SL encounters political turmoil with local currency rating at risk

Sri Lanka now encounters an unprecedented political and economic crisis in its 74 year democratic administration history since independence without a functioning government after the president fled the country from mass protests this week.

Foreign exchange reserves have been depleted to US$ 1.92 billion and the country is embroiled in a messy public debt default.

Sri Lanka’s turmoil is mainly balance of payments crisis, several eminent economic experts said adding that the pandemic crippled its tourism-dependent economy due to a slump in international travel, weighing on a key source of external revenues.

Meanwhile, rising imports and large debt servicing costs – a consequence of loose fiscal policy and heavy foreign exchange borrowing – caused a rapid decline in international reserves.

This precarious situation was compounded by this year’s surge in oil prices – a key commodity import – and rising US interest rates.

The Central Bank simply did not have the firepower to defend the Sri Lankan rupee against these global pressures and the currency has collapsed by more than 40 percent against the dollar so far this year.

Meanwhile Fitch Ratings has placed Sri Lanka’s local currency rating ‘Under Criteria Observation’ (UCO) following shift in policy to apply + and – modifiers to the agency’s CCC ratings.

Sri Lanka’s long term foreign currency rating has been downgraded to RD but its long term rupee rating is at ‘CCC’.

“The UCO assignment indicates that ratings may change as a direct result of the final criteria,” Fitch said.

“It does not indicate a change in the underlying credit profile, nor does it affect existing Outlooks.

“We will resolve the UCO status within six months officials aid. The outcomes will depend on Fitch’s assessment of the appropriate notching based on the new criteria.”

Introduction of Modifiers at ‘CCC’: The recently published Sovereign Rating Criteria introduces +/- modifiers in the ‘CCC’ category. Sovereigns rated ‘CCC’ could experience a one-notch rating change, potentially migrating from ‘CCC’ to ‘CCC-‘ or ‘CCC+’.