Political Risks Still Challenge Sri Lanka’s Emergence From Default, Says Fitch

Political risks pose a major challenge to cash-strapped Sri Lanka's emergence from debt default, New York-based credit ratings agency Fitch said on Thursday, even as it welcomed the successful formation of a new government under President Ranil Wickremesinghe. 

Last week, Sri Lanka’s Parliament elected six-time Prime Minister Ranil Wickremesinghe as Gotabaya Rajapaksa's successor, who resigned after fleeing to the Maldives and then to Singapore. 

"The new president was confirmed by a large majority in parliament, and his government has drawn in some opposition members. This gives some hope that it will have sufficient support to negotiate and carry out difficult reforms as part of efforts to restore macroeconomic stability and debt sustainability,"  Fitch said in a statement. 

The credit ratings agency said having a stable government could help Sri Lanka unlock funding support from the IMF. 

The Washington-based lender on Wednesday said the newly-elected Sri Lankan government must begin debt restructuring talks with its creditors, including China, before it can hope of getting the bailout package sanctioned. 

"Sri Lanka needs to reach a debt restructuring agreement with creditors, including China before an agreement can be reached between the IMF and the Sri Lankan Government," International Monetary Fund Chief Economist Pierre-Olivier Gourinchas said. 

Fitch said that while the Sri Lankan government’s parliamentary position appears strong, public support remains weaker, as the Parliament and the government remain dominated by politicians from the Sri Lanka People’s Freedom Alliance, which is closely affiliated with the Rajapaksa family. 

"This may increase the risk of further destabilising protests if economic conditions do not improve and/or reforms generate public opposition," it said. 

Sri Lanka is in the midst of the worst economic crisis since 1948 that has led to a debilitating political crisis in Sri Lanka where Rajapaksa was forced out of power due to his poor handling of the economy. 

"We expect any reform package agreed with the IMF by the government to include elements such as higher taxes, expenditure rationalisation and a commitment to a greater degree of exchange-rate flexibility," Fitch said. 

"There is a significant risk that such reforms could cause public opposition that might impede their implementation. In the absence of an IMF deal, we expect Sri Lanka to face a very strained external position in the near term," it stated. 

A massive protest on July 13 attempted to break into the parliamentary complex in continuation with the July 9 popular uprising, forcing Rajapaksa to leave the country to the Maldives and then to Singapore. 

On July 9, anti-government protesters occupied the official residence of Rajapaksa and the private home of Wickremesinghe. 

The mob also torched the private residence of Wickremesinghe. 

In a statement on June 30, Fitch noted that it assessed Sri Lanka’s public debt as unsustainable and confirmed that it would require adequate financing assurances from Sri Lanka’s creditors so that debt sustainability would be restored. 

"The country has little foreign exchange to pay even for essential imports such as fuel, food and medicines, with official reserve assets at just $1.9 billion (just over one month of imports) as of end-June," it said. 

Debt negotiations could be complicated by debt owed to China. 

This amounted to $5 billion at end-2020, including bilateral official lending and loans from the China Development Bank and Export-Import Bank of China, accounting for around 13 per cent of Sri Lanka’s external debt, according to the IMF. 

China has traditionally preferred to offer relief for large loans through deferrals such as maturity extensions, payment rescheduling or grace periods, rather than through write-downs, Fitch said. 

However, this approach could increase challenges for Sri Lanka to successfully negotiate debt restructuring with other creditors, including private creditors, that delivers the debt sustainability sought by the IMF, it explained.