Sri Lanka faces high risk of default on its local currency bonds as it seeks to reduce debt, key to securing financing from the International Monetary Fund to bring relief to the crisis-hit island.
Fitch Ratings’ ‘CCC’ rating on long-term local currency debt that was confirmed in May ‘reflects a high risk that local currency debt will be included in the debt restructuring,’ wrote Sagarika Chandra, managing director. Hong Kong-based partner, in a statement. . Sri Lanka had $30 billion in external debt and $34 billion in domestic debt at the end of April.
Sri Lanka defaulted on its dollar debt in May for the first time and must strike a restructuring deal with private bondholders and official creditors, including China, Japan and India, to secure the loan. approval of the IMF’s board of directors for a loan of 2.9 billion dollars. The nation is facing a lawsuit in a US court over its debt overhaul proposal, with one of the bondholders, Hamilton Reserve Bank Ltd., accusing Sri Lanka of setting favorable terms for domestic banks.
“There is a big question mark over whether sustainable debt levels can be achieved by simply restructuring the US dollar market and concessional debt,” Kenneth Akintewe, head of Asian sovereign debt at abrdn, told AFP. Singapore. “It can be said that the local currency debt also needs to be restructured in order to reach what the IMF would consider to be sustainable levels.”
The signals from the government are mixed. President Ranil Wickremesinghe said in August that the government was considering including local bonds in the debt restructuring. Meanwhile, Central Bank Governor Nandalal Weerasinghe said he was confident the country’s debt could be made sustainable without domestic debt restructuring.
Sri Lanka is walking a tightrope juggling the need to meet IMF requirements while ensuring that the impact of debt restructuring on the economy is manageable. Fitch warned that “a default on local currency debt could have adverse effects on the Sri Lankan banking sector that would erode the net benefits of such restructuring.”
Officials are working with financial and legal advisers on a debt restructuring strategy and intend to make a presentation to creditors in the coming weeks, the finance ministry said last week.
Imposing a local-currency debt restructuring could also prove difficult, as the ratings firm considers public support for the government to be “weak” and anticipates risks to reforms associated with political instability. An interim budget last week raised tax rates and included reforms to restore the country’s fiscal health and meet IMF demands.
“If there is also a haircut on these bonds, there will be a huge impact on the banking sector,” said Sanath Manatunge, managing director of Commercial Bank of Ceylon PLC, adding that this would also make sovereign bonds vulnerable in restructured dollars.