The weak credit metrics,
shrinking forex reserves, depreciating exchange rate, rising inflation, higher domestic interest rates, higher debt payments in local currency terms, and a weaker domestic economy weigh on the default risk of the nation and have led to increase in the financing costs of the island nation. The government bond spreads to US Treasuries have widened to more than 1,600bps from ~500bps before the pandemic. The rating could be affirmed if the government demonstrates its capacity to use short-term financing sources as a means to buy time and could be downgraded in a status quo scenario where the financing of Sri Lanka’s large external debt repayments remained uncertain. The rating agency said, “In contrast to the urgency of the situation — and notwithstanding the government’s stated commitment to repay its debt — Moody’s expects a credible and durable financing strategy to only materialize over a number of years.”
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