Moody’s Ratings places Sri Lanka on review for upgrade

• Assigns (P) Caa1 to new USD denominated issuances 
• Move follows Govt. announcing exchange offer to ISB holders 

Moody’s Ratings (Moody’s) has placed the Government of Sri Lanka’s Ca long-term foreign currency issuer rating on review for upgrade. Previously, the outlook was stable.

Concurrently, it has assigned (P) Caa1 foreign currency senior unsecured ratings to Sri Lanka’s new USD-denominated issuances in its exchange offer, specifically the macro-linked bonds (MLBs), the governance-linked bond (GLB), as well as the stepup and past-due interest (PDI) bonds.

The existing Ca ratings on Sri Lanka’s foreign currency senior unsecured debt issuances that are in default and will be exchanged for the new debt issuances reflect the expected financial loss and are unchanged.

Moody’s said the decision to place the issuer rating on review for upgrade reflects the announcement of the exchange offer by the Government, which if successful will conclude the restructuring of its international bonds held by private-sector creditors and reduce the default risk on new and future issuances. 

In particular, the relatively comprehensive debt restructuring and ongoing reforms under the Government’s programs with development partners including the International Monetary Fund (IMF) are leading to a significant reduction in external vulnerability and Government liquidity risk, while raising prospects for fiscal and debt sustainability, albeit from a weak starting point. Willingness and capacity to implement reforms speak to Sri Lanka’s governance, a driver of this rating action.

The Government has been in default since April 2022, when it announced that it would suspend the servicing of external debt repayments.

The review period is expected to last until the exchange offer period closes and there is clarity on the outcome of the restructuring of international bonds.

The assignment of the (P) Caa1 ratings to Sri Lanka’s new foreign currency issuances reflects our assessment that, according to the terms and conditions of the exchange offer, the issuances constitute direct, unconditional and unsecured obligations of the Government and will rank pari passu among themselves and equally with all of the Government’s other unsecured and unsubordinated obligations. The provisional rating takes into account our assessment that debt restructuring will provide material debt and repayment relief, as well as Sri Lanka’s relatively solid growth prospects and the return of reform appetite that is gradually restoring policy credibility and effectiveness.

These credit supports are balanced against our expectation that the Government’s debt affordability will remain very weak and its debt burden high compared to peers.

The payments for the MLBs are contingent on GDP outcomes, including potential changes to the principal value ranging from -21% to 22% relative to the notional amount exchanged in the offer. The payments depend on a point-in-time comparison of realised GDP outcomes published by the IMF against the IMF’s currently published baseline scenario of projected GDP outcomes.  

“In rating these debt instruments, we do not assess the likelihood of any of the GDP outcomes determining the payments,” Moody’s said. 

Once the point-in-time comparison is conducted and any adjustments to contractual obligations are made, there will be no other source of variation to debt payments.

Sri Lanka’s local and foreign currency country ceilings remain unchanged at Caa1 and Ca, respectively. The three-notch gap between the local currency ceiling and the sovereign rating balances a contained Government footprint, against still relatively limited but increasing foreign exchange buffers that confer macroeconomic risks, as well as a domestic political environment that has weighed on policymaking. The three notch gap between the foreign currency ceiling and local currency ceiling takes into consideration the high level of external indebtedness and still low, albeit rising, level of foreign exchange buffers.