S&P upgrades SL’s local currency rating following DDO completion

• Says completion of the restructuring exercise is supportive of SL’s near-term creditworthiness 
• Despite restructuring efforts S&P expects SL’s net general govt. debt to remain above 100% of GDP until at least 2026
• Says govt.’s interest burden likely to be more than 70% of revenues in 2023 and remain above 50% in 2026

S&P Global Ratings yesterday raised its long and short-term local currency sovereign credit ratings on Sri Lanka to ‘CCC+/C’ from ‘SD/SD’ (selective default) following the recently completed Domestic Debt Optimisation (DDO) programme.
The outlook on the ‘CCC+’ long-term local currency rating is stable. 
S&P also raised the issue rating on Sri Lanka’s local currency bond maturing in October 2023 to ‘CCC+’ from ‘D’ in line with the change in the sovereign credit rating.

This could be seen as first formal recognition of Sri Lanka’s ongoing economic recovery.
“The stable outlook on the long-term local currency rating reflects the balance of improvements to the government’s debt profile achieved through its domestic restructuring exercises against the continued risk to government’s fiscal sustainability posed by Sri Lanka’s ongoing economic, external, and fiscal pressures,” S&P said.

“We raised our local currency ratings on Sri Lanka to ‘CCC+/C’ to reflect a forward-looking opinion about Sri Lanka’s creditworthiness on local currency obligations following the completion of the government’s domestic debt exchange programme with superannuation funds. 
We viewed this exchange as distressed rather than opportunistic due to the government’s very high interest burden and local currency debt stock. In our opinion, the restructuring also resulted in lenders receiving less than originally promised,” the rating agency added. 

Sri Lanka also completed on Sept. 21, 2023, a separate restructuring exercise on its debt owed to the Central Bank of Sri Lanka. Outstanding provisional advances and Treasury bills held by the Central Bank were converted primarily into Treasury bonds with maturities in 2029-2038, carrying fixed interest rates that will step down in 2025 and 2027. 
A much smaller portion of the outstanding credits have been converted to short-term Treasury bills. S&P said its sovereign ratings do not reflect the government’s capacity and willingness to service financial obligations to public sector enterprises or similar official creditors. 
“Nevertheless we view the completion of this restructuring exercise, in addition to the restructuring to superannuation funds, as supportive of Sri Lanka’s near-term creditworthiness on its local currency obligations because it will further reduce refinancing needs as well as the government’s interest bill. 

In our view, the successful completion of the domestic debt exchange with superannuation funds suggests that the government will continue to service its unaffected outstanding local currency bonds in the near term. However, Sri Lanka remains dependent upon favourable economic developments to continue to meet its financial commitments,” the rating agency noted.As of May 2023, local currency-denominated Treasury bills and bonds outstanding were approximately Rs.14.1 trillion, or about 60 percent of GDP. 
Sri Lanka’s restructuring exercises on some of these obligations will not affect the size of the outstanding debt stock because there is no haircut on the value of the notes. 
Banks, which were not included in the domestic debt exchange programme on local currency bonds, are estimated to hold approximately 27 percent of Treasury bills and 43 percent of Treasury bonds. 

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Despite Sri Lanka’s ongoing restructuring endeavours aimed at stabilising the government’s fiscal situation, S&P anticipates that net general government debt will continue to hover at an elevated level, exceeding 100 percent of GDP until at least 2026. “Likewise, we estimate that the government’s interest burden will be more than 70 percent of revenues for 2023, and will remain above 50 percent in 2026. These outcomes will be highly dependent on the pace of nominal GDP growth, fiscal consolidation and revenue growth, prevailing interest rates in the economy, and future restructuring outcomes, among other variables,” the rating agency noted.