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At the same time, the credit rating agency affirmed its ‘SD/SD’ long- and short-term foreign currency ratings.
In a statement, S&P Global Ratings said the outlook on the ‘CCC+’ long-term local currency rating is stable, adding that it has also raised the issue rating on Sri Lanka’s local currency bond maturing in October 2023 to ‘CCC+’ from ‘D’.
Outlook
The New York-based credit rating agency’s long-term foreign currency rating on Sri Lanka is ‘SD’. The company said it does 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
S&P Global Ratings said it 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
Further, S&P Global Ratings said it could raise the long-term local currency sovereign credit rating on Sri Lanka if it perceives 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 it expects.
The credit rating agency added that it could raise its 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.
S&P Global Ratings’ 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
S&P Global Ratings noted that it raised its 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.
The credit rating agency has viewed this exchange as distressed rather than opportunistic due to the government’s very high interest burden and local currency debt stock. The agency opined that the restructuring also resulted in lenders receiving less than originally promised.
S&P Global Ratings 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 says its sovereign ratings do not reflect the government’s capacity and willingness to service financial obligations to public sector enterprises or similar official creditors.
Nevertheless, the credit rating agency views 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 its 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, the statement read further.
As of May 2023, local currency-denominated Treasury bills and bonds outstanding were approximately LKR 14.1 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 S&P Global Ratings’ assessment. Likewise, the credit rating agency estimate that the government’s interest burden will be more than 70% of revenues for 2023, and will remain above 50% in 2026. It says 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.
(S&P Global Ratings)