Sri Lanka is running on empty and may be perilously close to defaulting on its foreign debt payments, the latest international sovereign ratings downgrade suggests. Citing an “increased probability of default’’, Fitch Ratings on Friday downgraded Sri Lanka’s long-term foreign-currency issuer default rating to ‘CC’ from ‘CCC’. In the high-yield credit market, debt rated ‘CCC’, [...]

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Fitch rating revision: Debt default fears worsen but Lanka assures repayment

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Sri Lanka is running on empty and may be perilously close to defaulting on its foreign debt payments, the latest international sovereign ratings downgrade suggests.

Citing an “increased probability of default’’, Fitch Ratings on Friday downgraded Sri Lanka’s long-term foreign-currency issuer default rating to ‘CC’ from ‘CCC’.

In the high-yield credit market, debt rated ‘CCC’, signifies the lowest-rated tier, (also called “trash’’), before a default. Sri Lanka has to repay two International Sovereign Bonds of US$ 500m next month and US$ 1b in July, 2022.

The government also faces foreign-currency debt service payments, including principal and interest, of US$ 6.9b in 2022, equivalent to nearly 430% of official gross international reserves as of November 2021, Fitch said. The cumulative foreign-currency debt service, including interest and principal, would be about US$26b from next year through to 2026. 

 

The Central Bank of Sri Lanka said the Fitch downgrade is “hasty’’ and “reckless’’, ahead of “the first test date of 31 December 2021’’, and assured that “Sri Lanka will honour all debt obligations in the period ahead’’. A statement said Sri Lanka “has not delayed a single payment even under severe stresses that were caused by the COVID-19 pandemic over the past two years.’’

In July, Sri Lanka repaid a US$1b ISB (International Sovereign Bond) by the deadline. Before that, Moody’s Investors Service had flagged a risk of default.

Just as it did in October, following a Moody’s debt downgrade, the Central Bank asked stakeholders and international investors to “work with Sri Lanka to surf the turbulent tides, which are expected to settle in the next few days.’’

Fitch said the downgrade factors in “an increased probability of a default event in coming months’’ in view of the “worsening external liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows’’. Fitch said the severity of financial stress was illustrated by elevated government-bond yields and downward pressure on the rupee.

Economist Nishan de Mel of Verite Research tweeted in response yesterday that rating downgrades were no longer a surprise. “There is more to come. Why? Sri Lanka economic policy has the wrong goals: repaying foreign debt holders in full is now counter productive. The right goal is to increase the quality and quantity of reserves. But govt is not listening.’’

The Central Bank said, “Fitch appears to have completely ignored the standby swap facility with the People’s Bank of China of around US$1.5 billion, of which the drawal is imminent. The credit lines and other inflows expected following high-level meetings in India and the Middle Eastern and other regional economies are also not given due consideration by Fitch in arriving at this decision.’’

In its statement, Fitch said: “A drawdown on the existing currency swap facility with the People’s Bank of China (PBOC) could boost reserves by up to 10 billion yuan (US$1.5 billion equivalent). However, even with resources from the swap facility, foreign exchange reserves are likely to remain under pressure, in our view. Additional sources of financing could come from an economic support package from India, which contains a swap facility under the South Asian Association for Regional Cooperation currency framework of US$400 million, a swap facility with the Qatar Central Bank, remittances securitisation and a revolving credit facility with the Bank of China Limited (A/Stable). However, even if all these sources are secured, we believe it will be challenging for the government to maintain sufficient external liquidity to allow for uninterrupted debt servicing in 2022.’’

Fitch also said wide fiscal deficits were worsening the outlook for debt sustainability. “The 2021 fiscal deficit target of 8.9% of GDP was missed by a wide margin, and we expect the government deficit to widen to about 11.5% of GDP in 2022. We believe 2022 revenue targets are optimistic, especially in light of our expectation of weak economic activity. We forecast general government debt to reach about 110% of GDP by 2022, and to keep rising under our baseline, absent major fiscal consolidation.’’

On October 28, just ahead of the annual budget, Moody’s flagged default risks and downgraded Sri Lanka to ‘Caa2’ from ‘Caa1’, citing the lack of “comprehensive financing to meet the government’s forthcoming significant maturities, in the context of very low foreign exchange reserves’’. Then, too, Central Bank rejected the ratings action, saying “the country’s external position’’ had strengthened.

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