The government of Sri Lanka announced on Wednesday that an agreement has been reached to proceed with the restructuring of around $12.5 billion of foreign debts. This is a significant development in the island nation's precarious recovery from a serious financial crisis.

The South Asian nation's economy was pushed to the verge of collapse by a decline in foreign exchange reserves, and as a result, it made its first default on its foreign debt in May 2022.

One of the main requirements imposed by the International Monetary Fund (IMF) under a $2.9 billion bailout package that assisted Sri Lanka in stabilizing its currency, reducing inflation, and enhancing public finances was the restructuring of foreign bonds.

The agreement with a subset of bondholders, comprising around half of Sri Lanka's bond market, is subject to approval by the Official Creditor Committee (OCC), which is composed of bilateral creditors and the IMF, to guarantee that it aligns with the international lender's debt sustainability assessment for the nation.

Following this week's formal second round of talks with bondholders, Sri Lanka reached the most recent accord.

In a regulatory statement, the government stated, "Sri Lanka looks forward to further constructive interaction to finalize the ISB (International Sovereign Bonds) restructuring."

The framework suggests reducing past interest by 11% and face value by 28%, with interest payments to begin in September. 

The plan suggests exchanging four current bonds denominated in dollars for a combination of three fixed income products.

One is a typical bond, also referred to as "plain vanilla," with a 4% yield that matures in 2028. The second is a set of macro-linked bonds, wherein principal and payouts are subject to change based on the nation's economic performance. If the economy exceeds the IMF's baseline estimates, payments will be adjusted upward, and if it falls short, payouts will be changed downward.

Sri Lankan sovereign dollar bonds were marginally up in price on Wednesday, still trading around 57 or 58 cents on the dollar. The bonds were up nearly 15% year to date at the index level up to Tuesday’s close, according to JPMorgan data.

Sri Lanka signed in late June an agreement with creditor nations including Japan, India and China to restructure about $10 billion in bilateral debt.

Sri Lanka now needs to present the proposal to all its bondholders who need to agree to the deal for the restructuring to be finalised.

The country, whose total external debt is $37 billion, also has to finalise arrangements with China Development Bank to restructure debt of $2.2 billion, according to the latest finance ministry data.