With Sri Lanka having completed its debt restructuring, all eyes are set on what will come next for the nation as it prepares for the development that it missed out on in the last two years and for repayment of debt by 2028.
The Government is yet to give a clear policy direction on how it will take the country forward in the next five years.
Nevertheless, questions remain regarding whether the Government can borrow now that it has completed debt restructuring, plans for the post-restructuring period, and the status of newly issued dollar bonds of the Government.
SL bonds are still junk bonds
Speaking during a televised interview, Committee on Public Finance (COPF) Chairman Dr. Harsha de Silva said that although Sri Lanka had completed debt restructuring, the country had not gained a significant amount of respect from the international financial market.
The newly issued dollar bonds are given a ‘CCC+’ credit rating, which is still considered junk bonds. Dr. de Silva stated that Sri Lanka should obtain a ‘BBB+’ rating to borrow cheaply from the financial market.
He added that if the Government continued the current economic reforms, Sri Lanka could achieve a ‘BBB+’ rating by the end of 2026 or 2027.
“It is good that we came out of Restricted Default (RD) status, but we have more work to do in order for the market to accept us,” Dr. de Silva noted.
Moreover, he said that although Fitch and Moody’s had upgraded Sri Lanka’s credit rating, S&P Global had not upgraded the country due to the default on the SriLankan Airlines bonds.
“Therefore, S&P Global revealed that we are still at default as a country since we have defaulted on the $ 175 million bond of SriLankan Airlines,” Dr. de Silva said.
In a statement, S&P Global stated that it would raise the long-term foreign currency sovereign credit rating once Sri Lanka completed the restructuring of its remaining foreign currency-denominated commercial debt, including the Government-guaranteed bond that SriLankan Airlines had issued.
“The rating would reflect Sri Lanka’s creditworthiness post-restructuring,” it added.
S&P Global said that it would retain the long-term foreign currency rating on Sri Lanka at Selective Default (SD).
The stable outlook on the long-term local currency rating reflects the balance of improvements to Sri Lanka’s debt profile achieved through its domestic and external restructuring exercises against continued risk to the Government’s fiscal sustainability from ongoing economic, external, and fiscal pressures over the next 12 months.
“We could raise the long-term local currency rating on Sri Lanka if we perceive that the sustainability of the Government’s large local currency debt stock has improved further,” it commented.
Dr. de Silva pointed out that the current Government did not have a development plan other than the policies of the International Monetary Fund (IMF), which were only set to stabilise the economy, adding that there should be policies in place to grow the economy beyond the IMF programme.
SL needs ‘B’ rating to borrow at low cost
Speaking to The Sunday Morning, University of Colombo (UOC) Department of Economics Professor in Economics Priyanga Dunusinghe revealed that Sri Lanka could now commence borrowing as it had completed the debt restructuring. However, the country cannot borrow at the current level of credit rating as the interest rate will be higher due to the risk premium attached.
He added that the risk premium attached to dollar bonds was high when the credit rating remained low.
Therefore, Prof. Dunusinghe noted that Sri Lanka needed to improve its credit rating to make sure that the country received a rating that was bearable in the long run when it came to debt repayment.
“If we get to ‘B+,’ we will be able to borrow at a lower interest rate,” he said, noting that Sri Lanka should move one notch up to attain a ‘B’ rating and a ‘B-’ rating from both Fitch and Moody’s, respectively.
Moreover, he said that S&P’s decision to retain Sri Lanka at default status was a temporary one, since it technically had limitations in upgrading the rating as the SriLankan Airlines bond was being restructured.
However, he noted that on the whole, even S&P agreed that Sri Lanka’s credit rating should improve.
A restrictive credit market in future
Prof. Dunusinghe said that the extent to which Sri Lanka would be able to upgrade its credit rating in future would depend on the Government’s economic reforms and how it was planning to enhance its revenue position.
He noted that Sri Lanka would need to look beyond the IMF revenue target of 15% of Gross Domestic Product (GDP) in the years to come as there was a high possibility for the global credit markets to become restrictive in terms of lending.
