Ongoing Restructuring Negotiations: Sri Lanka remains in default on its foreign-currency obligations, but negotiations with private external creditors are progressing. Recently, authorities announced a preliminary debt restructuring agreement with members of the Ad Hoc Group of Bondholders, who represent holders of Sri Lanka’s international sovereign bonds, and with the China Development Bank (A+/Negative), indicating forward movement in the process.
This follows the April 12, 2022 decision to suspend debt servicing on various external debt categories, including international bonds and foreign currency-denominated loans. Sri Lanka’s Long-Term Foreign-Currency IDR (Issuer Default Rating) has been at ‘Restricted Default’ since May 2022, after the expiration of a grace period.
Policy Uncertainty After Elections: The recent presidential election in September 2024 resulted in the victory of an opposition leader. Fitch notes that this introduces uncertainty to the country’s policy direction, which could delay the completion of foreign-currency debt restructuring or the renegotiation of the IMF program. The new government’s 2025 budget, expected by November 2024, may provide more clarity on future policies.
Completion of Local-Currency Debt Exchange: Sri Lanka completed its domestic debt optimization in September 2023, exchanging the Central Bank’s treasury bills and advances for new bonds and bills. As a result, Fitch upgraded the Local-Currency IDR to ‘CCC-‘, where it currently stands.
High Government Debt: The IMF projects that Sri Lanka’s gross general government debt-to-GDP ratio will only gradually decline to around 103% by 2028, from approximately 116% in 2022. This forecast accounts for both local and foreign-currency debt restructuring, but the debt burden will remain elevated even after these measures.
Improving External Metrics: Sri Lanka’s foreign-currency reserves have improved, reaching USD 6.0 billion in August 2024, up from USD 4.4 billion at the end of 2023. This improvement is partly due to the suspension of external debt servicing, along with increases in tourism and overseas remittances. The current account recorded a surplus in 2023, and another is expected in 2024. However, Sri Lanka remains reliant on official financing, with no access to international capital markets.
Stronger Revenue Generation: Weak implementation of the IMF program, particularly regarding fiscal measures, could impede debt sustainability. While Sri Lanka has historically struggled with revenue collection, several significant tax reforms have been enacted since May 2022. These include increases in corporate income tax, value-added tax, and fuel excise taxes, which helped boost revenue collection by 42% year-on-year in the first half of 2024.
Additional fiscal measures under consideration include further increases in corporate income tax to 45%, an additional value-added tax on digital services, and reforms to tax administration aimed at improving transparency and limiting exemptions.
Economic Recovery in Progress: Sri Lanka’s economy is expected to grow by 3.9% in 2024, with an average growth rate of 3.6% between 2025 and 2026. Real GDP growth rebounded to around 5.0% year-on-year in the first half of 2024 after contracting by 7.0% during the same period in 2023. Industrial growth surged by 11.3% in 2024, following an 18.0% contraction in 2023. Services also showed a recovery of about 2.7% during the same period.
Inflation Under Control: Inflationary pressures have eased, allowing for further monetary policy easing between 2024 and 2026. The Central Bank of Sri Lanka has reduced the standing deposit facility rate by 725 basis points since June 2023, as inflation dropped to 0.6% in August 2024. Inflation has remained in single digits for over a year, after peaking at 67% in September 2022.
Banking Sector Stabilisation: While non-performing loans in the banking sector remain high due to the economic strain of the sovereign default, the sector is stabilising. This recovery is supported by improving economic conditions and the completion of the domestic debt optimisation, which has mitigated some of the impact on banks.
ESG – Governance: Sri Lanka maintains an ESG Relevance Score of ‘5’ for Political Stability and Rights, as well as for the Rule of Law.
