Morgan Stanley rates Pak, Ghana sovereign bonds better than SL

Influential global investment bank Morgan Stanley has rated sovereign bonds of Pakistan and Ghana better than Sri Lanka’s for a multitude of adverse factors, making the fiscal future more challenging for the Government. 

In its report on Emerging Market Credit Strategy, Morgan Stanley has emphasised Sri Lanka sovereign is on a tightrope walk.

“Sri Lanka’s leverage is set to rise further, pressuring debt sustainability, but external funding sources should be enough in the near term. We prefer the front end of the curve, and see a lack of catalyst for the long end to rally. We prefer Pakistan and Ghana over Sri Lanka,” Morgan Stanley said. 

It said Sri Lanka spreads are currently trading at over 1,000bp, generally considered a stress threshold in the markets. “The concerns are not unfounded as Sri Lanka faces a heavy external debt-redemption schedule in 2020,” it added.

However, Morgan Stanley thinks the funding sources in the form of the IMF, other bilaterals and multilaterals, China and rollover of bonds/loans in the near term should be enough to meet funding requirements of $7-7.5 billion. 

“Our concerns are more related to the fiscal side, where the sovereign faces a low growth, high deficit backdrop. Furthermore, running the debt-sustainability analysis indicates that the recent FX depreciation is also putting pressure on the solvency metrics,” Morgan Stanley opined.

As such, it said, a rebound in growth and for the tourism sector or an IMF program would be needed to allay those concerns.

From a strategy standpoint, Morgan Stanley said tying up of external financing should primarily benefit the front end of the SRILAN curve. 

“For the long end to rally, we need to see credit improvements. We also discuss the risk/reward for the long end, where we see upside capped at around eight to 10 points, but considering where distressed credits trade the downside could be larger in a tail risk scenario. We prefer Pakistan over Sri Lanka in the Asian context, and Ghana over Sri Lanka in the global context. We also put on a sell SRILAN 30, buy GHANA 30 trade,” Morgan Stanley said in its report. 

On Friday, Fitch Ratings downgraded Sri Lanka’s sovereign rating, predicting the economic shock from COVID-19 would further erode rising public and external debt sustainability. Accordingly the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) have been changed to ‘B-’ from ‘B’. The Outlook is Negative.

Fitch said Sri Lanka’s external financing challenges had increased in the current environment of global risk aversion and financial market volatility, with large upcoming external debt redemptions and limited foreign-currency (FX) reserves.

Sri Lanka’s reserves are about $ 7.2 billion, but the country’s external debt payments from May to December 2020 amount to $ 3.2 billion, including a $ 1 billion international sovereign bond payment due in October. Fitch estimates Sri Lanka’s external liquidity ratio, defined as liquid external assets/external liabilities, at about 64%, among the weakest in the ‘B’ rating category.

Fitch observed general Government debt was high and the pandemic had increased risks to public debt sustainability. The rating agency’s baseline forecast is for gross general Government debt/GDP to rise to about 94% in 2020 and 96% in 2021, from an estimated 87% in 2019, and to continue rising, increasing the risk of debt distress. This will see gross general Government debt stay far greater than the ‘B’ median of 52%.

Fitch forecasts GDP to contract to 1.0% in 2020, from 2.3% growth in 2019, on account of the pandemic. Sri Lanka has so far recorded a relatively small number of coronavirus cases, and authorities have begun to loosen lockdown restrictions.