Fitch Ratings said yesterday it has downgraded Sri Lanka’s Long-Term Local-Currency (LTLC) Issuer Default Rating (IDR) to ‘C’ from ‘CC’. 

The issue ratings on local-currency bonds have also been downgraded to ‘C’ from ‘CC’. The Long-Term Foreign-Currency (LTFC) IDR has been affirmed at ‘RD’ (Restricted Default) and the Country Ceiling at ‘B-’.

Fitch typically does not assign Outlooks to ratings of ‘CCC+’ or below.

Domestic Debt Restructuring Proposal Announced: The downgrade of Sri Lanka’s LTLC IDR reflects Fitch’s view that a sovereign local-currency debt restructuring process has begun, as parliament approved the Government’s domestic debt restructuring plan on 1 July. On 4 July, the authorities launched a formal exchange offer to bondholders for those bonds that are eligible for the restructuring.

Restructuring Plan Outlined: The debt restructuring announcement outlines a domestic debt optimisation (DDO) strategy, which includes treatment of Sri Lanka’s domestic debt as well as domestically issued foreign-currency debt. The key elements of the DDO include: conversion of CBSL’s T-bills and provisional advances to the Government into treasury bonds (T-Bonds); exchange of superannuation funds’ T-Bonds into longer maturity T-Bonds; exchange of outstanding Sri Lanka development bonds (SLDBs), which are US-dollar denominated but governed by local law, into new US dollar or Sri Lankan rupee instruments; and, restructuring of local-law foreign-currency denominated bank loans of the Government.

The debt restructuring excludes banks’ holdings of Sri Lankan rupee-denominated treasury securities, but bank holdings of SLDBs will be affected.

DDO Qualifies as DDE: In Fitch’s view, the proposed DDO will qualify as a distressed debt exchange (DDE) under our criteria, as it entails a material reduction in terms and is needed to avoid a traditional payment default. We will downgrade the LTLC IDR to ‘RD’ upon closing of the exchange offer and following confirmation that the exchange will be executed. The Government plans to complete the exchange within July.

Foreign Currency IDR in Default: The sovereign remains in default on foreign-currency obligations and has initiated a debt restructuring arrangement with official and private external creditors. The Ministry of Finance had issued a statement on 12 April 2022 that it had suspended normal debt servicing of several categories of external debt, including bonds issued in international capital markets, foreign currency-denominated loan agreements and credit facilities with commercial banks and institutional lenders.

ESG - Governance: Sri Lanka has an ESG Relevance Score of ‘5’ for Political Stability and Rights as well as for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. These scores reflect the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model (SRM). Sri Lanka has a medium WBGI ranking in the 45th percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.

ESG - Creditor Rights: Sri Lanka has an 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 LTFC IDR at ‘RD’ reflects a default event.

CBSL debunks  DDO doomsayers