Fitch Ratings has affirmed Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘RD’ (Restricted Default) and Long-Term Local-Currency IDR at ‘CCC-’.
Fitch typically does not assign Outlooks to issuers with a rating of ‘CCC+’ or below.
The rating agency said sovereign remains in default on Sri Lanka’s foreign-currency obligations, while restructuring negotiations are ongoing with Sri Lanka’s private external creditors.
“The authorities’ recent announcement that a preliminary debt restructuring agreement has been reached, in principle, with members of the steering committee of the Ad Hoc Group of Bondholders (representing foreign holders of Sri Lanka’s international sovereign bonds) and China Development Bank (A+/Negative) suggests progress is being made.”
The agreement comes after the 12 April 2022 announcement suspending debt servicing on several categories of external debt, including bonds issued in international capital markets, foreign currency-denominated loans and credit facilities with commercial banks and institutional lenders.
Sri Lanka’s Long-Term Foreign-Currency IDR has been on ‘RD’ since May 2022, once the grace period expired.
Fitch said it believes the result of Sri Lanka’s 2024 Presidential election “add uncertainty to the country’s policy direction and could lead to a delay in the completion of the foreign-currency debt restructuring or renegotiation of the IMF programme.”
The upcoming 2025 budget, to be adopted by November 2024, could offer clarity on the new government’s policies, the statement said.
The statement by Fitch Ratings further stated:
“Policy Uncertainty Following Elections: Sri Lanka’s September 2024 Presidential election was won by one of the opposition leaders. Fitch believes the result add uncertainty to the country’s policy direction and could lead to a delay in the completion of the foreign-currency debt restructuring or renegotiation of the IMF programme. The upcoming 2025 budget, to be adopted by November 2024, could offer clarity on the new government’s policies.
Local-Currency Debt Exchange Complete: Sri Lanka completed the local-currency portion of its domestic debt optimisation in September 2023. This followed the exchange of the Central Bank of Sri Lanka’s treasury bills and provisional advance into new treasury bonds and bills. This led us to upgrade the Local-Currency IDR to ‘CCC-’. The rating is being affirmed at this level.
Government Debt to Stay High: The IMF forecasts Sri Lanka’s gross general government debt/GDP ratio to decline only gradually to about 103% of GDP by 2028, from about 116% in 2022. This forecast incorporates a local- and foreign-currency debt restructuring scenario. However, this level of debt would still be elevated, even after the restructuring.
External Metrics Improving: Foreign-currency (FX) reserves have been improving, with gross FX reserves reaching around USD6.0 billion in August 2024, against USD4.4 billion at end-2023, partly due to the suspension of external debt service. Other supporting factors include an uptick in tourism and overseas worker remittances. The current account was in a surplus in 2023 and we expect a surplus in 2024. The sovereign, however, remains dependent on official financing sources without access to international capital markets.
Stronger Revenue Generation: Weak IMF program implementation, in particular of fiscal measures, remains a risk to achieving debt sustainability. Sri Lanka has a weak longer-term revenue raising record, but the authorities have implemented several major tax measures since May 2022 to boost revenue collection and achieve debt sustainability. These included raising the corporate income tax rate, hikes to the value-added tax rate and raising fuel excise taxes. This saw revenue collection improve by 42% yoy in 1H24.
Additional fiscal measures in the pipeline include an increase in the corporate income tax to 45%, from 40%, for certain types of economic activity, an additional value-added tax rate on the supply of digital services, further tax administration reforms as well as limiting tax exemptions and making them more transparent.
Economy on a Recovering Trend: We expect economic growth to recover to 3.9% in 2024 and average at 3.6% over 2025-2026. Real GDP growth, in seasonally adjusted terms, recovered to about 5.0% yoy in 1H24 after contracting by 7.0% during 1H23, driven by a pick-up in industrial growth to 11.3% after a contraction of about 18.0% in 1H23. Services also recovered by about 2.7% during the same period after a contraction in 1H23.
Inflation in Check: We expect further easing of monetary policy over 2024-2026, after the Central Bank of Sri Lanka reduced the standing deposit facility rate by a cumulative 725bp since June 2023, as underlying inflationary pressure remains muted. Inflation was about 0.6% in August 2024, in seasonally adjusted terms, and has been in the single digits for over a year. A surge in inflation, peaking in September 2022 at around 67%, was successfully curtailed by the central bank.
Banking Sector Stabilising: The banking sector’s non-performing loans remain high, partly owing to the economic stress associated with the sovereign default. However, the domestic bank operating environment continues to show signs of stabilisation, in line with improved economic indicators. This supports the recovery in banks’ operational flexibility. The completion of the local-currency portion of Sri Lanka’s domestic debt optimisation was a major step towards reducing the impact of the sovereign’s debt restructuring on the banking sector.
ESG – Governance: Sri Lanka has an ESG Relevance Score of ‘5’ for Political Stability and Rights as well as for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Sri Lanka has a medium WBGI ranking in the 36th percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
ESG – Creditor Rights: Sri Lanka has an ESG Relevance Score of ‘5’ for Creditor Rights, as willingness to service and repay debt is highly relevant to the rating and is a key rating driver with a high weight. The affirmation of Sri Lanka’s Long-Term Foreign-Currency IDR at ‘RD’ reflects a default event.”