Fitch downgrades SL to ‘CC’ on heightened default concerns

• Rating agency says things would get worse in 2022 before it gets better in 2023 
• Supply shortages could persist through 2022 due to lingering Fx liquidity crunch  
• Forecasts 2022 economic growth at 2%, weaker than estimated 3.6% in 2021
• SL has US$ 6.9 bn of Fx debt for settlement in 2022, 430% of current reserves 
• Markets lose faith on CB’s six-month road map which promised around US$ 10bn inflows

Fitch Ratings last week joined the list of global rating agencies to downgrade Sri Lanka’s sovereign rating for the second time in an year on the mounting concerns of a debt default in the coming months due to razor-thin external reserve buffers, which depleted faster than what the rating agency had anticipated a year ago.  
The rating agency also cited the six-month road map unveiled by the Central Bank on October 1, which promised around US$ 10 billion worth of foreign currency inflows to ride through the near term external liquidity crunch, but the markets have lost faith in the plan and have begun questioning the credibility of the Central Bank as nothing has happened after three months into the plan. 
The assurances given by the Central Bank to provide the markets an update on the progress of the plan on November 30 was never met.   
Given these circumstances, Fitch Ratings cut Sri Lanka’s Long-Term Issuer Foreign Currency Issuer Default Ratings (IDR) to ‘CC’ from ‘CCC,’ adding that they do not assign Outlooks or amplify modifiers for sovereigns at or below ‘CCC’ rating.  
“The downgrade reflects our view of an increased probability of a default event in coming months in light of Sri Lanka’s worsening external liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows,” the rating agency said explaining the rationale behind their latest move. 

 “The severity of financial stress is illustrated by elevated government-bond yields and downward pressure on the currency,” they added. 
Roughly two months ago, Moody’s slashed Sri Lanka’s sovereign rating to Caa2 from Caa1, which was also their second such downgrade in an year, bringing the country’s credit deeper into the speculative grade, citing the same reasons and adding that the large financing envelop that they consider to be secured remains elusive.
With only S&P remaining to come out with their rating update on the Sri Lankan sovereign, which is unlikely to be different from what have already been delivered by the two of the big three global rating agencies thus far, Sri Lanka is getting closer to become a Latin America styled ‘Basket Case,’ with a looming debt default, widespread hunger and poverty caused by soaring consumer prices and shortages of essential commodities, high unreported unemployment and lawlessness running amok in everyday society. 
Sri Lanka’s foreign reserves fell to a dangerously low of US$ 1.6 billion in November, which doesn’t even cover a month of imports. 
Fitch noted that the pace of decline in reserves was much higher than what they expected at their last review.  Sri Lanka’s external reserves declined by US$ 2.0 billion since August and by US$ 4.0 billion since the end of last year. 
Sri Lanka has two sovereign bods, worth US$ 500 million and US$ 1.0 billion due for settlement in January and July next year and the total foreign currency debt obligations for the entirety of 2022, including those two and the interest is estimated at US$ 6.9 billion, which is 430 percent of the officials gross international reserves at present.  “We believe it will be difficult for the government to meet its external debt obligations in 2022 and 2023 in the absence of new external financing sources,” Fitch said.  Cumulative foreign currency debt obligations including interest up for settlement from 2022 through 2026 is about US$ 26 billion, an uphill battle for Sri Lanka given the lingering effects of the evolving pandemic have on its tourism sector and the weaker prospects it has in attracting direct investments. 
While the undrawn US$ 1.5 billion equivalent Chinese Yuan denominated swap line and the additional financing that could come from India and Qatar by way of swap facilities and few other bilateral financing arrangements could help the country ride through its near term obligations, Fitch is of the belief that it would be challenging for the government to maintain sufficient external liquidity to allow uninterrupted debt servicing in 2022. 
Sri Lanka is expecting US$ 400 million from India under the South Asian Association for Regional Cooperation currency framework and another billion dollars worth of a swap from the Qatar Central Bank.  Fitch also referred to another revolving credit facility with the Bank of China without providing additional specifics. 
Referring to reports of the government contemplating on an International Monetary Fund (IMF) programme, the rating agency said any programme, though would unlock multilateral financing, could well suggest debt restructuring to bring about debt sustainability. 
The rating agency also cited the higher current account deficit in the Balance of Payment and the wider fiscal deficit than what the authorities expect to keep adding pressure on the external finances and thereby the rupee, which has weakened by 7 - 8 percent thus far this year. 
Hence, they think that would complicate the government’s 2025 debt reduction target to bring it down to 89 percent of GDP and to narrow fiscal deficit to 4.8 percent of GDP as annual interest payments alone swallow 95 percent of the its revenues, which is well above the peer median of 11.3 percent. 
Under these circumstances, Fitch is of the view that the economic conditions in 2022 could be weaker due to challenging external positions and the exchange rate pressure to have a knock on impact on economic activities. 
“Foreign currency shortages in 2021 hampered food and fuel imports, and continued external liquidity stress could worsen supply shortages, hurting economic activity”, they added. 
Therefore Fitch expects the economic growth in 2022 to slow to 2.0 percent in 2022 from an estimated 3.6 percent in 2021 prior to recovering to 4.3 percent in 2023, partly due to the base effects and gradual easing of domestic pressures, although downside risks to this forecast remain.