according to JPMorgan prices. The broader iTraxx Asia Ex-Japan Series 8 Index of 70 issuers rose 1 basis point to 88.5 basis points.

The indexes are benchmarks for protecting bonds against default. Traders use them to speculate on changes in credit quality. A basis point, or 0.01 percentage point, is worth $1,000 on a swap that protects $10 million of debt from default.

Credit-default swaps, financial instruments based on bonds or loans, were conceived to protect bondholders by paying the buyer face value in exchange for the underlying securities should the borrower default. A decrease in the price indicates improving investor perceptions of credit quality and an increase suggests deterioration.