S&P Global Ratings affirmed its long- and short-term foreign and local currency sovereign credit ratings on Sri Lanka at ‘CCC+/C’. The outlook on the long-term foreign and local currency ratings is stable. We have revised the transfer and convertibility assessment to ‘B-’ from ‘CCC+’. 

The stable outlook reflects our expectations that the conditions allowing for continued economic growth and fiscal repair in Sri Lanka will persist over the next six to 12 months. We expect improvements in fiscal indicators even as economic growth decelerates and current account deficits return. Risks to external demand, inflation, and financing conditions are significant. Hence, we do not expect material improvements to sovereign credit support over this period. 

We could lower the ratings on Sri Lanka if we see indications of renewed risks of funding and liquidity stresses. Developments that could precede such signs include significantly weaker external or fiscal performances, leading to funding pressures.

We could raise the ratings if we believe that economic growth will continue and will help to drive further improvements in Sri Lanka’s external and fiscal metrics. This would allow the Government to accumulate more credit buffers and improve its ability to manage its repayment needs. 

Sri Lankan Government debt levels are high. The general government interest burden, at about 45% of revenue, is also heavy. We also see a temporary weakening of Sri Lanka’s external and fiscal balances due to recent exogenous shocks, including Cyclone Ditwah in late 2025 and war in the Middle East.

We believe official financing should continue to help the Government to meet its financing needs, and the country’s economic recovery and structural reform efforts to anchor fiscal and external improvements should remain intact.

Higher energy and input costs could dampen Sri Lanka’s economic growth in the next few quarters as the Middle East war continues to disrupt energy and stockfeed supply chains. Disruption to flights and economic activities in that region could also reduce tourism earnings and remittances.

We expect the impact of exogenous shocks, particularly the Middle East war and Cyclone Ditwah, to be temporary. In both cases, the Government’s policy responses have contained economic damage. For instance, the Government’s post-cyclone emergency relief helped to restore key transport connectivity to the most-affected regions, even though substantial reconstruction work remains. The timely disbursement of assistance and cash transfers to vulnerable groups supported consumption.

We forecast net general government (GG) debt, including state-owned enterprise (SOE) guarantees, will be about 92% of GDP for 2026. Given the economy’s strong performance and the appreciation of the Sri Lankan Rupee from the 2023 level, it is likely that the upside threshold in Sri Lanka’s macro-linked bonds (MLBs) will be breached. This would trigger higher coupon payouts of 1.75%-2% over 2029-2032 and higher principal payouts of 17%-22%, depending on the bond series.

We expect net GG debt to decline to about 83% in 2029. In addition to the higher principal payout from the MLBs, we have added the Chinese renminbi (RMB) 10 billion currency swap with the Chinese central bank to government debt data. Sri Lankan banks also purchase substantial quantities of government debt, with aggregate exposure significantly exceeding 20% of system assets.

While the fiscal outlook is more benign, Sri Lanka’s external outlook is becoming more challenging due to the rapidly rising import bill and continuing uncertainties posed by the Middle East war. Fuel imports rose more than 100% year on year in rupee terms in April and May and the currency has depreciated around 8% against the US Dollar in the first half of the year. This has eroded external buffers.

We do not expect the deterioration in the external position to be significant. This is due to the Government’s actions to stabilise the currency, including raising the policy rate by 100 bps in May, shortening the export proceeds conversion timeframe, and allowing the currency to act as a shock absorber to avoid draining reserves excessively.

We expect the current account to flip to a deficit of 1.7% of GDP in 2026. Gross external financing needs as a share of current account receipts and usable reserves will widen to around 110% this year from 104% in 2025 before improving to 106% by 2029. This still compares favourably with the precrisis average of more than 120%. We expect external debt net of public and financial sector external assets to average 103% of current account receipts from 2026-2029.

S&P Global