Moody’s Investors Service (“Moody’s”) has today placed the Government of Sri Lanka’s Caa1 foreign currency long-term issuer and senior unsecured debt ratings under review for downgrade.
The decision to place the ratings under review for downgrade is driven by Moody’s assessment that Sri Lanka’s increasingly fragile external liquidity position raises the risk of default. This assessment reflects governance weaknesses in the ability of the country’s institutions to take measures that decisively mitigate significant and urgent risks to the balance of payments.
Although the government has secured some financing, mainly from bilateral sources, its financing options remain narrow with borrowing costs in international markets still prohibitive. Absent large and sustained capital inflows through a credible external financing strategy, Moody’s expects Sri Lanka’s foreign exchange reserves to continue declining from already low levels, further eroding its ability to meet sizeable and recurring external debt servicing needs, and increasing balance of payment risks. Extremely weak debt affordability — with interest payments absorbing a very large share of the government’s very narrow revenue base — compounds the debt repayment challenge.
The rating review will focus on assessing whether the sovereign is able to use a period of time provided by its current foreign exchange reserves and bilateral arrangements to implement measures that widen and increase its financing sources for the medium term, and thereby avoid default for the foreseeable future.
Sri Lanka’s foreign currency country ceiling has been lowered to Caa1 from B3, while the local currency country ceiling remains unchanged at B1. The three-notch gap between the local currency ceiling and the sovereign rating balances relatively predictable institutions and government actions against the low and declining foreign exchange reserves adequacy that raises macroeconomic risks as well as the challenging domestic political environment that weighs 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 the risk of transfer and convertibility restrictions being imposed given low foreign exchange reserves adequacy, with some capital flow management measures already imposed. These ceilings typically act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.