SL among countries vulnerable to contagion shocks: Moody’s

• Warns prolonged risk aversion and capital outflows will exacerbate weaknesses in sovereign credit profiles
• Concerned borrowing costs will increase for countries with near-term debt repayments such as SL
• Credit metrics such as external vulnerability, debt and debt affordability likely to deteriorate if risk-off environment persists

Moody’s Investors Service yesterday said low-rated emerging market sovereigns with large near-term international bond repayments such as Sri Lanka and significant reliance on foreign currency and private sector credit are particularly vulnerable to the impact of deteriorating economic conditions on capital markets.

Sri Lanka (B2 stable), Pakistan (B3 stable) and Egypt (B2 stable) would see a marked weakening in debt metrics because of large gross borrowing needs that raise interest payments when borrowing costs rise, and narrow revenue bases that push fiscal deficits wider when interest payments rise, the international rating agency said in a new report.

Low-rated EM sovereigns with large international bond maturities over the next few quarters face significant rollover risk. Given local-currency depreciation, a sharp increase in credit spreads, and dysfunctional primary markets for new issuances, unless some risk appetite returns, non-investment grade EM sovereigns will face significant costs refinancing maturing international bonds, the report warned.

While some countries have already secured refinancing for individual bonds, Sri Lanka (B2 stable), Honduras (B1 stable), Turkey (B1 negative) and Tunisia (B2 stable) are in particular susceptible given the size of upcoming international bond redemptions as a share of foreign-exchange reserves.

“The coronavirus outbreak and sharp commodity price declines are triggering significant financial market volatility and risk aversion that few emerging market sovereigns are immune to,” said a Moody’s Assistant Vice President and Analyst Christian Fang.

“Emerging market sovereigns that need to access international bond markets to refinance their foreign-currency debt or that borrow heavily from private sector lenders in foreign currency would currently face prohibitive conditions,” added Fang.

Moreover, policymakers have limited capacity to mitigate capital flight and/or the sharp increase in credit risk premia in foreign currency.

While some countries have already secured refinancing for maturing international bonds, Sri Lanka (B2 stable), Honduras (B1 stable), Turkey (B1 negative) and Tunisia (B2 stable) are susceptible given the size of upcoming international bond redemptions as a share of foreign-exchange reserves.

Non-investment grade sovereigns with a large amount of foreign currency debt owed to private creditors, such as Bahrain (B2 stable), Oman (Ba2 stable) and Angola (B3 stable) are also particularly vulnerable. Access to financing from development partners or waivers on official debt service may mitigate this risk for some, but pressure will remain on exposure to private sector debt.

Should the risk-off environment persist for some time, leading to capital flight, sharp local currency depreciation and higher domestic interest rates, credit metrics are likely to deteriorate significantly for some sovereigns, the report added.

In particular, persistent tightening in financing conditions will increase debt burdens, weaken debt affordability and intensify external vulnerability risk. Under Moody’s stress scenario, Bahrain, Tajikistan (B3 negative), Zambia (Caa2 negative) and Belarus (B3 stable) would face significant external pressure.