Fitch Ratings yesterday downgraded Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to ‘CC’, from ‘CCC’, citing probable risks pertaining to restructuring of domestic debt. 

“Sri Lanka continues to service its local currency debt but the downgrade of the Long-Term Local-Currency IDR reflects our view that a local-currency debt default is probable, in view of an untenably high domestic interest payment/revenue ratio, high-interest costs, tight domestic financing conditions and rising local-currency debt/GDP in the context of high domestic fiscal financing requirements, which authorities forecast at about 8 percent of GDP in 2022,” the rating agency said. 

According to authorities, domestic interest payments in 8M22 were Rs.718.8 billion, taking the domestic interest/revenue ratio to an estimated 56 percent in 8M22. 

Fitch pointed out that the reliance on the Central Bank financing has increased, as domestic options are limited.  
Fitch said it expects a local debt restructuring would aim to maintain financial system stability, for example, by extending maturities or lowering coupon payments, rather than a reduction in face value.  

With regard to the external debt scenario, the rating agency said that having taken into account the developments observed in recent months, it is of the view that the timing of completion of the external debt restructuring remains uncertain. 

Pointing out that the local banking sector faces tight liquidity, as Sri Lankan banks’ access to foreign-currency funding is constrained by the sovereign default, Fitch said a restructuring could necessitate recapitalisation by the government.  

While further regulatory forbearance measures could keep banks compliant with regulatory minimums on a reported basis, Fitch said underlying capital positions could stay weak.  

Further, the rating agency said it expects a contraction in GDP in 2023 and so is less optimistic about the government’s fiscal consolidation path. 

“We expect general government debt/GDP to reach around 109 percent by end-2022,” it said. 

It added there is still uncertainty about the pace of the country’s economic outlook in 2023, partly because the timing of the external debt restructuring is unknown.  

“We forecast growth to contract by 2.2 percent in 2023 then to pick up in 2024 under our baseline,” it said. 
Meanwhile, on creditor rights, Fitch has given Sri Lanka an ESG Relevance Score of ‘5’, as the willingness to service and repay debt is highly relevant to the rating and is a key rating driver with a high weight.