Fitch Ratings has downgraded Sri Lanka's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CCC'.
The downgrade reflects Sri Lanka's increasingly challenging external-debt repayment position over the medium term. In particular, a sharp rise in the sovereign debt to GDP ratio associated with the coronavirus shock and narrowing financing options have heightened debt sustainability risks.
"Sri Lanka's external funding needs are substantial over the medium term, and in our view, risks to the sovereign's ability to meet its external-debt service obligations have increased. The government's external-debt obligations amount to USD 23.2 billion between 2021 and 2025 or about USD 4 billion annually, against FX reserves at end-October of just USD 5.9 billion. The sovereign's financing and debt service challenges are exacerbated by its existing financing model, which has resulted in very high general government interest to revenues ratios. The average interest to revenue ratio from 2016 to 2020 is about 50%, substantially above the 'CCC' peer median of about 11%," Fitch Ratings said.
Although the Sri Lankan government plans to meet their external-debt obligations in 2021-2025 through a combination of sources, including bilateral, multilateral and commercial financing, Fitch Ratings said that access to such external financing options will become more challenging against the backdrop of already high debt levels and an expected further weakening of government debt dynamics.
Meanwhile, Fitch believes that financing conditions for potential market issuance have tightened materially, notwithstanding the reduction in political and policy uncertainty following the completion of parliamentary elections in August 2020 and submission of the draft 2021 budget in November.
"We think there are now increasing risks to Sri Lanka's ability to meet its external-debt repayments as reflected in our forecast of a steady decline in FX reserves in 2021 and 2022. We expect Sri Lanka's external liquidity ratio, defined as liquid external assets/external liabilities, will remain low at about 63%, against a 'CCC' median of about 68% in 2021.
In the 2021 budget, the authorities have planned external borrowings of project and programme loans mostly through bilateral and multilateral sources (about USD1.8 billion), as well as foreign commercial loans (about USD1.4 billion) for budget support. The authorities do not currently anticipate a financing arrangement with the IMF," the ratings agency said. In May 2020, S&P Global Ratings downgraded its long-term foreign- and local-currency sovereign credit ratings on Sri Lanka to B- from B, citing a deterioration in the country's already weak fiscal position amid an expected economic contraction.
In September, Moody’s Investors Service downgraded Sri Lanka’s sovereign rating two notches to Caa1, from B2, citing wide budget deficits, slow reforms and weak institutions.
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