• Downgrades SL’s rating to ‘CCC’, citing probability of a default 
• Became third rating agency to downgrade SL in past three months 
• Newly beefed up foreign reserves to US $ 3.1bn fail to impress S&P 
• Says US $ 1.2bn relief package announced last week will expand fiscal gap 
• Points out that efficacy of current monetary policy will be tested by inflation, global policy normalisation and forex crunch  

S&P Global Ratings (S&P) downgraded Sri Lanka’s sovereign credit rating yesterday, citing heightened conditions for a foreign debt default in the next 12 months, becoming the third rating agency to strike against Sri Lanka’s waning external financing position in the last three months. 

S&P slashed the sovereign rating to ‘CCC’, from ‘CCC +’, bringing Sri Lanka deeper into the junk territory, with the rating outlook left at ‘Negative’, since it was last revised in August, 
citing the same reasons.

It appears that the foreign reserves, which clawed back to US $ 3.1 billion in December-end, from around US $ 1.6 billion in November-end, had failed to impress S&P, as the rating agency anticipates further bleeding from the reserves in the coming months.

“Foreign exchange resources will be further pressured over the coming quarters by additional external sovereign debt maturities and current account requirements,” said the rating agency.  

 “These developments indicate a rising probability of sovereign default scenarios playing out over the next 12 months in the absence of an unforeseen positive development,” S&P said, providing a rationale for the rating action.   “The negative outlook reflects our expectation that Sri Lanka’s external financial position will deteriorate further over the coming quarters. This would affect Sri Lanka’s ability to service its debt over the next 12 months,” it added.

Sri Lanka is facing an uphill task in keeping its economy afloat amid its waning external reserves with the upcoming debt repayments and the foreign exchange necessary for the day-to-day imports.  A section of economists have called to defer the January 18, US $ 500 million bond payment to save foreign exchange for crucial imports such as fuel, medicines and milk powder.  But Central Bank Governor Ajith Nivard Cabraal yesterday said default would bring even more pain to the economy and concluded that it was not an option. 

Instead, he reassured that all debts coming up for due in 2022, which S&P puts at US $ 6.6 billion over the next 12 months, would be repaid in full and on time. 

Sri Lanka is negotiating a US $ 2.9 billion worth of financial assistance package consisting of swaps and bilateral funding with India and Qatar, while another fresh loan is sought from China.  But S&P appears less convinced, as it said additional inflows might be insufficient to offset the estimated predetermined short-term drains and added, “The ability of the government to secure additional foreign financing over the next two quarters will be a key determinant of its ability to prevent a deeper external liquidity crisis.” 

Meanwhile, commenting on the roughly US $ 1.2 billion or Rs.229 billion worth fiscal stimulus package announced by the government last week, the rating agency said it would to likely push the fiscal deficit higher.  “We estimate a deficit of 11.1 percent of GDP for Sri Lanka in 2021 and the government’s fiscal shortfall will likely hit 9.8 percent in 2022. If revenue growth underperforms the government’s targets, we believe capital expenditure may be cut to partially offset the deficit,” the rating agency said, warning the authorities of continuous fiscal slippages to worsen already very high debt levels. 

Meanwhile, commenting on the monetary policy, the rating agency said the monetary settings remain a credit weakness while noting that the country suspended the work towards an updated Monetary Law Act in mid-2021. 

Under these conditions, S&P said, “The credibility and effectiveness of the Central Bank’s monetary policy will be further tested by high inflation, the potential for a faster normalisation of global monetary conditions and the prevailing shortage of foreign exchange in the economy.”