ECONOMYNEXT – Sri Lanka’s sovereign rating remains at Selective Default (SD), but the country’s sovereign bonds have been downgraded to “D” after missed interest payments, said Standard and Poor’s, a rating agency.

“The Sri Lankan government remains in default on certain foreign currency obligations, including international sovereign bonds (ISBs),” the S&P said.

“We do not expect the government to make the payments within 30 calendar days of their due dates.

“We have downgraded the relevant bonds’ ratings to ‘D’, following missed interest payments due on June 3, June 28 and July 18, and a missed principal payment due on July 25.”

Sri Lanka continues to pay its senior creditors with money from deferred payments from the Asian Clearing Union.

Sri Lanka began borrowing heavily in foreign bond markets from 2015 after breaking its currency peg with extraordinary liquidity injections under “flexible inflation targeting and the country lost the ability to roll over maturing rupee bonds to gross funding level”.

From 2015 to 2019, the country only experienced monetary stability in 2017 and 2019, as the pegged exchange rate regime was broken by liquidity injections to target an “output gap”.

However, the targeting of the output gap led to monetary crises (balance of payment deficit) and growth fell with the fall of stabilization measures.

From 2020 to 2022, even more aggressive liquidity injections were made and taxes were also cut, indicating that there was a “persistent output gap” until all foreign exchange reserves, including borrowed reserves, are lost and the country defaults in peacetime.

The International Monetary Fund provided technical assistance to Sri Lanka to calculate the output gap and also endorsed “flexible inflation targeting”, with overnight repo injections, forward repo injections, the pure and simple purchase of bonds, despite the presence of a reserve collection anchor.

On April 12, 2022, Sri Lanka defaulted despite peace.

The full statement is reproduced below:

Sri Lanka bonds downgraded to ‘D’ after missed payments; Sovereign ratings confirmed

Insight

The Sri Lankan government remains in default on certain foreign currency obligations, including International Sovereign Bonds (ISBs).

We do not expect the government to make payments within 30 calendar days of their due date.

We downgraded the relevant bonds to ‘D’, following missed interest payments due on June 3, June 28 and July 18, and a missed principal payment due on July 25.

We confirmed our ratings ‘SD/SD’ in foreign currency and ‘CCC-/C’ in local currency on Sri Lanka. The outlook on the long-term rating in local currency is negative.

Rating Action

On August 15, 2022, S&P Global Ratings affirmed its long-term “SD” and “SD” short-term foreign currency sovereign ratings on Sri Lanka. At the same time, we confirmed our long-term “CCC-” and short-term “C” sovereign ratings in local currency. The outlook on the long-term rating in local currency remains negative.

In addition, we have downgraded to “D” from “CC” the issue ratings of the following bonds with missed coupon or principal payments:

US$650 million, 6.125% bonds due June 3, 2025.

US$1.0 billion, 6.825% bonds due July 18, 2026.

US$1.0 billion 5.875% bond due July 25, 2022.

US$500 million, 6.35% bonds due June 28, 2024.

Our assessment of transferability and convertibility at ‘CC’ is unchanged.

Outlook

Our exchange rating for Sri Lanka is “SD” (Selective Default). We do not assign an outlook to “SD” ratings because they express a condition and not a forward-looking opinion on the probability of default.

The negative local currency rating outlook reflects the high risk of commercial debt repayments over the next 12 months amid Sri Lanka’s economic, external and fiscal pressures.

Downside scenario

We may downgrade local currency ratings if there are indications of non-payment or restructuring of Sri Lankan rupee-denominated bonds.

Positive scenario

We could revise the outlook to stable or raise the local currency ratings if we perceive that the likelihood of local currency government debt being excluded from any debt restructuring has increased. This could be the case if, for example, the government receives significant donor funding, giving it time to implement immediate and transformative reforms.

We would upgrade our long-term foreign currency sovereign credit rating once the government bond restructuring is complete. The rating would reflect Sri Lanka’s creditworthiness after the restructuring. Our post-restructuring ratings tend to be in the “CCC” or “B” low categories, depending on the new sovereign debt structure and its ability to sustain that debt.

Reasoning

Sri Lanka’s external public debt moratorium prevents the payment of interest and principal obligations due on the government’s ISBs. Thus, the interest payments due on June 3, June 28 and July 18 on its ISB maturing in 2024, 2025 and 2026, and the payment of the principal on its ISB of July 25, 2022, would have been affected. As a result of the missed payments, and given that we expect payment will not be made within 30 calendar days of the due date, we have lowered the issue ratings of these bonds to “D” (default).

Overdue payments now include the following bonds:

US$1.0 billion, 5.875% bonds due 2022.

US$1.25 billion, 5.75% bonds due 2023.

US$500 million, 6.35% bonds due 2024.

US$1.5 billion, 6.85% bonds due 2025.

US$650 million, 6.125% bonds due 2025.

US$1.0 billion, 6.825% bonds due 2026.

US$1.5 billion, 6.20% bonds due 2027.

US$1.25 billion, 6.75% bonds due 2028.