S&P Global Ratings today raised its long- and short-term local currency sovereign credit ratings on Sri Lanka to 'CCC+/C' from 'SD/SD' (selective default). At the same time, we affirmed our 'SD/SD' long- and short-term foreign currency ratings. The outlook on the 'CCC+' long-term local currency rating is stable. We also raised the issue rating on Sri Lanka's local currency bond maturing in October 2023 to 'CCC+' from 'D'.
Outlook
Our long-term foreign currency rating on Sri Lanka is 'SD'. We do not assign outlooks to 'SD' ratings because they express a condition and not a forward-looking opinion of default probability.
The stable outlook on the long-term local currency rating reflects the balance of improvements to the government's debt profile achieved through its domestic restructuring exercises against the continued risk to the government's fiscal sustainability posed by Sri Lanka's ongoing economic, external, and fiscal pressures.
Downside scenario
We could lower the long-term local currency ratings on Sri Lanka if there are indications of further restructuring of obligations denominated in Sri Lankan rupees (LKR) to commercial creditors. Developments that could precede these indications include a rapid rise in inflation, a further rise in the government's interest burden, or a significantly worse fiscal performance by the government leading to local currency funding pressures.
Upside scenario
We could raise the long-term local currency sovereign credit rating on Sri Lanka if we perceive that the sustainability of the government's large local currency debt stock has improved further. This could be the case if, for example, the government's fiscal metrics, and the performance of the Sri Lankan economy, improve much more quickly than we expect.
We could raise our long-term foreign currency sovereign credit rating upon completion of the government's bond restructuring. The rating would reflect Sri Lanka's creditworthiness post-restructuring.
Our post-restructuring ratings tend to be in the 'CCC' or low 'B' categories, depending on the sovereign's new debt structure and capacity to support that debt.
Rationale
We raised our local currency ratings on Sri Lanka to 'CCC+/C' to reflect a forward-looking opinion about Sri Lanka's creditworthiness on local currency obligations following the completion of the government's domestic debt exchange program with superannuation funds. We viewed this exchange as distressed rather than opportunistic due to the government's very high interest burden and local currency debt stock. In our opinion, the restructuring also resulted in lenders receiving less than originally promised.
We also raised the rating on Sri Lanka's October 2023 local currency bond to 'CCC+', in line with the change in the sovereign credit rating.
Sri Lanka also completed on Sept. 21, 2023, a separate restructuring exercise on its debt owed to the Central Bank of Sri Lanka. Outstanding provisional advances and Treasury bills held by the central bank were converted primarily into Treasury bonds with maturities in 2029-2038, carrying fixed interest rates that will step down in 2025 and 2027.
A much smaller portion of the outstanding credits have been converted to short-term Treasury bills. S&P Global Ratings' sovereign ratings do not reflect the government's capacity and willingness to service financial obligations to public sector enterprises or similar official creditors.
Nevertheless we view the completion of this restructuring exercise, in addition to the restructuring to superannuation funds, as supportive of Sri Lanka's near-term creditworthiness on its local currency obligations because it will further reduce refinancing needs as well as the government's interest bill.
In our view, the successful completion of the domestic debt exchange with superannuation funds suggests that the government will continue to service its unaffected outstanding local currency bonds in the near term. However, Sri Lanka remains dependent upon favorable economic developments to continue to meet its financial commitments.
As of May 2023, local currency-denominated Treasury bills and bonds outstanding were approximately LKR14.1 trillion, or about 60% of GDP. Sri Lanka's restructuring exercises on some of these obligations will not affect the size of the outstanding debt stock because there is no haircut on the value of the notes. Banks, which were not included in the domestic debt exchange program on local currency bonds, are estimated to hold approximately 27% of Treasury bills and 43% of Treasury bonds.
Although Sri Lanka's ongoing restructuring efforts will help to stabilize the government's fiscal dynamics, net general government indebtedness will remain at a very high level of more than 100% of GDP through at least 2026, in our assessment. Likewise, we estimate that the government's interest burden will be more than 70% of revenues for 2023, and will remain above 50% in 2026. These outcomes will be highly dependent on the pace of nominal GDP growth, fiscal consolidation and revenue growth, prevailing interest rates in the economy, and future restructuring outcomes, among other variables.