He said that the credit market was expected to have low liquidity and high interest rates in the next decade when compared to the 2010 decade, when major economies pumped in a lot of money following the 2008 financial crisis, leading to higher liquidity with low interest rates.
“This is one of the reasons why many poor countries have got into debt pacts, having borrowed heavily at a lower cost,” he said.
Given this context, Prof. Dunusinghe said that Sri Lanka must introduce drastic economic reforms in order to enhance its economic performance as well as its financial position, which would in turn improve the country’s credit rating, enabling it to borrow at a low cost.
He noted that lower liquidity in the credit market was expected in the years to come due to the heavy accumulation of debt by major economies that was expected over the next few years.
According to the Institute of International Finance (IIF), the world’s debt stock surged by over $ 12 trillion in the first three quarters of 2024 to a fresh record of nearly $ 323 trillion, accompanied by falling borrowing costs and rising risk appetite.
It notes that large government budget deficits suggest that sovereign debt could rise by a third by 2028 to approach $ 130 trillion, increasing repayment risks worldwide.
“Rising trade tensions and supply chain disruptions threaten global economic growth, increasing the likelihood of mini-boom-bust cycles in sovereign debt markets as inflationary pressures resurface and public finances tighten,” it notes in its report, adding that the increased interest cost as a result could “exacerbate fiscal strains” and make debt management increasingly difficult.
The IIF points out that debt in emerging markets approached a record $ 105 trillion in 2024 – a whopping 245% of GDP with debt service costs rising everywhere at the fastest clip in the developed world.
Moreover, it notes that fully meeting global emissions reduction targets could add an extra $ 38 trillion to global debt by 2028.
“With significant amortisations due in 2025 and 2026, particularly in emerging markets, rising volatility could leave some sovereigns vulnerable to sudden shifts in investor sentiment, underscoring the risk of liquidity crises,” the IIF notes.
Foreign financing depends on secondary yields
Speaking to The Sunday Morning, Verité Research Lead Economist Anushan Kapilan said that access to foreign financing would depend on the secondary market yield, where the Government could approach the market and issue bonds only if the yield rates were much lower, as the latter rates had reached around 25% at the height of the crisis.
He said that currently the yield rates were much lower and under 6% due to the low risk involved.
When asked about access to bilateral funding, he said that it was unclear whether bilateral debt restructuring had been finalised, although it was in the last stages, as priority had been given to completing the commercial debt restructure.
However, he noted that some countries such as India and China had lent to Sri Lanka even during the debt restructuring through grants and humanitarian assistance, although not every country would lend in such a manner.
Kapilan added that once the completion of bilateral debt restructure was officially announced, it would open the possibility of new bilateral lending to Sri Lanka.
SL growth was driven by debt, construction
In an interview conducted by the independent think tank Advocata Institute, its Academic Chair Dr. Sarath Rajapatirana said that Sri Lanka’s economic growth in the past, especially during the postwar period after 2010, had mainly been driven by debt and the construction sector instead of being based on total factor productivity.
According to him, when it comes to the economic growth of a country, there are periods of higher growth and lower growth.
“Higher growth was recorded when the Government stepped out to allow the private sector to do its thing and lower growth was recorded when there was too much interference,” he explained.
He pointed out that when public servants were asked to select the areas of investment, they were unable to fulfil the task well, noting that if public servants were not held responsible for investment decisions, then it was impossible to have an efficient government, high productivity, or higher growth.
Dr. Rajapatirana said that empirical evidence showed that countries that had undergone rapid growth had total factor productivity while countries that had adopted new technologies had high productivity.
Largest contribution to DDO from banks
In a presentation at a staff meeting held with senior officials of the Ministry of Finance, Planning, and Economic Development on Wednesday (1), Treasury Secretary Mahinda Siriwardana said that debt service reduction through debt restructuring during the 2022-’27 period should close external financing gaps of $ 16.9 billion.
He said that through external debt restructuring and restructuring of official bilateral debt, International Sovereign Bonds (ISBs), and other external commercial debt, Sri Lanka expected to reduce Gross Financing Needs (GFN) by 2.6% of GDP.
Meanwhile, through the restructuring of Treasury bills and Provisional Advances of the CBSL, Sri Lanka Development Bonds (SLDBs) held by banks, and foreign currency obligations of State-owned banks, GFN has been reduced by 1% of GDP.
