Four years after Sri Lanka’s economic crisis pushed its sovereign credit rating into default territory, Fitch Ratings has upgraded the country’s Long-Term Issuer Default Ratings to ‘B-’ from ‘CCC+’, with a Stable Outlook.
The upgrade reflects improvements in Sri Lanka’s fiscal and external accounts, stronger government revenue, a modest rebuilding of foreign exchange reserves and the implementation of macroeconomic and structural reforms. However, the country remains in speculative-grade territory, with high debt and interest costs, limited reserve buffers and rising external repayment obligations continuing to pose challenges.
Fitch said the upgrade reflects the implementation of macro-stabilisation policies supported by structural reforms, which have reduced external financing risks and provided a degree of resilience against economic shocks.
The latest rating action marks a significant change from April 2022, when Fitch downgraded Sri Lanka to ‘Restricted Default’ as the country’s foreign exchange crisis intensified. The sovereign was subsequently upgraded to ‘CCC+’ in December 2024, with that rating affirmed in October 2025.
The move to ‘B-’ indicates that Fitch now views Sri Lanka’s credit profile as more consistent with a sovereign facing material, although less immediate, default risks. The improved rating could support investor confidence and gradually contribute to better financing conditions for the government and domestic companies, while strengthening the country’s prospects of returning to international bond markets.
However, Fitch’s assessment does not represent a complete recovery in Sri Lanka’s sovereign credit position. The country remains several rating levels below investment grade, while its debt and interest burdens are considerably higher than the median for similarly rated sovereigns.
Sri Lanka’s foreign exchange reserves are also expected to cover less than three months of external payments. External debt repayments are projected to increase significantly after 2028, creating another major test for the country’s post-crisis recovery.
At the centre of the improved rating is Sri Lanka’s stronger fiscal performance. Fitch expects the primary budget surplus to reach 2.6 percent of GDP in 2026, compared with a record 5.4 percent in 2025. The primary balance, which excludes interest payments, is an important indicator of whether government revenue is sufficient to cover non-interest expenditure.
The overall budget deficit is nevertheless projected to widen to 4.1 percent of GDP in 2026 from 2.3 percent in 2025. Fitch attributed part of the increase to reconstruction expenditure following Cyclone Ditwah and targeted energy-support measures.
Government revenue has benefited from tax reforms and a temporary increase in import duties following the release of pent-up demand for imported vehicles. While vehicle-related revenue is expected to moderate, Fitch forecasts government revenue to remain just below 16 percent of GDP over the coming years, with primary surpluses expected to remain above 2 percent as revenue mobilisation and expenditure controls continue.
The Public Financial Management Act provides an additional fiscal anchor by limiting non-interest expenditure to 13 percent of GDP through 2031. Fitch noted, however, that this limit has been exceeded in 2026 due to expenditure associated with cyclone reconstruction.
The agency has also highlighted the possibility of increased fiscal pressures as Sri Lanka approaches the 2029 elections. Maintaining fiscal discipline will remain important as the country seeks to preserve the gains achieved through revenue and expenditure reforms.
Government debt is forecast to decline to 92.9 percent of GDP in 2026 from 96.7 percent in 2025, before falling into the low-80 percent range over the following five years. Despite this projected improvement, Sri Lanka’s debt burden remains significantly above the 54.7 percent median for sovereigns rated in the ‘B’ category.
Interest costs remain another major constraint. Fitch expects Sri Lanka’s interest-to-revenue ratio to decline to 41 percent in 2026 from 45.6 percent in 2025 and a peak of 76.3 percent in 2023. Despite the improvement, the projected ratio remains substantially above the 12.7 percent median for ‘B’-rated sovereigns.
External pressures are also expected to persist. Fitch forecasts the current account to move into a deficit of 1.2 percent of GDP in 2026, following three consecutive years in which Sri Lanka recorded an average surplus of 1.5 percent.
Higher energy prices, including the impact of the US-Iran conflict, have increased the country’s energy import bill and temporarily affected tourism inflows. Higher worker remittances have provided some support, helping cushion the pressure on the external sector.
Sri Lanka’s dependence on imported fuel and fertiliser continues to leave its external position vulnerable to geopolitical developments and global commodity price movements. Fitch expects the current account to return to near balance in 2027 as the energy shock eases.
Continued financing from the International Monetary Fund and other multilateral institutions is expected to support the balance of payments and help Sri Lanka increase gross official reserves to around US$7.7 billion by the end of 2026. Even at that level, reserves would cover approximately 2.9 months of current external payments.
The relatively limited reserve buffer leaves the economy exposed to renewed external shocks. A prolonged increase in oil prices, weaker tourism earnings or a decline in remittances could place renewed pressure on the rupee and external liquidity.
Another significant challenge will emerge as Sri Lanka approaches a period of higher external debt repayments. Fitch expects external debt servicing requirements to increase over the next five years, particularly after 2028. The agency also expects the highest threshold associated with the country’s macro-linked bonds to be triggered, resulting in higher interest and principal payments.
Sri Lanka is considering a return to international bond markets in 2027, while the current IMF Extended Fund Facility is scheduled to conclude in March 2027. The improved sovereign rating provides a stronger basis for a potential market return compared with the previous ‘CCC+’ rating, although borrowing conditions will continue to depend on global financial markets, investor confidence and the sustainability of Sri Lanka’s debt trajectory.
Fitch also noted that a follow-on IMF programme remains possible. Such an arrangement could provide an additional financing backstop while supporting continued economic reforms as external debt repayments increase.
Economic growth is forecast to moderate to 4.1 percent in 2026 from an average of 5 percent over the previous two years, before settling at slightly above 4 percent over the medium term. Fitch said the economy has remained resilient despite the impact of Cyclone Ditwah and the US-Iran conflict, although energy vulnerabilities continue to present downside risks.
Inflation is projected to average 6.3 percent in 2026, compared with negative 0.5 percent in 2025. The increase is expected to be driven by the global energy shock, El Niño conditions and domestic price pressures.
Fitch does not currently expect further monetary policy tightening following the Central Bank’s 100-basis-point increase in its key policy rate to 8.75 percent in May. Inflation is forecast to decline to just below the Central Bank’s 5 percent target in 2027.
The rating agency identified several factors that could support a further sovereign upgrade, including a substantial reduction in government debt and interest costs, stronger economic growth and a large and sustainable increase in foreign exchange reserves.
Conversely, weaker fiscal discipline, declining revenue collection, slower debt reduction or renewed external liquidity pressures could undermine the progress reflected in the latest rating upgrade.
The move to ‘B-’ therefore marks an important stage in Sri Lanka’s post-default recovery, while the country’s ability to sustain fiscal reforms, strengthen reserves, manage debt repayments and maintain economic stability will remain central to its longer-term credit outlook.
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