The deal will help Sri Lanka clear the first review of a bailout under the International Monetary Fund (IMF) executive board program by the year end, which would trigger a second IMF tranche of about $334 million.

"This agreement serves as a key milestone in Sri Lanka's ongoing endeavour to achieve public debt sustainability and to foster economic recovery," said Sri Lanka's treasury secretary Mahinda Siriwardana.

The small island nation, mired in its worst financial crisis in decades, has been trying to reach restructuring deals with creditors since last year after defaulting on its foreign debt in May 2022 due to record-low foreign exchange reserves.

Sri Lanka's finance ministry said the agreement in principle covered approximately $5.9 billion of outstanding public debt and consisted of a mix of long-term maturity extension and reduction in interest rates.

Japan co-chairs Sri Lanka's official creditor committee, together with France and India, which is comprised of 15 nations. China, which has already struck a deal with the island nation, is Sri Lanka's largest bilateral creditor and has not joined this group as a formal member.

"I expect this case will be applied as a leading case in dealing with debt problems in middle income nations," said Japan's top financial diplomat, Masato Kanda, describing the agreement as a "major achievement".

The Paris Club of creditor nations, which includes Japan, said the agreement could be formalised in the coming weeks.

According to data from Sri Lanka's finance ministry, its external debt was $36.6 billion at the end of June this year. Once the debt restructuring is completed, Sri Lanka hopes to reduce its overall debt by $16.9 billion.

RESTRUCTURING MILESTONE

"This is a key milestone for debt restructuring," said Udeeshan Jonas, chief strategist at equity research firm CAL Group.

"The good news is that this activates the second IMF tranche and that also means ADB (Asian Development Bank) and other funding comes into place helping the government's borrowing requirements to come down."

"The next step will be for Sri Lanka to negotiate a deal with the sovereign bondholders," Jonas added.

Sri Lanka's overseas bonds extended gains after the debt agreement was officially confirmed, with longer-dated notes rising as much as 1.6 cents on the dollar to just over 50 cents at 1213 GMT time, according to Tradeweb data.

Sri Lanka's finance ministry said it would next focus on striking similar deals with other bilateral creditors for debt amounting to $274 million.

It will also try to reach agreement with bondholders who hold the bulk of the island nation's $12.5 billion worth of international sovereign bonds.

The debt restructuring proposal sent by private creditors in October did not receive a favourable response from Sri Lanka's finance ministry, which said it had "serious reservations" about the construct of proposed macro-linked bonds.

Kanda said negotiations were "on track" with bilateral creditors and they were working on details of a memorandum of understanding. He declined to comment on details such as the interest rates that would be applied to the restructured debt, or the repayment period.

The IMF did not immediately respond to request for comment.

"These engagements will ensure that the overall debt treatment granted to Sri Lanka is consistent with the IMF program parameters," the official creditor committee said in a statement.

The agreement with the group of creditor nations comes about a month after the island nation reached a deal with the Export-Import Bank of China covering about $4.2 billion of outstanding debt.

"As far as the information we have is concerned, conditions set by China are comparable to ours," Kanda said.