• Local-currency bonds tendered in domestic debt exchange have been downgraded to ‘D’, from ‘C’
• Sri Lanka’s foreign-currency bonds have been affirmed at ‘D’
• Says LTLC IDR will remain in ‘RD’ until debt exchange is completed in its entirety 

Fitch Ratings announced yesterday it has downgraded Sri Lanka’s Long-Term Local-Currency (LTLC) Issuer Default Rating (IDR) to ‘RD’ (Restricted Default), from ‘C’.
The ratings on its local-currency bonds tendered in the domestic debt exchange have been downgraded to ‘D’, from ‘C’, while its other four local-currency bonds not tendered in the domestic debt exchange have been affirmed at ‘C’, the rating agency said in a statement yesterday. 
Further, the ratings on Sri Lanka’s foreign-currency bonds have been affirmed at ‘D’.
Fitch stated that the downgrade of Sri Lanka’s LTLC IDR reflects the partial completion of an exchange of Sri Lanka’s Treasury bonds (T-bonds) on September 14, as part of a broader domestic debt optimisation (DDO) launched in July 2023. 
The DDO also includes conversion of Treasury bills (T-bills) held by the Central Bank of Sri Lanka (CBSL) into T-bonds, which has not yet 
been completed. 
“The exchange of T-bonds constitutes a distressed debt exchange (DDE) under the agency’s criteria, given that the maturity extension of the tendered bonds represents a material reduction in terms versus the original contractual terms and given that the exchange is needed to avoid a traditional payment default,” the agency said. 
The eligible bonds for which tenders were received and accepted have been exchanged into 12 new instruments of equal size and the same aggregate principal amount, maturing between 2027 and 2038. Accepted tenders reached about 37 percent of the outstanding principal amount of eligible bonds outstanding as of June 28, 2023. Accepted tenders were predominantly by superannuation funds, which will face higher tax rates on income from T-bonds, if they did not meet a participation threshold.
On the continuity of Local-Currency Debt Service, Fitch said it believes that Sri Lanka has continued to service the T-bonds throughout the DDO process and that T-bonds not tendered in the exchange would continue to be serviced as per their original terms, including but not limited to the entirety of the 12 series of T-bonds (out of 61 eligible series) for which no valid tenders were received.
Four of these 12 series were rated by Fitch and were affirmed at ‘C’, prior 
to withdrawal.
Under Fitch’s rating criteria, the LTLC IDR will remain in ‘RD’ until the debt exchange is completed in its entirety.

“Fitch deems the process incomplete, as the exchange of T-bills held by the CBSL is still pending. Fitch regards the T-bills as public debt securities and they are also held by private investors,” the rating agency said.
Further, the rating agency noted that the sovereign remains in default on foreign currency obligations and has initiated a debt restructuring with official and private external creditors.
The Finance Ministry issued a statement on April 12, 2022 that it had suspended normal debt servicing of several categories of external debt, including the bonds issued in international capital markets, foreign currency-denominated loans and credit facilities with commercial banks and institutional lenders.