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Sri Lanka is on track to be downgraded to “SD” by Standard and Poors”

ECONOMYNEXT – Standard and Poor’s (S&P)a ratings agency, downgraded Sri Lanka to “CC” from “CCC” after the country said most external debt payments would be suspended pending restructuring, and said a selective default rating (SD) would likely be awarded once effective the non-payment begins.

The outlook is negative.

Sri Lanka said it would suspend debt repayments from April 12 and invited creditors to negotiations.

“We are likely to lower Sri Lanka’s foreign exchange ratings to ‘SD’ following confirmation of non-payment of interest or principal on any of its foreign currency commercial obligations, including coupon payments on its due international sovereign bonds. on April 18,” the rating agency said.

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Sri Lanka printed 2.1 trillion rupees despite a highly unstable peg regime (flexible exchange rate) or soft peg in the two years to February 2022, pushing inflation to 18.7% in March in addition to creating currency shortages.

The island had been skating on thin ice since 2015, with ‘flexible’ inflation targeting, printing money to create currency crises in 2015/2016 and 2018 sharply increased foreign borrowing after losing the ability to settle maturing debt with inflows.

International sovereign bond borrowings increased from US$5.0 billion to US$14 billion during the period and state-owned Ceylon Petroleum Corporation also borrowed dollars after being banned from buying foreign currency in the market as currency shortages emerged from “flexible” inflation targeting.

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When currency shortages occur due to money printing in a peg (inflationary policy), dollars cannot be “bought” for rupees to pay for imports or debt (inability to transfer real wealth from the domestic credit system linked to the base money from the rupee to the dollar credit system), a phenomenon known as the “transfer problem”.

Currency shortages can only take place in pegs and not in a clean floating regime.

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Sri Lanka was gradually downgraded during “flexible” inflation targeting when instability was triggered by cash rate targeting and output gap targeting (a type of monetary stimulus) .

Economists and analysts have called for a single-peg monetary regime to end instability and a review of central bank law to end monetary impunity and accommodation for fiscal excesses.

In 2019, taxes were cut for fiscal stimulus and bond auctions were crippled by price controls and Treasuries were bought in bulk by the central bank, sending the balance of payments booming again.

“There are currently limited upside scenarios for the ratings,” S&P said.

“Following the completion of any bond restructuring, we will assign new sovereign credit ratings in foreign and local currencies that reflect Sri Lanka’s post-exchange creditworthiness.”

Sri Lanka’s foreign currency rating is downgraded to “CC” from “CCC”; Negative outlook

Insight

Sri Lanka announced the suspension of normal external debt service on April 12, 2022.
• The government has declared that most categories of external public debt will be suspended, pending formal restructuring under a potential IMF-backed program.

• We have downgraded our long-term foreign currency sovereign credit rating on Sri Lanka to “CC” from “CCC” to reflect the virtual certainty of default on certain relevant bonds. We also downgraded our long-term sovereign credit rating in local currency from “CCC” to “CCC-”. At the same time, we confirmed the short-term “C” rating.

• The negative outlook on ratings reflects the high risk for commercial debt repayment in the context of Sri Lanka’s economic, external and fiscal pressures.

Rating Action

SINGAPORE (S&P Global Ratings) April 13, 2022 – S&P Global Ratings today downgraded its long-term sovereign currency rating on Sri Lanka from “CCC” to “CC”. At the same time, we lowered our long-term sovereign rating in local currency from “CCC” to “CCC-”. The outlook on long-term ratings is negative.

In addition, we confirmed our short-term “C” sovereign ratings in foreign and local currencies.

We have also revised down our assessment of the transfer and convertibility from “CCC” to “CC”,

Outlook

The negative ratings outlook reflects the high risk to commercial debt repayment in the context of Sri Lanka’s economic, external and fiscal pressures.

We may downgrade the foreign currency rating to “SD” (selective default) following confirmation that the government has missed a coupon or principal payment on foreign currency commercial debt, including its next coupon payment on April 18 on international sovereign bonds, or upon confirmation of debt. restructuring terms.

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

Ratings upgrade scenarios are currently limited. Upon completion of any bond restructuring, we will issue new sovereign credit ratings in foreign and local currencies that reflect Sri Lanka’s creditworthiness after the swap.

Reasoning

Amid soaring external funding pressures and alongside increasingly widespread social and political protests, the Sri Lankan government announced on April 12 that it would suspend debt servicing on its foreign currency obligations.

Sri Lanka has coupon payments due on April 18 for its 2023 and 2028 international sovereign bonds. We expect the government will not pay these coupons, and have therefore lowered our foreign currency sovereign ratings on Sri Lanka to ” CC “.

The Sri Lankan government said it had approached the IMF for help in setting up an economic recovery program and for emergency financial assistance.

Until a comprehensive debt restructuring plan is formulated, servicing of foreign currency denominated debts will be suspended. Affected debt includes international bonds, bilateral government-to-government credit facilities excluding swap lines with the Central Bank of Sri Lanka (CBSL), credit facilities with commercial banks and institutional lenders, and amounts payable by government or public sector entities on called guarantees. Obligations governed by Sri Lankan law may not be affected.

We are likely to downgrade Sri Lanka’s currency ratings to ‘SD’ upon confirmation of non-payment of interest or principal on any of its foreign currency commercial obligations, including coupon payments on its international sovereign bonds due April 18.

According to published reports, the government intends to continue paying its debts in local currency for the time being. Our sovereign local currency ratings “CCC-/C” of Sri Lanka reflect the continued strong economic and monetary pressures.

While the central bank could technically create Sri Lankan rupees to meet upcoming obligations, this could have significant inflationary implications, with consumer prices already rising at a rapid pace of 17.5% year-on-year in February.

Sri Lanka’s local currency debt also constitutes a considerable part of its overall indebtedness and, therefore, of its very high interest burden relative to income.

Sri Lanka’s debt restructuring process will likely be complicated and could take months. Negotiations with the IMF to establish a reform and financing program are in their early stages.

Sri Lanka has also experienced considerable political uncertainty in recent weeks, marked by the resignation of the entire government cabinet, in addition to the CBSL Governor, in early April, and the ruling coalition’s apparent loss of majority representation. in parliament.

Failure to put in place a sustainable government could further complicate and hamper progress in discussions with the IMF and ultimately delay a debt restructuring plan.