Fitch Ratings yesterday downgraded Sri Lanka’s Long-Term Local-Currency (LTLC) Issuer Default Rating (IDR) to ‘C’ from ‘CC’. 

While the issue ratings on local-currency bonds have also been downgraded to ‘C’ from ‘CC’, the Long-Term Foreign-Currency (LTFC) IDR has been affirmed at ‘RD’ (Restricted Default) and the Country Ceiling at ‘B-’, the rating agency announced yesterday.

“The downgrade of Sri Lanka’s LTLC IDR reflects Fitch’s view that a sovereign local-currency debt restructuring process has begun, as parliament approved the government’s domestic debt restructuring plan on July 1,” Fitch Ratings said in a statement released yesterday.

On July 4, the authorities launched a formal exchange offer to bondholders for those bonds that are eligible for the restructuring.

The debt restructuring announcement outlines a domestic debt optimisation (DDO) strategy, which includes treatment of Sri Lanka’s domestic debt as well as domestically issued foreign-currency debt. 

The key elements of the DDO include conversion of CBSL’s T-bills and provisional advances to the government into treasury bonds (T-bonds); exchange of superannuation funds’ T-bonds into longer maturity T-bonds; exchange of outstanding Sri Lanka development bonds (SLDBs), which are US-dollar denominated but governed by local law, into new US dollar or Sri Lankan rupee instruments; and, restructuring of local-law foreign-currency  denominated bank loans of the government.

The debt restructuring excludes banks’ holdings of Sri Lankan rupee-denominated treasury securities, but bank holdings of SLDBs will be affected. 

Fitch said the proposed DDO will qualify as a distressed debt exchange (DDE) under its criteria as it entails a material reduction in terms and is needed to avoid a traditional payment default. 

“We will downgrade the LTLC IDR to ‘RD’ upon closing of the exchange offer and following confirmation that the exchange will be executed. The government plans to complete the exchange within July,” Fitch said. 

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 the proprietary Sovereign Rating Model (SRM) of Fitch.

Sri Lanka has a medium WBGI ranking in the 45th 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. 

In terms of Creditor Rights, Sri Lanka has an ESG Relevance Score of ‘5’, as willingness to service and repay debt is highly relevant to the rating and is a key rating driver with a high weight, said Fitch. It noted that the affirmation of Sri Lanka’s LTFC IDR at ‘RD’ reflects a default event.