UPDATE 5-Sri Lanka sells $1.5 bln, 10-year eurobond at 6.85 pct yield

* Sells $1.5 billion, 10-yr as planned, sees $3.3 bln demand

* Proceeds expected to help close budget deficit

* Initial price guidance ‘very high’ - economist (Adds final pricing, details)

COLOMBO/HONG KONG, Oct 27 (Reuters) - Sri Lanka paid less than it had expected to borrow $1.5 billion via a 10-year sovereign bond on Tuesday, with strong orders helping bring down the yield on the issue to 6.85 percent from initial guidance of around 7 percent.

The Finance Ministry will use the funds to help plug a gap in the budget, government sources said.

After the Aug. 17 election, the new government said it would not be able to limit the 2015 deficit to a targeted 4.4 percent of gross domestic product due to heavy spending and weak revenue. Finance Minister Ravi Karunanayake has said the deficit is likely to reach 6.5-6.8 percent of GDP.

The size of the issue matched the initially planned amount after orders came in for $3.3 billion across 290 accounts, with 55 percent of the orders coming from the United States, 29 percent from Europe and the rest from the Asia.

Of the accounts, 88 percent represented fund managers, 9 percent represented banks and 3 percent bid on behalf of pensions and insurance funds.

In a statement early on Tuesday assigning a ‘B+’ rating to the bond, Standard & Poor’s put the size of the issue at $1 billion. But it later corrected its release to say the size had not been decided.

Currency dealers and economists had varied on the government’s ability to borrow whole $1.5 billion at 7 percent.

Amal Sanderatne, chief economist and CEO at Colombo-based Frontier Research, called the initial pricing guidance “very high” compared to past Sri Lankan sovereign bonds.

On May 28, the country had raised $650 million via a 10-year sovereign bond after aiming for $1 billion. That bond carried a 6.125 percent per annum yield.

But given Sri Lanka’s low foreign currency reserves and an uncertain global interest rate environment, a high pricing “is something they need to do,” Sanderatne said.

Sri Lanka’s reserves stood at $6.5 billion in August, well down from $8.8 billion in October 2014 as the central bank propped up the rupee while keeping interest rates low. After facing heavy pressure on its reserves, the central bank opted to let the currency float on Sept. 4.

Sri Lanka, rated B1/B+/BB- by Moody’s, S&P and Fitch respectively, mandated Citigroup, Deutsche Bank , HSBC and Standard Chartered for the US dollar bond offering, the people familiar with the plans said.

S&P said its Sri Lanka sovereign credit rating “reflects the country’s relatively low wealth, improving but still moderately weak external liquidity, and a high government debt and interest burden.”

The International Monetary Fund has raised concerns about Sri Lanka’s revenue shortfall and says the government needs to implement tough reforms, including tax measures, to address the matter. ($1 = 140.98 Sri Lankan rupees) (Reporting by Shihar Aneez; Editing by Sunil Nair and Hugh Lawson)