Fitch Ratings has indicated that it may upgrade Sri Lanka’s Issuer Default Rating (IDR) from its current ‘Restricted Default’ (RD) status after the country completes its commercial debt restructuring. This restructuring is seen as a crucial step in restoring Sri Lanka’s relationship with the international financial community.
Sri Lanka’s post-default rating will depend on Fitch’s evaluation of the country’s financial health once the debt restructuring process is finalized. Fitch previously upgraded Sri Lanka’s Long-Term Local-Currency IDR to ‘CCC-’ in September 2023, following the successful implementation of a domestic debt optimization plan. Despite this, the rating agency warns that the country’s government debt levels will remain relatively high, even with successful restructuring.
High Debt Levels Remain a Concern
The International Monetary Fund (IMF) projects that Sri Lanka’s government debt-to-GDP ratio will gradually decrease from around 116% in 2022 to about 103% by 2028, following both domestic and international debt restructuring efforts. However, this still indicates a relatively high level of debt for the country.
Fitch has pointed out that Sri Lanka’s revenue-to-GDP ratio remains low, although recent tax-raising measures introduced since May 2022 have begun to improve the situation. The country’s revenue collection increased by 43% year-on-year through July 2024, far exceeding the nominal GDP growth rate of 9.5% during the first half of the year. Fitch projects that the revenue-to-GDP ratio will rise from 11.4% in 2023 to 15.5% by 2026.
However, these projections could be affected by policy changes introduced by a new government after the upcoming parliamentary elections.
Impact of Parliamentary Elections
Sri Lanka’s parliamentary elections, scheduled for November 14, 2024, could significantly influence the country’s fiscal policy. The outcome of the election may impact the president’s ability to implement necessary policy changes. According to Fitch, the current president’s capacity to push through reforms will depend partly on the results of the election.
The Janatha Vimukthi Peramuna (JVP) and its allies held a limited number of seats in the outgoing legislature, but recent trends suggest that there could be considerable changes in the composition of the new parliament.
Economic Recovery Continues Despite Uncertainty
Despite the uncertainties surrounding the election, Sri Lanka’s economy is showing signs of recovery. In the first half of 2024, the country experienced 5% real GDP growth, a significant improvement compared to the 7.3% contraction during the same period in 2023. Fitch expects Sri Lanka’s economy to grow by 3.9% in 2024, with an average growth rate of 3.6% projected for 2025-2026.
External liquidity pressures have also eased, with foreign exchange reserves rising to USD 6 billion by August 2024, a 66% year-on-year increase. However, Fitch warns that the speed of recovery in reserves could slow when Sri Lanka resumes its external debt repayments.
Debt Restructuring Progress and IMF Programme
Fitch has emphasized that Sri Lanka’s commitment to its debt restructuring process, along with the terms agreed with international sovereign bondholders in September, has reduced risks associated with the debt treatment process. The country’s reaffirmation of its dedication to the IMF programme, as well as the principle of comparability of treatment between official creditors and bondholders, is seen as a positive sign for the restructuring process.
On October 4, 2024, Sri Lanka’s Finance Ministry announced the successful conclusion of consultations with the IMF and the country’s Official Credit Committee. The ministry confirmed that the preliminary agreement is compatible with the terms of the IMF programme, which Fitch views as a positive development for the country’s debt restructuring prospects.
Fitch has kept Sri Lanka’s Long-Term Foreign-Currency IDR at ‘RD’ since May 2022, as the country continues to suspend payments on its foreign-currency debt. However, the ongoing efforts to restructure the debt and comply with IMF requirements are viewed as positive steps towards a more stable financial future for Sri Lanka.
The Road Ahead
Sri Lanka is at a crucial juncture in its economic recovery. While the country has made significant strides in addressing its debt challenges, high government debt levels remain a concern. The successful completion of the debt restructuring process will be key to Sri Lanka’s future financial stability and its ability to regain credibility in the international financial community.
Additionally, the outcome of the upcoming parliamentary elections will play a significant role in shaping the country’s economic policies moving forward. If the new government is able to implement necessary reforms and maintain Sri Lanka’s commitment to the IMF programme, the country may be able to sustain its recovery and continue on its path towards economic stability.
In conclusion, while Sri Lanka’s economic outlook is improving, challenges remain. The country’s ability to manage its debt levels, maintain economic growth, and implement necessary fiscal reforms will be crucial in determining its long-term financial health. With continued commitment to the IMF programme and successful debt restructuring, Sri Lanka may be able to emerge from its current financial challenges and build a more stable and prosperous future.
