Fitch Ratings has downgraded Sri Lanka’s sovereign rating to ‘CC’ from ‘CCC’ and warned there is an increased probability of Colombo defaulting on its external debt obligations unless it receives additional external financing. The country’s Central Bank disputed the move, terming it “hasty”.

Sri Lanka has been facing a severe economic crisis for more than a year now, with the government barely being able to stabilize its foreign exchange reserves. In response, a strict import control regime has been put in place—in order to cut down import bills—which further created a shortage of essentials. 

In an assessment, the New York-based rating agency said, “The downgrade reflects our view of an increased probability of a default event in coming months in light of Sri Lanka’s worsening external liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows.”

The country’s obligations next year include two international sovereign bonds of $500 million due in January and $1 billion due in July.  “We believe it will be difficult for the government to meet its external debt obligations in 2022 and 2023 in the absence of new external financing sources,” Fitch Ratings said on Saturday. 

The severity of the crisis has reached a level that the government had to shut the country’s only refinery this week amid uncertainty over supplies. 

A drawdown on the existing currency swap facility with the People’s Bank of China (PBOC) could boost reserves by up to CNY10 billion ($1.5 billion equivalent). However, even with resources from the swap facility, foreign exchange reserves are likely to remain under pressure, the assessment added. 

Additional sources of financing could come from an economic support package from India, which contains a swap facility under the South Asian Association for Regional Cooperation currency framework of USD400 million, a swap facility with the Qatar Central Bank, remittances securitization, and a revolving credit facility with the Bank of China Limited. 

Despite all these measures, Fitch said it would be challenging for the government to maintain sufficient external liquidity to allow for uninterrupted debt servicing in 2022.

Media reports this week suggested the government has been mulling over approaching the International Monetary Fund (IMF). However, there is no consensus as the Central Bank has reportedly opposed the move. 

Furthermore, the IMF deal, which would provide multilateral financing, itself comes with tough reform recommendations—something the government might find hard to implement, given the strong union culture in the country. (SAM)