Fitch upgrades SL’s Long-Term Local-Currency IDR to ‘CCC-’ from ‘RD’

Fitch Ratings announced last week it has upgraded Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to ‘CCC-’ from ‘RD’ (Restricted Default).
While the Country Ceiling at ‘B-’, the Short-Term Local-Currency IDR has been downgraded to ‘RD’ from ‘C’.
In a statement to the media on Thursday (28), Fitch said the Short-Term Local-Currency IDR has been downgraded following the exchange of treasury bills held by the central bank and subsequently upgraded to ‘C’ in line with the Sovereign Rating Criteria, as it believes the local-currency debt exchange has now been completed.

The upgrade of Sri Lanka’s Long-Term Local-Currency IDR to ‘CCC-’ reflects the completion of the local-currency portion of Sri Lanka’s domestic debt optimization (DDO) plan, launched in July 2023, following the exchange of the Central Bank of Sri Lanka’s (CBSL) treasury bills and provisional advance into new treasury bonds and bills on 21 September 2023, noted Fitch Ratings.

“We assume the debt restructuring will lower Sri Lanka’s gross financing needs over the medium term, in line with the targets under IMF’s Extended Fund Facility, and support an improvement in the country’s debt metrics over time. Local-currency restructuring could accelerate progress towards the restructuring of external debt,” the rating agency said.
General government debt and the interest costs faced by the government is expected to remain high, despite the debt restructuring. Sri Lanka’s gross general government debt-to-GDP ratio is set to fall only gradually to just above 100 percent of GDP by 2028, from 128 percent of GDP in 2022, according to IMF programme forecasts published in March 2023, which incorporated a local- and foreign-currency debt restructuring scenario.

The IMF scenario forecasts the government interest-to-revenue ratio will decline to 42 percent by 2028, from over 70 percent in 2022.
The authorities expect the completion of the local-currency debt exchange to lower Sri Lanka’s gross government financing needs (GFN)/GDP by about 1.5pp over 2027-2032, according to documents published in July. Fitch asserted that the external debt restructuring, which authorities expect to reduce GFN by an additional 2.6pp, remains critical to achieving the target of reducing GFN below 13 percent by 2027-2032, from 34 percent in 2022.

The DDO on the local-currency debt entailed an extension of maturities on certain categories of domestic debt and offered several options, including nominal haircuts, currency redenomination, and maturity extensions. Outstanding treasury bills purchased by the CBSL in the primary market were converted into 10 step-down fixed-coupon new treasury bonds and 12 existing treasury bills.
Noting that stronger revenue is key, Fitch said it believes the IMF programme implementation, in particular fiscal measures, will be central to achieving debt sustainability.
“The risks remain significant, in our view, as a record of weak revenue generation presents challenges to achieving a faster reduction in the budget deficit and the general government debt-to-GDP ratio,” it said.

Fitch noted that the exclusion of banks’ holdings of treasury securities from the DDO has alleviated some of the pressure on their capital positions from weakening loan quality and rupee depreciation as well as any immediate funding and liquidity stresses.
“We believe any incremental risk to the banks’ capital from foreign-currency debt restructuring is likely to be manageable given their limited exposure to the defaulted sovereign bonds (3.6 percent of their combined total assets at end-1H23) and high provision coverage,” the rating agency said.
Fitch said Sri Lanka’s ESG Relevance Score of ‘5’ for Creditor Rights, as willingness to service and repay debt is highly relevant to the rating and is a key rating driver with a high weight. The affirmation of Sri Lanka’s Long-Term Foreign-Currency IDR at ‘RD’ reflects a default event.