He further noted that through Domestic Debt Optimisation (DDO) and restructuring of bonds held by superannuation funds including the Employees’ Provident Fund (EPF), GFN had been reduced to 0.5%, bringing the overall GFN reduction to 4.1% of GDP, so that annual GFN could be below 13% of GDP between 2027 and 2032.
Moreover, Siriwardana said that the State banks had also contributed through the restructuring of Ceylon Petroleum Corporation (CPC) loans amounting to $ 2.43 billion.
“Therefore, the banking sector (including the CBSL) made the largest contribution to the debt relief provided by domestic creditors in the DDO,” he said.
SL has completed bilateral debt deals
Siriwardana noted that Sri Lanka had negotiated the restructuring of official debt with the 17 members of the Official Creditor Committee (OCC, co-chaired by Japan, India, and France) and the Export-Import (Exim) Bank of China, pointing out that the official creditors provided debt relief through maturity extensions, capital grace periods, and interest rate reductions.
He added that following over a year of negotiations, the Memorandum of Understanding (MOU) with the OCC and the debt treatment agreement with the Exim Bank of China was signed on 24 June 2024, where Sri Lanka received capital grace periods until 2028, reduced interest, and progressive amortisation with final repayments in 2043.
Furthermore, he said that Sri Lanka had concluded the restructuring and required settlements of China Development Bank (CDB) liabilities on 24 December 2024, with all large outstanding external debt having been successfully restructured.
He added that the remaining smaller commercial debts (HSBC/ICBC, etc.) were in the advanced stages of finalisation, while restructuring agreements with smaller bilateral creditors outside of the OCC (Kuwait, Saudi Arabia, Iran, and Pakistan) were also being finalised.
“Beyond the Central Government debt, the $ 175 million bond issued by SriLankan Airlines is also expected to be restructured,” he said.
Using next decade to build external, fiscal buffers
Siriwardana observed that Sri Lanka must use the next 10 years to build up its external and fiscal buffers to meet future debt service obligations as the IMF-supported reform programme was designed to end by 2028.
He said that by 2028, Government revenue-to-GDP should reach 15.4% while gross international reserves reached $ 15.1 billion.
“If these targets are maintained, Sri Lanka will be able to meet its post-restructuring debt obligations with a degree of comfort,” he said.
Moreover, he said that the IMF-supported programme was designed to restore fiscal, monetary, and external stability, adding that Sri Lanka had thus far overperformed in many of the expected macroeconomic outcomes.
He noted that as long as the country adhered to the reform path, by 2028, Sri Lanka would have the required buffers to comfortably meet the post-restructuring debt service obligations as payments gradually increased.
Further, Siriwardana said that in order to ensure the continued growth of external buffers, it was essential that economic growth was driven by non-debt-creating inflows, such as the export of goods, the export of services, and Foreign Direct Investments (FDIs).
He added that Sri Lanka should expand access to export markets through strategic trade agreements, enabling integration with global value chains and improving supply capacity by addressing impediments to factor markets in terms of land, labour, and capital.
The Treasury Secretary also added that digitisation of the economy enhanced productivity and that the focus should be on productive, globally competitive, tradable sectors, regardless of whether that sector was in agriculture, manufacturing, or services.
He further noted that institutional reforms were needed in areas such as investment facilitation and promotion, trade negotiation, and productivity enhancement.
“Improved governance with strong institutions, whilst addressing corruption vulnerabilities, is essential to complement this envisaged development,” he added.
Maintaining macroeconomic discipline
Finally, Siriwardana said that while the overall restructuring provided the country with significant debt relief and fiscal space, it was up to Sri Lanka to ensure that it adhered to basic macroeconomic discipline that would enable it to sustain revenue targets and foreign exchange reserve targets.
“As long as Sri Lanka maintains such macroeconomic discipline, the debt relief provided by the restructuring will ensure debt sustainability,” he said, adding that it required extremely cautious and prudent management of the macroeconomy, going forward, without resorting to ad hoc policies and making serious policy mistakes as experienced during the end-2019/early-2022 period.