Oct. 8 (Bloomberg) -- Sri Lanka's government will start its first overseas bond sale, testing investor appetite for emerging-market debt following a global credit-market slump.

Barclays Capital, HSBC Holdings Plc and JPMorgan Chase & Co. will market the debt in Asia, Europe and the U.S. today and then start the sale, said W.A. Wijewardena, deputy governor of the Central Bank of Sri Lanka in Colombo, without disclosing a fundraising target. The central bank said in July it wanted to raise as much as $500 million as soon as September.

Losses linked to U.S. subprime mortgages at banks worldwide and escalating conflict between government forces and Tamil rebels prompted authorities to hold off on starting the sale. President Mahinda Rajapaksa is now pushing ahead after Mexico sold $1 billion of dollar-denominated bonds last month and Venezuela completed a $1.2 billion offering earlier in October.

``They are going to learn a lot on the roadshow about current investor risk appetite given the difficult economic and political conditions in Sri Lanka,'' said Jason Noble, a Singapore-based fixed-income analyst at Principal Global Investors, which manages about $1 billion of Asian debt. ``We haven't seen a decisive move for the better in either the economy or the political situation.''

The central bank has raised its benchmark interest rate seven times in the past two years to 10.5 percent, the highest in Asia, from 8.25 percent to battle inflation. Consumer prices rose 17.3 percent in September from a year earlier. Governor Nivard Cabraal on Sept. 14 said he expects the $26 billion economy to expand 7 percent in 2007, slower than 7.5 percent that he forecast earlier in the year.

Increased Confidence

Asian bond sales declined by 75 percent in the third quarter after mortgage defaults prompted a surge in corporate borrowing costs and sent investors to the relative safety of U.S. government debt. Governments and companies in Asia outside Japan sold $4.4 billion of bonds denominated in dollars, euros and yen in the July-to-September period, compared with a record $17.7 billion the previous period, according to data compiled by Bloomberg.

Investors became more comfortable holding emerging-market debt in October. The spread, or extra yield, investors demand to own emerging-market bonds instead of U.S. Treasuries narrowed to 1.90 percentage points from 2 percentage points a week ago, according to JPMorgan Chase & Co.'s EMBI Plus index.

The difference was as much as 2.50 percentage points on Aug. 16, the highest since 2005. Vietnam Prime Minister Nguyen Tan Dung said that month he would review plans for a $1 billion bond sale based on demand for emerging market debt.

Civil War

Fitch Ratings gave Sri Lanka a negative outlook in 2006 because of the violence, meaning it is more inclined to reduce the credit ranking. Borrowing costs have surged. The yield on the government 7.6 percent local-currency bond due in August 2009 climbed to 16.2 percent from 11.469 percent a year ago, according to data compiled by Bloomberg.

By contrast, similar-maturity bonds from Turkey, the Philippines, Uruguay and Venezuela with the same BB- debt ranking from Fitch Ratings all have yields that are less than half Sri Lanka's. Of the four, Veneuzuela's rate of 7.56 percent is the highest.

The government wants the Liberation Tigers of Tamil Eelam to return to negotiations after two rounds of talks in Geneva last year failed to make progress. A 2002 cease-fire collapsed after only four years and more than 5,000 people have been killed since December 2005, according to Agence France-Presse.

Air Strikes

``A further deterioration in the security situation to the point where it adversely affects Sri Lanka's credit fundamentals could lead to a downgrade,'' Paul Rawkins, a London-based senior director at Fitch Ratings, said in a report released today.

Tourist arrivals fell 15 percent to 44,742 in August after rebels launched an air attack on oil and gas facilities near the capital Colombo, closing the international airport for flights at night in May and June.

Fitch's BB- ranking on the new bond is three levels below investment grade. Standard & Poor's has a B+ rating for the nation's long-term foreign-currency bonds, four levels below investment grade, with a stable outlook.

The debt sale will also serve as a benchmark for Sri Lankan companies raising money in international capital markets, the central bank said on July 13. Sri Lanka Telecom Ltd., the nation's biggest telephone company, raised $100 million in November 2004 in the first overseas debt offering by a company from the South Asian island.

To contact the reporter on this story: Wes Goodman in Singapore at wgoodman@bloomberg.net.

Last Updated: October 8, 2007 02:47 EDT