Fitch Ratings said yesterday it has affirmed Sri Lanka’s Long-Term Foreign- and Local Currency Issuer Default Ratings (IDR) at ‘B+’ and revised the Outlook to Stable from Negative.
The country ceiling and issue ratings on Sri Lanka’s senior unsecured foreign- and local-currency bonds are also affirmed at ‘B+’. The Short-Term Foreign- and Local-Currency IDRs are affirmed at ‘B’. Key rating drivers: Sri Lanka’s ‘B+’ rating balances its weak public finances and strained external liquidity position compared with peers against the steady progress made on the country’s ongoing International Monetary Fund (IMF) supported program, which commenced in June 2016.
The IMF program has eased near-term pressure on the balance of payments. The rating is supported by Sri Lanka’s favourable growth performance as well as its basic human development indicators and governance standards, which are more favourable as compared with some peers.
The Outlook revision reflects the following key rating drivers:
Improving fiscal finances: Fitch estimates that Sri Lanka’s 2016 fiscal performance was better than in 2015, following strong revenue growth that was supported by a Value-Added Tax (VAT) hike. This, along with lower Government spending, should narrow the deficit in 2016 to around -5.6% of GDP, from -7.4% in 2015.
Fitch believes the 2016 VAT hike to 15% from 11% and other revenue reforms announced in the 2017 budget are likely to support further fiscal deficit reductions in 2017, with the agency revising down its 2017 deficit forecast to -4.7% of GDP against its earlier estimate of close to -7%.
The authorities’ 2017 deficit estimate of -4.6% is below the agency’s estimate, as the authorities have higher growth assumptions. However, Fitch expects authorities to lower spending if there is a large revenue shortfall to keep the fiscal deficit under control.
Improved policy coherence and credibility: Sri Lanka’s three-year extended fund facility with the IMF has improved policy coherence and credibility and has eased some near-term balance of payments pressure. Fitch expects the country’s external funding profile to benefit from support by multilateral agencies, although its external liquidity position remains weak compared with peers.
The IMF-supported program sets ambitious fiscal targets and the authorities have made steady progress, meeting their quantitative performance targets for the first review in November 2016. Progress on some structural benchmarks has also been made, including passage of the 2017 Budget in line with program targets.
Stable growth trends: Sri Lanka’s growth performance remains favourable. Fitch estimates the country’s five-year (2012-2016) average real GDP growth at 5.3%, which is stronger than some of its ‘B’ category peers. However, Fitch has revised its 2016 growth estimate to around 4.5%, from 5.3% (forecast at the time of the last review) due to weaker-than-expected 1H16 growth caused by the May 2016 floods.
Furthermore, the Central Bank of Sri Lanka hiked-up interest rates twice in 2016 by a cumulative 100bp, slowing credit growth and private consumption, although this has also improved macro stability.
Sri Lanka’s ‘B+’ IDRs reflect the following key rating drivers:
Relatively high Government debt: Fitch estimates overall gross general Government debt to have reached close to 77% of GDP by end-2016, although it should gradually decline over 2017-2018 due to improving Government revenues. At this level, Government debt remains above the 56% ‘B’ median and 51% ‘BB’ median. Further, foreign-currency debt – which is close to 40% of GDP – weakens Sri Lanka’s fiscal finances, as it increases the risk of higher debt in local currency terms if the rupee depreciates sharply.
Weak external liquidity position: Sri Lanka’s external liquidity position is weakened by low foreign-exchange reserves and high external debt service payments. Measured by Fitch’s external liquidity metric, this ratio is far below the ‘B’ and ‘BB’ median. As per the agency’s estimate, the external liquidity ratio was close to 58% at end-2016, against around 163% for the ‘B’ median and 155% for the ‘BB’ median.
Furthermore, Sri Lanka’s external finances are vulnerable to a sell-off in Treasury bills and bonds by foreign investors, which currently account for nearly 30% of foreign-exchange reserves. Outflows from Treasury bills and bonds in October and November 2016 led to a fall in foreign-exchange reserves, although the reserves improved by around $ 419 m from end-November 2016 to around $ 6 b by end-2016.
Strong human development indicators: Sri Lanka’s basic human development, including education, health and literacy standards, is high compared with the ‘B’ and ‘BB’ median, as indicated by a favourable United Nations Human Development Index score. The country also ranks better than the ‘B’ median on the World Bank’s composite governance indicator score – falling in the 48th percentile against the 31st percentile of the ‘B’ median.
Sovereign rating model and qualitative overlay: Fitch’s proprietary sovereign rating model (SRM) assigns Sri Lanka a score equivalent to a rating of ‘BB-’ on the Long-term Foreign-Currency IDR scale.
Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its qualitative overlay (QO), relative to rated peers, as follows:
Public Finances: -1 notch to reflect Sri Lanka’s weak fiscal position on account of high Government debt and interest payments as a share of Government revenue.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Rating sensitivities: The Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are balanced.
The main factors that, individually or collectively, could trigger positive rating action are:
Continued improvement in public finances underpinned by a credible medium-term fiscal strategy, including a broadening of the government revenue base.
Increase in foreign-exchange reserves supported by smaller current-account deficits and higher non-debt capital inflows.
The main factors that, individually or collectively, could trigger negative rating action are:
Deterioration in policy coherence and credibility, leading to a loss of investor confidence, or a derailment of the International Monetary Fund supported program that leads to external funding stress.
Reversal of fiscal improvements that leads to a failure to stabilise Government debt ratios.
Key assumptions: Global economic assumptions are consistent with Fitch’s latest global economic outlook.