Sri Lanka's Finance Ministry said creditors, including foreign governments, were free to capitalise any interest payments due to them or opt for payback in Sri Lankan rupees.
Crisis-stricken Sri Lanka has defaulted on its $51 billion external debt after running out of foreign exchange to import desperately needed goods.
"The government is taking the emergency measure only as a last resort in order to prevent further deterioration of the republic's financial position," Sri Lanka's finance ministry said in a statement on Tuesday.
It added that the immediate debt default was to ensure "fair and equitable treatment of all creditors" ahead of an International Monetary Fund (IMF)-assisted recovery programme for the South Asian nation.
"It has come to a point that making debt payments are challenging and impossible. The best action that can be taken is to restructure debt and avoid a hard default," central bank Governor P. Nandalal Weerasinghe told reporters.
The governor said the action was being taken in good faith, emphasising that the country of 22 million people had never defaulted on its debt payments.
"This will be on a temporary basis until we come to an agreement with creditors and with the support of a programme with the IMF," said Weerasinghe, who took office last week amid growing public unrest triggered by the economic crisis.
"We need to focus on essential imports and not have to worry about servicing external debt," he said.
Sri Lanka is grappling with its worst economic downturn since independence, with regular blackouts and acute shortages of food and fuel.
International rating agencies had downgraded Sri Lanka last year, effectively blocking the country from accessing foreign capital markets to raise much-needed loans to finance imports.
Sri Lanka had sought debt relief from India and China, but both countries instead offered more credit lines to buy commodities from them.
The island nation's foreign reserves stood at a paltry $1.93 billion at the end of March, with foreign debt payments of around $4 billion due this year, including a $1 billion international sovereign bond maturing in July.