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Sunday Dec 15, 2024
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Moody’s Investors Service yesterday warned the COVID-19 outbreak will exacerbate the Government’s liquidity and external risks and predicted difficulty in managing the widening Budget deficit as well as attracting non-debt foreign earnings to build reserves.
Moody’s has already placed Sri Lanka currently holding a B2 sovereign rating for a review, which will likely result in a downgrade. Its latest report warned Sri Lanka was facing simultaneous domestic and external shocks amid the global coronavirus outbreak.
It acknowledged the Government has taken measures to secure financing from non-market sources for debt repayment, including securing both lending and swap facilities.
“In March, Sri Lanka secured a $ 500 million syndicated loan from China Development Bank (A1 stable), which we expect to increase to around $ 1.2 billion in the current year. The Government has also requested around $ 800 million over the next two years from the IMF under the Rapid Financing Facility, as well as seeking additional funding from the Asian Development Bank (ADB, Aaa stable), the World Bank (IBRD, Aaa stable), the Asian Infrastructure Investment Bank (AIIB, Aaa stable) and Agence Française de Développement.”
The Central Bank of Sri Lanka (CBSL) also has worked on securing swap line arrangements with other central banks that buffer external repayment risks. These include a $ 400 million swap line with the Reserve Bank of India, which has been approved, and a $ 1.5 billion equivalent swap line in renminbi with the People’s Bank of China.
“While such measures do temporarily boost foreign exchange reserves, they are time-bound and represent a liability to the monetary authority. They do not meaningfully increase foreign exchange reserves as do non-debt-creating inflows, such as export receipts or foreign investment, either portfolio or direct.”
Moody’s expects Sri Lanka will reorient some of its external funding to multilateral and bilateral creditors. At this stage, beyond the immediate term, Sri Lanka has not fully secured financing from official sources to cover repayment needs, it warned.
The Government’s external debt servicing payments will be around $ 4 billion to $ 4.5 billion annually over 2020-25, or around $ 25.8 billion in total. This amount includes international sovereign bonds of $ 1 billion each in October and July 2021. It does not account for any further external financing of the budget deficit in coming years. Dollar international sovereign bonds account for $ 8.4 billion, or about 30%, of all maturing external Government debt service payments over 2020-25.
At these levels, Sri Lanka’s bond maturities are among the highest of rated frontier market sovereigns as a proportion of foreign exchange reserves. The low reserve levels highlight the Government’s significant exposure to refinancing risk.
The rating agency also warned Sri Lanka faces multiple challenges from capital outflows, marked local currency depreciation, wider risk premia and a further decline in real GDP growth that will raise Sri Lanka’s debt burden, liquidity constraints and the cost of external debt servicing.
“This comes at a time when Sri Lanka’s credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt service payments and very weak debt affordability,” the report said.
“We expect that the higher cost of debt, lower revenue, and greater expenditure to support the economy will widen the budget deficit to over 8% of GDP in 2020-21. The extent to which the Government can prioritise, or delay, spending to contain deficits is limited, given the authorities’ relatively rigid spending structure.”
Moody’s warned cuts to capital expenditure would further weaken growth and combined with slower nominal GDP growth and a weaker exchange rate, expects the Government’s debt burden to rise close to 100% of GDP over the coming years.
“Debt affordability, already among the weakest of rated sovereigns, will decline further, with interest payments absorbing more than 50% of Government revenue in 2020-21.”
“We expect Sri Lanka’s authorities to face difficulties in managing the country’s twin deficits amid the current turbulent environment. The lack of an effective and credible policy response to arrest a more severe and prolonged deterioration in credit metrics would further dim prospects for reforms that would meaningfully strengthen Sri Lanka’s fiscal and external position. The delay in General Elections could add to this challenge,” it said.
The report also warned that even though the Central Bank has stepped in with policy rate reductions, this will have limited impact given the weaker foreign exchange inflows and Government debt payment requirements.
“The Government has sought multilateral and bilateral external financing which will help to cover imminent repayments. However, the Government’s external debt service payments amount to around $ 4 billion annually over 2020-25, on top of wider budget deficits, which will be partially funded externally.”
Moody’s expects the Government to increasingly tap domestic financing sources; however, refinancing external debt domestically would further weaken the rupee and already thin foreign exchange reserve adequacy.
“We expect the fiscal deficit to increase to over 8% of GDP over the coming years, on weaker Government revenue and greater spending.”
“Amid the currently turbulent environment, we expect that Sri Lanka will face difficulties in managing the country’s twin deficits.”
The rupee has depreciated by around 6% against the dollar since the beginning of March. Concurrently, spreads on Sri Lankan international sovereign bonds over US Treasuries have widened sharply in recent weeks to around 1,600 basis points, indicating significantly impaired market access.
An islandwide curfew and lockdowns in major manufacturing and services activities in some regions of the country since 20 March will slow the domestic economy through weaker consumption and investment.
Particularly for the informal sector, which employs a substantial portion of the population, weak economic activity will hurt households’ incomes and purchasing power. Moody’s expects construction activity, which grew just 1.7% year-on-year in the fourth quarter, to take a major hit amid supply-chain disruption. Tourism and apparel are also expected to be affected.
“Given global travel and activity restrictions and weaker oil prices, we expect to see a decline in overseas remittances of around $ 1.5 billion (about 2% of 2020 forecast GDP). This will weigh on foreign exchange inflows and domestic consumption. We expect economic growth to slow to 1.5% in 2020, with risks tilted sharply to the downside.”
