On Friday, S&P Global Ratings raised Sri Lanka’s long- and short-term foreign currency sovereign credit ratings from ‘SD/SD’ (selective default) to ‘CCC+/C’.

The agency also affirmed its ‘CCC+/C’ long- and short-term local currency ratings. The outlook for both long-term foreign and local currency ratings is stable, and the transfer and convertibility assessment remains ‘CCC+’.

S&P Global Ratings stated that the stable outlook reflects a balance between its expectation of Sri Lanka’s continued economic recovery—supported by fiscal reforms and improvements in external conditions—and the country’s high debt levels and heavy interest burden over the next one to two years.

However, the agency warned that it could lower the ratings if signs of renewed funding or liquidity stress appear. Potential triggers for a downgrade include a rapid rise in inflation, an increase in the government’s interest burden, or significantly weaker fiscal performance, which could create funding pressures.

Conversely, S&P noted that it could raise the ratings if economic growth remains robust and fiscal and external improvements become more entrenched, improving the government’s ability to manage its large debt.

The upgrade also reflects Sri Lanka’s recent efforts to restructure its remaining commercial debt, including government-guaranteed SriLankan Airlines (SLA) bonds, following its December 2024 exchange of most Eurobonds. Negotiations on SLA debt began earlier this year, with offers made based on comparability with other external creditors.

S&P added that some lenders could become holdout creditors, which might limit further progress in negotiations. However, this is unlikely to disrupt the overall debt restructuring process due to principles of comparability of treatment and the most-favored creditor clauses in Sri Lanka’s restructured bonds.

The ratings are supported by Sri Lanka’s strong economic recovery, rapid fiscal consolidation and reform under the ongoing IMF program, accumulation of foreign exchange reserves, improvement in its external position, and progress in reducing fiscal risks from state-owned enterprises.

These strengths are offset by the country’s high debt, as much of its high-yield domestic commercial debt was excluded from restructuring, and a very heavy interest burden of about 50% of general government revenue. These structural vulnerabilities will take time to address, especially as external debt servicing is set to increase in 2029.

Overall, the ‘CCC+’ ratings indicate that Sri Lanka’s creditworthiness remains vulnerable and dependent on favorable financial and economic conditions, but the government is not facing a near-term payment crisis.