Fitch Ratings: IMF Support Offers Hope for Sri Lanka’s Economic Stability, but Debt Negotiations Remain Challenging
Fitch Ratings, based in Hong Kong, has stated on March 10, 2023, that they anticipate Sri Lanka to receive financial assistance from the International Monetary Fund (IMF). The IMF’s Executive Board has set a review date of March 20 for the country’s USD2.9 billion staff-level agreement, signed in September 2022, which provides a positive indication that Sri Lanka will secure financing support from the IMF. Fitch Ratings highlighted that Sri Lanka is facing economic challenges such as high levels of external debt, declining foreign exchange reserves, and slowing economic growth, and that the IMF’s financial support is much-needed to stabilize the macroeconomic environment. However, the funding is subject to Sri Lanka’s implementation of structural reforms and fiscal consolidation measures. The news of potential financial assistance from the IMF is expected to provide some relief to Sri Lanka’s government, which has already taken steps to address the country’s economic situation through policy measures and efforts to attract foreign investment.
The International Monetary Fund’s funding is expected to improve Sri Lanka’s external liquidity, however, the exact timing of any potential debt restructuring agreement with both official and private creditors remains uncertain. The announcement of a date for the Executive Board review signals that the IMF believes the financing assurances it has received from key official creditors are credible enough to proceed. Sri Lanka’s President recently confirmed that China, along with India and Paris Club official creditors, have expressed their support. He also stated that Sri Lanka has completed all the prior actions required under the IMF program, but the ultimate decision to approve the package rests with the IMF Board, which will conduct its own assessment.
Approval of the programme by the Board would enable the release of IMF funding and potentially unlock additional financing from multilateral creditors, which would increase official foreign-exchange reserves. These reserves have already risen by 30% since their low point in October 2022, but they remain low at USD 2.2 billion in February, equivalent to just one month of imports.
The improved external liquidity is expected to contribute to a more stable macroeconomic environment. Since late February 2023, the exchange rate has appreciated, and if this trend continues, it should further curb inflation, which had already moderated in the second half of 2022.
However, Sri Lanka’s economic prospects will likely remain limited until a debt restructuring agreement is reached.
It is currently unclear whether Sri Lanka will be able to strike a deal with its creditors. However, recent developments are viewed as a positive step forward in debt negotiations, as they indicate that official creditors’ financing assurances align with the parameters of the IMF’s programme aimed at achieving sustainable debt levels. Despite this progress, it’s possible that debt restructuring talks may continue for a prolonged period.
The case of Zambia, where the IMF approved a support package in August 2022, but debt restructuring talks are still ongoing, illustrates this risk. Even if official creditors are more cooperative in Sri Lanka’s case, negotiations with private-sector creditors could still pose challenges and add further complications.
Debt negotiations in Sri Lanka are complicated by the issue of whether to include local-currency debt in any restructuring. In December 2022, we downgraded Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to ‘CC’ from ‘CCC’. We believe that a local-currency debt default is likely due to an excessively high domestic interest payment/revenue ratio, significant interest costs, tight domestic financing conditions, and rising local-currency debt/GDP. The authorities have projected high domestic fiscal financing requirements of around 8% of GDP in 2022. If the government announces plans to restructure or defaults on its local-currency debt, the Long-Term Local-Currency IDR would be downgraded further.
Fitch has rated Sri Lanka’s Long-Term Foreign-Currency IDR at ‘RD’. We could move the IDR out of ‘RD’ once the sovereign completes a commercial debt restructuring that we consider has normalized its relationship with the international financial community. Sri Lanka’s post-default ratings will depend on our evaluation of its credit profile. If the parameters of the IMF program allow for a moderate and extended debt reduction process, it could facilitate debt restructuring negotiations but may also weigh on the sovereign’s post-default credit ratings.