Fitch Ratings has further downgraded Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to ‘CC’, from ‘CCC’, and has affirmed the Long-Term Foreign-Currency IDR at ‘RD’ (Restricted Default). Fitch typically does not assign Outlooks to ratings of ‘CCC+’ or below.
Fitch has also removed the Long-Term Local-Currency IDR from Under Criteria Observation, on which it was placed on 14 July, following the publication of the updated Sovereign Rating Criteria.
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% of GDP in 2022.
According to authorities, domestic interest payments in 8M22 were Rs. 718.8 billion, taking the domestic interest/revenue ratio to an estimated 56% in 8M22; the highest among sovereigns rated ‘CCC+’ and below.
Reliance on Central Bank financing has increased, as domestic options are limited. Domestic debt rose to about 53% of Government debt by end-July 2022, according to official provisional data. Treasury bill issuance has been increasing.
Fitch 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. Sri Lanka continues to service its local-currency debt.
The sovereign remains in default on foreign-currency obligations and has initiated a debt restructuring arrangement with official and private external creditors.
The Ministry of Finance issued a statement on 12 April that it had suspended normal debt servicing of several categories of external debt, including bonds issued in international capital markets, foreign currency-denominated loan agreements and credit facilities with commercial banks and institutional lenders.
Fitch downgraded the Long-Term Foreign-Currency IDR to ‘RD’ following the expiry of the 30-day grace period on coupon payments that were due on 18 April 2022.
A Staff-Level Agreement with the IMF was reached on 1 September for $ 2.9 billion, for 48 months, under the Extended Fund Facility. The facility will not be approved until Sri Lanka has implemented agreed actions, financing assurances have been received from official creditors and good-faith efforts have been made to reach agreement with private creditors.
Banking Sector Faces Tight Liquidity: Sri Lankan banks’ access to foreign-currency funding is constrained by the sovereign default. Any local-currency debt restructuring would elevate funding and liquidity stress, given the predominance of local-currency funding, at 74% of the total, and large holdings of local currency-denominated Government securities.
A restructuring could necessitate recapitalization by the Government, though further regulatory forbearance measures could keep banks compliant with regulatory minimums on a reported basis, however, underlying capital positions could stay weak.
