Moody's places Sri Lanka's Caa1 rating under review for downgrade

The rating decision is driven by assessment that the island nation's increasingly fragile external liquidity position raises the risk of default. It also reflects governance weaknesses in the ability of the country's institutions to decisively mitigate significant and urgent risks to the balance of payments.

 Although the government has secured some financing, mainly from bilateral sources, its financing options remain narrow with borrowing costs in international markets still prohibitive, Moody's said in a statement.

Moody's expects Sri Lanka's foreign exchange reserves to continue declining from already low levels. This will further erode its ability to meet sizeable and recurring external debt servicing needs, and increasing balance of payment risks.

It has extremely weak debt affordability with interest payments absorbing a very large share of the government's very narrow revenue base. This compounds the debt repayment challenge.

The review will focus on whether the sovereign is able to use time provided by current foreign exchange reserves and bilateral arrangements to implement measures that widen and increase its financing sources for the medium term. And avoid default for the foreseeable future, it added.

Sri Lanka's foreign currency country ceiling has been lowered to Caa1 from B3, while the local currency country ceiling remains unchanged at B1. The three-notch gap between the local currency ceiling and the sovereign rating balances relatively predictable institutions and government actions against the low and declining foreign exchange reserves adequacy.