While struggling to overcome ongoing financial crisis, Fitch Rating has downgraded Sri Lanka’s long-term foreign-currency Issuer Default Rating (IDR) from ‘CCC’ to ‘CC’.

The leading credit rating agency has graded the Indian Ocean island nation’s economic situation on the basis that there was an increased probability of default as liquidity injections made to sterilize interventions and enforce a 6 per cent policy rate continue to drain reserves and create forex shortages.

“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 severity of financial stress is illustrated by elevated government-bond yields and downward pressure on the currency,” Fitch Rating stated supporting its view on Lanka.

“Sri Lanka’s foreign-exchange reserves have declined much faster than we expected at our last review, owing to a combination of a higher import bill and foreign-currency intervention by the Central Bank of Sri Lanka. Foreign exchange reserves have declined by about $2 billion since August, falling to $1.6 billion at end-November, equivalent to less than one month of current external payments (CXP). This represents a drop in foreign-currency reserves of about $4 billion since end-2020.

“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. Obligations include two international sovereign bonds of $500 million due in January 2022 and $1 billion due in July 2022. The government also faces foreign-currency debt service payments, including principal and interest, of $6.9 billion in 2022, equivalent to nearly 430 per cent of official gross international reserves as of November 2021. Cumulative foreign-currency debt service, including interest and principal, amounts to about $26 billion from 2022 through to 2026,” the rating agency said as it analysed Sri Lanka’s volatile economic situation.

The Fitch Rating also stated that Sri Lanka would find it hard despite currency swap facilities from India and China.

“A drawdown on the existing currency swap facility with the People’s Bank of China (PBOC) could boost reserves by up to 10 billion yuan ($1.5 billion equivalent). However, even with resources from the swap facility, foreign exchange reserves are likely to remain under pressure, in our view. 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 $400 million, a swap facility with the Qatar Central Bank, remittances securitisation and a revolving credit facility with the Bank of China Limited (A/Stable). However, even if all these sources are secured, we believe it will be challenging for the government to maintain sufficient external liquidity to allow for uninterrupted debt servicing in 2022,” the Fitch Rating opined.

However the Central Bank of Sri Lanka responding to Fitch downgrading said that it was a reckless action by rating agencies continues despite being informed of the imminent inflows as outlined in the Six-month Road Map.

“Investors are advised not to be dissuaded by such action. Progress of inflows will be announced during next week” the Central Bank said.