Fitch Ratings has downgraded Sri Lanka’s Long-Term Local-Currency (LTLC) Issuer Default Rating (IDR) to ‘C’ from ‘CC’. The issue ratings on local-currency bonds have also been downgraded to ‘C’ from ‘CC’. 

The Long-Term Foreign-Currency (LTFC) IDR has been affirmed at ‘RD’ (Restricted Default) and the Country Ceiling at ‘B-’.

The downgrade of Sri Lanka’s LTLC IDR reflects Fitch’s view that a sovereign local-currency debt restructuring process has begun, as parliament approved the government’s domestic debt restructuring plan on 1 July. 

On 4 July, the authorities launched a formal exchange offer to bondholders for those bonds that are eligible for the restructuring.

The debt restructuring announcement outlines a domestic debt optimisation (DDO) strategy, which includes treatment of Sri Lanka’s domestic debt as well as domestically issued foreign-currency debt. 

The key elements of the DDO includ: conversion of CBSL’s T-bills and provisional advances to the government into treasury bonds (T-bonds); exchange of superannuation funds’ T-bonds into longer maturity T-bonds; exchange of outstanding Sri Lanka development bonds (SLDBs), which are US-dollar denominated but governed by local law, into new US dollar or Sri Lankan rupee instruments; and, restructuring of local-law foreign-currency denominated bank loans of the government.

The debt restructuring excludes banks’ holdings of Sri Lankan rupee-denominated treasury securities, but bank holdings of SLDBs will be affected.

In Fitch’s view, the proposed DDO will qualify as a distressed debt exchange (DDE) under its criteria, as it entails a material reduction in terms and is needed to avoid a traditional payment default. 

“We will downgrade the LTLC IDR to ‘RD’ upon closing of the exchange offer and following confirmation that the exchange will be executed,” the rating agency said.

The government plans to complete the exchange within July.