Economy over politics

For decades in post-Independent Sri Lanka politics has always held sway over the economy. Crucial policy decisions that needed to be made to develop Sri Lanka’s economy, link it to global value chains and foster growth based on exports and investment were often undermined by political agendas. Unfortunately, it would appear that the latest constitutional deadlock has also resulted in politics and political self-interest taking precedence over economic priorities. 

Over three weeks have lapsed since President Maithripala Sirisena plunged Sri Lanka into a constitutional crisis by appointing MP Mahinda Rajapaksa as the Prime Minister. Despite Parliament rejecting the appointment last week with two votes on a no confidence motion, President Sirisena is yet to accept the decision. Speaker Karu Jayasuriya stated in Parliament that at present he does not recognise a Prime Minister and Cabinet stands dissolved. This also means that the post-26 October Sirisena-Rajapaksa Government also has no legality within Parliament. 

To add to this confusion, Sri Lanka has also not passed a Budget for 2019. Even though Parliament is empowered to make decisions regarding public finances, it is unclear how a Finance Minister unrecognised by Parliament can access money from the consolidated fund for State purposes. Therefore it is unsurprising that international rating agency Moody’s decided on Tuesday to downgrade Sri Lanka’s sovereign rating. This development was feared by many but does not come as a surprise since Moody’s had earlier warned that political instability was a credit negative. 

Moody’s downgraded the Government of Sri Lanka’s foreign currency issuer and senior unsecured ratings to B2 from B1 for a number of reasons. The decision to downgrade the rating to B2 is driven by Moody’s view that ongoing tightening in external and domestic financing conditions and low reserve adequacy, exacerbated most recently by a political crisis which seems likely to have a lasting impact on policy even if ostensibly resolved quickly, have heightened refinancing risks beyond levels anticipated before.    

What this means is that when Sri Lanka needs to go to international capital markets to raise money to repay an estimated $ 3 billion in 2019, it may have to pay a higher interest rate. This could heap additional pressure on the country as Sri Lanka’s debt to GDP ratio is already at about 79%. 

The Central Bank last week outlined its plans to ready $ 1 billion that needs to be repaid in January and said it was confident of gaining enough funds through swaps and other means to repay a second $ 500 million by April. The remaining debt later in the year, however, could require an international sovereign bond, which could be where the ratings downgrade could have the strongest impact. 

In an external environment where the appreciation of the dollar and higher interest rates in the US are seeing an outflow of capital from international markets, a ratings downgrade adds one more concern to those entrusted with managing Sri Lanka’s economy, particularly the Central Bank. 

In an environment where limited reserves are squeezed by both high debt repayment and a need to defend the currency, a balance of payments crisis is always lurking in the background. This snowballing effect, with possible fiscal slippage likely as Sri Lanka heads to elections, could see the public having to tighten belts in the future.