International ratings agency Fitch downgraded cash-strapped Sri Lanka on Saturday by one notch to ‘CC’ due to mounting fears of a sovereign default on its $26 billion foreign debt.

The downgrade came a day after Sri Lanka reported a 1.5 per cent contraction in the third quarter of this year, as a foreign exchange crisis wrecked its recovery from the coronavirus pandemic.

Fitch said the downgrade reflected its view of an “increased probability of a default event in coming months”, as Sri Lanka’s foreign reserves slumped to $1.58 billion at the end of November.

“We believe it will be difficult for the government to meet its external debt obligations in 2022 and 2023 in the absence of [the] new external financing sources,” the agency said in a statement.

It noted Sri Lanka had to repay two international sovereign bonds of $500 million in January 2022 and $1 billion in July 2022 with little improvement in capital inflows into the nation of 21 million people.

Foreign-currency debt service payments, including principal and interest, for the next year total $6.9 billion, or the equivalent of nearly 430 per cent of the island’s official gross international reserves as of November 2021.

“Cumulative foreign currency debt service, including interest and principal, amounts to around $26 billion from 2022 through to 2026,” Fitch said.

The island’s tourism-dependent economy was hammered by the pandemic and the authorities responded to falling foreign exchange reserves with a broad import ban, triggering shortages, including food, fuel and medicines.

The crisis has spread to affect manufacturing and services and agriculture has also suffered badly due to a ban on agrochemical imports.

Sri Lanka’s economy had grown 12.3 per cent in the second quarter but a third wave of infections that forced a 41-day curfew saw services and industries heavily affected, the statistics office said on Friday.

Its foreign reserves of $1.58 billion at the end of November compared with $7.5 billion when the government of Gotabaya Rajapaksa took over two years ago.

Supermarkets have rationed staples such as milk powder, sugar, lentils, tinned fish and rice, as commercial banks ran out of dollars to finance imports.

The central bank has been appealing for foreign currency, even loose change people may have after returning from overseas trips, as the government desperately looks for the dollars.

The banking regulator has also warned it will freeze accounts of informal money changers who offer higher prices for hard currency than official exchange rates.

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