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Tuesday, 1 October 2019 01:46 - - {{hitsCtrl.values.hits}}
Finance Ministry
Fitch Ratings yesterday affirmed Sri Lanka at ‘B’; Outlook Stable but said challenges remain as the Budget deficit is forecast at 5.4% in 2019, higher than the Government targeted 4.4%, and warned sustained policy uncertainty due to elections along with negative investor sentiment could impact debt refinancing that is estimated at $ 19 billion till 2023.
Fitch Ratings also affirmed Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘B’ with a Stable Outlook.
Sri Lanka’s ‘B’ rating balances high government debt and contingent liabilities, a challenging external financing profile and subdued economic growth against higher human development standards and per capita income levels compared with peer medians, the rating agency said in its latest report.
The policy environment has improved after the resolution of last year’s political standoff.
The 2019 Budget was passed and the IMF program resumed and was extended by one year to June 2020.
The IMF staff announced recently an agreement on the sixth review of the extended fund facility (EFF).
The currency appreciated by about 3% against the dollar by end-1H19 after weakening by nearly 19% by end-2018.
However, Sri Lanka is entering an election cycle, with the Presidential Elections in November this year followed by Parliamentary Elections in 2020, and the risk of policy slippage and political tensions resurfacing closer to the elections remains high, in Fitch’s view.
Fitch forecasts a budget deficit of 5.4% of GDP in 2019, above the authorities’ target of 4.4%, as weak growth partly reflecting the drop in tourists has adversely affected revenue collection.
The deficit is expected to stabilise at about 5% of GDP in 2020 and 2021 under the baseline assumptions. Downside risks to Fitch’s projections could arise from a shift towards a more expansionary fiscal policy.
“Fitch has revised its growth forecast for 2019 to 2.8% from 3.6% at the time of the previous review in December 2018 because of the negative impact of the April bombings on tourism, which accounts for about 5% of GDP. Growth slowed to 2.6% in 1H19 from 4.2% in 1H18, dragged down by a slowdown in services. However, the recovery in tourism has been faster than our expectations and we anticipate an improvement in growth in 2020 and 2021 to 3.3% and 3.4%, respectively.” Tourist arrivals in August fell about 28% y-o-y after a decline of about 71% in May, according to the latest data from the Central Bank.
Sri Lanka’s near-term external and fiscal financing constraints have eased somewhat after the resumption of the IMF program in February and the issuance of $ 4.4 billion of sovereign bonds to date in 2019. In addition, the sovereign has also repaid $ 1.5 billion in international sovereign bonds. Foreign-exchange reserves rose to $ 8.5 billion after declining to $ 6.9 billion by end-2018. We project foreign-exchange reserve coverage to remain at around three months of current external payments through 2021. Nonetheless, Sri Lanka’s external debt obligations (principal and interest) remain substantial over 2020-2023, with nearly $ 19 billion due, and its external liquidity ratio remains far weaker than peer medians.
A prolonged period of policy uncertainty accompanied by an adverse shift in investor sentiment could exacerbate Sri Lanka’s external refinancing risks.
Monetary policy continues to focus on maintaining macroeconomic stability and inflation has remained subdued so far in 2019, partly a result of the slowdown in growth and lower food and commodity prices. The benign outlook for inflation combined with slowing growth led the Central Bank of Sri Lanka to cut policy rates twice this year by a cumulative 100bp.
A planned amendment to the Monetary Law Act would establish price stability as the primary objective of the central bank and support the shift towards flexible inflation targeting, thereby improving monetary-policy credibility.
“We expect Sri Lanka’s current account deficit to narrow slightly to 3.1% of GDP in 2019 from 3.2% in 2018, as the negative impact from lower tourism earnings has been somewhat offset by a drop in imports. Taxes imposed on a wide range of automobiles led to a contraction in vehicle imports, while gold and rice imports also fell. Sri Lanka’s trade deficit narrowed to $ 4.3 billion in the first seven months from a deficit of $ 6.4 billion a year earlier. We expect the current account deficit to narrow further to about 2.8% of GDP by end-2021 but there are risks to our forecast from a possible shift towards more expansionary fiscal and monetary policies or weaker-than-expected export performance.”
High government debt and large interest payments remain a key credit weakness. Sri Lanka’s gross general government debt (GGGD) was about 83% of GDP at end-2018, far greater than the current ‘B’ median of 56.4%.
Interest payments as a share of revenues were very high at about 44% (current peer median 10.4%), highlighting the relatively weak structure of Sri Lanka’s public finances. In addition, foreign-currency debt is nearly half of total government debt and leaves public finances vulnerable to renewed currency depreciation.
Fitch maintains a negative outlook on Sri Lanka’s banking sector as continued pressure on banks’ financial profiles due to pressure from a challenging operating environment is anticipated.
The trend of rising non-performing loans (NPLs) continued into 2019, with the sector-wide NPL ratio rising to 4.8% by end-June. Credit risks are likely to linger, reflected in an increase in restructured loans across banks. Rescheduled loans reflect situations where the bank takes pre-emptive action to restructure ahead of non-payment by the borrower and are not included in the headline NPL figures.
Banking-sector loans contracted by 0.5% in 1H19 after a 20% increase in 2018. Asset-quality stresses have weakened earnings and added to capitalisation pressures despite the capital injections made ahead of the Basel III implementation. Capital-raising plans could face execution risks as the recent rights issues of some banks have been undersubscribed.
Sri Lanka’s basic human-development indicators, including education standards, are high compared with the ‘B’ median. Furthermore, the country’s per capita income of $ 3,972 (Fitch estimates as of end-2019) is higher than its historic ‘B’ median of $ 3,391. Sri Lanka ranks in the 60th percentile of the UN’s Human Development Index compared with the 35th percentile of the current ‘B’ median.
