• Says SL’s external position has weakened due to falling reserves and weak demand for SLDBs
• Cautions that these developments will continue to affect investor confidence and increase external financing difficulties
• Says govt. may face an increasingly challenging financing environment over next 12 months

S&P Global Ratings yesterday revised its outlook on Sri Lanka’s long-term ratings to negative, from stable, while affirming its ‘CCC+’ long-term sovereign credit ratings and ‘C’ short-term ratings on Sri Lanka.

The negative outlook reflects the rating agency’s view that Sri Lanka’s financing environment may get more difficult over the next 12 months, which would affect Sri Lanka’s ability to service its debt.

S&P however said it may revise the outlook to stable or raise the rating, if external buffers can be significantly boosted or if Sri Lanka’s economic recovery is much stronger than it expected. 

“We revised the outlook to negative to reflect our assessment that risks to Sri Lanka’s debt-servicing capacity are rising and the government’s access to external financing is increasingly dependent on favourable economic and financial conditions. 

The country’s relatively modest income levels, vulnerable external profile, sizable fiscal deficits, heavy government indebtedness and hefty interest payment burdens reflect weak and evolving governance and institutional settings. These factors significantly constrain our ratings,” S&P said. 

“While expansionary macroeconomic policies have provided some relief to the pandemic-hit economy, they have weakened the government’s fiscal position and worsened the risks associated with the government’s already high debt burden,” it added. 

Meanwhile, S&P said despite the pandemic being much more severe in Sri Lanka this year compared with last year, it still expects economic activity to recover from the low base in 2020. 

However, the rating agency cautioned that downside risks to growth are still substantial, particularly given the unpredictable nature of the pandemic and the emergence of new infectious variants. 

“We forecast the economy will expand by 4.2 percent in real terms in 2021, following the 3.6 percent contraction in 2020 and average 4.2 percent from 2022-2024. This will bring per capita income to about US $ 3,900 in 2021, translating into real GDP per capita growth of 2.1 percent on a 10-year weighted-average basis. Although this growth is in line with peers at a similar income level, we believe that it is substantially below Sri Lanka’s potential,” S&P said.

Meanwhile, the rating agency pointed out that Sri Lanka’s external profile has weakened, with reserves falling below US $ 3 billion and financing conditions becoming more uncertain.

S&P said Sri Lanka’s fiscal deficit is likely to remain elevated while the pandemic continues to affect growth. This will likely worsen the government’s heavy indebtedness and add to the repayment burden.

The rating agency expects the infusion of the newly-approved Special Drawing Rights allocation by the IMF will boost Sri Lanka’s foreign reserves by about US $ 800 million. 

However, S&P noted that it would not be sufficient for the government to meet the upcoming maturities of more than US $ 5 billion till the end of 2022. 

 “Although the Central Bank has signed a number of bilateral currency swap arrangements with partnering central banks, including a 10 billion Chinese renminbi swap line with the People’s Bank of China, the adequacy of reserves will still be tenuous without additional means to boost reserves. 

The ability of the government to secure foreign financing over the next two quarters will be crucial to preventing an external liquidity crisis in 2022,” the rating agency said.