Colombo City
2025 growth seen at 4.2%; revenue on track for 15% of GDP and primary surplus
Net Govt. debt 101% of GDP in 2025, easing to 93% by 2028; interest about 51% of Govt. revenue this year
Macro-linked bonds likely to hit upside triggers, lifting coupons 1.75%-2% and principal 17%-22% in 2029-32
Holdout possible on SriLankan Airlines debt, but S&P sees low risk to overall debt restructuring
S&P Global Ratings yesterday raised its long- and short-term foreign currency sovereign credit ratings on Sri Lanka to ‘CCC+/C’ from ‘SD/SD’. It 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+’.
S&P said that while Sri Lanka has been actively negotiating with creditors on remaining commercial debt still in default, including SriLankan Airlines’ Government-guaranteed bonds, it believed that, based on the passage of time, further resolution was unlikely under current circumstances.
It noted that Sri Lanka’s economy had recovered steadily from its 2022 economic crisis, with some macroeconomic indicators already surpassing pre-crisis levels. However, its debt burden remains high even after the restructuring of most of its external debt.
“We therefore raised our foreign currency sovereign credit ratings on Sri Lanka to ‘CCC+/C’ from ‘SD/SD’ (selective default) to better reflect our forward-looking opinion of Sri Lanka’s creditworthiness. At the same time, we affirmed the ‘CCC+/C’ local currency ratings. The outlook on the ratings is stable,” the ratings agency said.
“The stable outlook reflects a balance between our 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 one to two years,” it said.
S&P said it could lower Sri Lanka’s ratings if signs of renewed funding and liquidity stress emerge. Triggers could include a rapid rise in inflation, a further increase in the Government’s interest burden, or materially weaker fiscal outcomes that create funding pressure.
The agency said an upgrade is possible if robust economic growth persists and fiscal and external improvements become more entrenched, strengthening the Government’s capacity to manage its large debt stock.
S&P explained that the latest upgrade reflects Sri Lanka’s efforts to complete the restructuring of remaining commercial debt, including Government-guaranteed SriLankan Airlines bonds, following the December 2024 exchange of most Eurobonds.
Talks on the airline’s debt began earlier this year with an offer grounded in comparability of treatment with other external creditors.
The agency sees a possibility of some holdout creditors that could make further resolution unlikely as time passes, but does not expect this to derail or reverse the overall restructuring because of comparability-of-treatment principles and most-favoured creditor clauses in the restructured bonds.
According to S&P, the rating is supported by a strong economic recovery, rapid fiscal consolidation and reform under an IMF program, a rebuild in foreign exchange reserves, an improving external position, and ongoing progress in reducing fiscal risks from State-owned enterprises.
Offsetting factors include a high debt burden, since most high-yielding domestic commercial debt was excluded from the restructuring, and a very heavy interest bill of about half of general Government revenue.
These structural weaknesses will take time to ease, particularly with external debt service set to rise from 2029. The CCC+ rating thus reflects vulnerability to financial and economic conditions, even though S&P does not see a near-term payment crisis.
On the institutional and economic backdrop, S&P said political stability and policy predictability have improved after the National People’s Power party won the presidency and a parliamentary supermajority in late 2024 and secured control of most local councils in May.
It expects continued growth in manufacturing and services as social stability has been restored. Global trade uncertainty could weigh on the external sector, although lower tariffs on Sri Lankan exports to the United States should reduce business uncertainty.
S&P anticipates growth will remain strong this year. Real GDP expanded by 4.9% in the second quarter, beating expectations and extending 2024’s momentum, with agriculture, textiles and garments, and tourism performing well. The agency expects momentum to slow in the second half of 2025 amid external uncertainties.
It forecasts real GDP growth of 4.2% in 2025 and about 3.5% on average over the following three to four years because of supply constraints linked to chronically low capital spending. That profile implies GDP per capita of about $ 4,900 in 2025 and a 10-year weighted average per-capita real growth rate of 2.2%, still below peers at similar income levels.
Given stronger economic performance and a firmer rupee, S&P said Sri Lanka is likely to breach the upside threshold in its macro-linked bonds. That would lift coupons by 1.75%-2% in 2029-2032 and raise principal payouts to 17%-22%, depending on the series.
On fiscal performance, the agency said the lifting of vehicle import restrictions has driven a surge in customs receipts. After revenue-to-GDP fell below 9% in 2021 and 2022, collections rose 26.5% year on year in the first seven months of 2025.
Revenue is on track to reach the 15%-of-GDP budget target, implying a primary surplus this year and a narrowing overall deficit to 5.4%, with further improvement to 4.5% by 2028. It expects the change in net general Government debt to average 5.3% over 2025-2028, including higher macro-linked bond payouts.
The stronger outturn reflects sustained reform under the IMF program, including changes to personal and corporate income tax rates, a higher VAT registration threshold, removal of sector-specific income tax exemptions, a higher withholding tax rate, and new taxes on digital services and services exports.
S&P cautioned that this year’s boost from pent-up vehicle demand may not repeat and said further measures such as repealing the simplified VAT system and introducing a property tax could help lock in gains.
Citing Treasury data, S&P noted that external debt restructuring yields an upfront reduction of $ 3.7 billion on $ 12.55 billion of international sovereign bonds and a 33% coupon cut in the macro-linked bond baseline, alongside about $ 8 billion of relief agreed by official creditors.
Because most domestic commercial debt was excluded, overall public debt remains high. S&P projects net general Government debt including SOE guarantees at about 101% of GDP in 2025, easing to roughly 93.4% by 2028.
Banks hold large amounts of Government paper, with exposure exceeding 20% of system assets. Interest costs are expected to reach 51% of revenue in 2025 and to average about 47% over 2025-2028.
Externally, S&P said the current account has been in surplus since 2023 and has stayed positive in the first seven months of this year even after vehicle import restrictions were lifted, supported by strong remittances.
Tourism has rebounded with arrivals exceeding pre-pandemic levels. These trends, together with IMF and other multilateral inflows, steady foreign direct investment even during the crisis, a stronger rupee, and lower external debt service, have enabled reserve rebuilding.
The agency expects gross external financing needs to average 107% of current account receipts and usable reserves over 2025-2028, better than the pre-crisis average above 120%, and sees external debt net of public and financial sector external assets averaging 118% of current account receipts versus more than 130% before the crisis.
S&P said inflation has been subdued since late 2023, with headline CCPI turning negative from September 2024 and then ticking up by 1.2% in August 2024. Lower price pressures should give the central bank room to keep policy rates in check and allow a gradual refinancing of high-yield crisis-era debt with cheaper instruments.
Although monetary settings remain a credit weakness, the agency expects policy credibility to improve with a longer record of autonomy following the 2023 Central Bank Act. It also noted that most foreign exchange restrictions imposed during the crisis have been removed and the remaining minor measures are likely to be phased out over the next two years.