On 19 September, S&P Global Ratings raised its long- and short-term foreign currency sovereign credit ratings on Sri Lanka to ‘CCC+/C’ from ‘SD/SD’.
The ratings agency also affirmed its ‘CCC+/C’ long- and short-term local currency ratings. The outlook on both the long-term foreign and local currency ratings is stable. The transfer and convertibility assessment remains ‘CCC+’.
The stable outlook reflects a balance between the agency’s expectation of Sri Lanka’s continued economic recovery, supported by fiscal reform and external improvements, and the country’s high debt and heavy interest burden over the next 1-2 years.
The agency could lower the ratings on Sri Lanka if it sees indications of renewed funding and liquidity stresses. Developments that could precede such signs include a rapid rise in inflation, a further rise in the government’s interest burden, or significantly weaker fiscal performance, leading to funding pressures.
The agency could raise the ratings if economic growth continues to be robust and it believes that Sri Lanka’s fiscal and external improvements are more entrenched. This would improve the government’s ability to manage its large debt.
The upgrade reflects Sri Lanka’s recent efforts to complete the restructuring of its remaining commercial debt, including government-guaranteed Sri Lankan Airlines (SLA) bonds, following its December 2024 exchange of most of its Eurobonds.
Negotiations on restructuring the SLA debt began earlier this year, with the airline and government making an offer based on comparability of treatment with other external creditors.
The agency sees a possibility that some lenders could become holdout creditors, making a further resolution in the negotiations unlikely, based on the passage of time.
It also believes this situation is also unlikely to disrupt or unwind the debt restructuring process, given the principles of comparability of treatment and the most-favoured creditor clauses in Sri Lanka’s restructured bonds.
The ratings on Sri Lanka are supported by its strong economic recovery, rapid fiscal consolidation and reform (supported by an ongoing IMF programme), accumulation of foreign exchange reserves, an improving external position, and sustained progress in reducing fiscal risks from its state-owned enterprises (SOE).
These strengths are counterbalanced by the country’s high debt - as most of its high-yielding domestic commercial debt was excluded from the debt restructuring exercise - and a very heavy interest burden of about 50% of general government revenue.
These structural vulnerabilities will take time to unwind, particularly as external debt servicing will start to increase in 2029.
The ‘CCC+’ ratings reflect the agency’s views that Sri Lanka’s creditworthiness is vulnerable and dependent upon favourable financial and economic conditions, but the government does not face a near-term payment crisis.
Institutional and economic profile: Political stability and robust growth underpin improving macroeconomic indicators. Political stability and policy predictability have improved following the strong mandate that the National People’s Power (NPP) party won at the presidential and parliamentary elections in late 2024.
The agency expects sustained growth in the manufacturing and services sectors, which have been recovering steadily following restoration of social stability.
Global trade uncertainty could weigh on the performance of Sri Lanka’s external sector, although reduced tariffs on Sri Lanka’s exports to the US will help to lower business uncertainty.
The ruling NPP secured a supermajority parliament following the 2024 general elections and also controls a majority of local councils following elections in May. This situation is relatively uncommon for Sri Lanka, which has historically been characterised by frequent political factionalism and crossovers.
The agency believes the government’s strong mandate demonstrates improved political stability and policy predictability, despite the NPP’s limited record and lack of governing experience.
It anticipates the government will continue the reform agenda under the IMF programme, particularly in implementing revenue-based budget repair, cost-recovery pricing for utilities, and other structural reform of public financial and debt management.
The government has demonstrated strong commitment to the IMF programme, mostly meeting - although some with delay - quantitative indicators and structural benchmarks, even when it involved politically difficult reform.
Sri Lanka has completed four reviews under the IMF programme, unlocking about $ 1.74 billion in programme funding.
Against this backdrop, the agency expects Sri Lanka’s economic growth to continue its strong recovery this year. Real GDP growth in the second quarter was above expectations at 4.9%, building on strong momentum from 2024.
The economy is performing well across sectors including agriculture, textile and garment manufacturing, and tourism, which were previous economic bright spots before the economic crisis.
However, the agency expects economic momentum to slow in the second half of 2025 as external uncertainties mount. Reduced US reciprocal tariffs on Sri Lankan exports of 20% are unlikely to directly affect export competitiveness, as this rate is consistent with those for regional peers. However, the potential second-order impact on business investment decisions and US final demand is more unpredictable.
The agency forecasts real GDP growth of 4.2% in 2025. Over the next 3-4 years, supply constraints, particularly given chronic under spending in capital expenditure, could keep growth more subdued at about 3.5%.
This would put GDP per capita at $ 4,900 in 2025 and 10-year weighted average per capita real GDP growth at 2.2%. Although growth has improved substantially, it remains below the average of peers with similar income levels.
(S&P Global Ratings)