Mixed score card from Fitch on Lanka’s sovereign

Fitch Ratings has given a mixed view on Sri Lanka’s sovereign in its latest overview.

The rating agency noted that whilst Sri Lanka’s external pressures are easing, the currency exposure was stalling fiscal improvements.

However, acknowledging fiscal consolidation, strong growth, and lower inflation, Fitch has affirmed Sri Lanka’s Foreign Currency and Local Currency ratings at BB- with a stable outlook.  Among key rating drivers listed by Fitch were political stability, policy consistency to deliver sustainable Balance of Payments (BOP), sustained strong growth, and improvements to the investment climate, as well as credible fiscal consolidation to put public debt on a more sustainable path.

Fitch said Sri Lanka’s public finances remain weak, with currency causing sharp General Government Debt rising in 2012. “Policy tightening has eased Balance of Payments (BOP) pressures, but needs to be monitored,” Fitch observed in the “Sri Lanka” section of the Asia Pacific Sovereign Credit Overview Q412.

“Sri Lanka couples limited fiscal flexibility, thanks to its high debt, with an already strongly negative real policy rate, suggesting limited scope for a policy response if a shock occurs,” Fitch added.

The report offers a snapshot sovereign credit profile for each of the 16 countries rated by Fitch in Asia-Pacific. It also accompanies ‘Emerging Asia Sovereign Outlook 2013,’ which focuses on cross-cutting themes affecting sovereign credit across the region.

Under Foreign Currency rating, only India’s outlook is negative and the rest of the countries in Emerging Asia, including Sri Lanka, remaining stable. In local currency, China (AA-) and India (BBB-) outlook is negative and stable for the rest.

Fitch Ratings said that Stable Outlooks dominate for Emerging Asian sovereign ratings.

The gap between the average Foreign Currency Issuer Default Ratings (IDRs) for Emerging Asian sovereigns and for global high-income countries has narrowed to five notches from eight in the wake of the Asian financial crisis in 1998.

“Nine of 11 emerging Asian sovereigns are on Stable Outlook, but stable does not mean static,” said Andrew Colquhoun, Head of Asia-Pacific Sovereigns at Fitch. “The only certainty is that shocks are inevitable. Sovereigns that are building buffers by strengthening their balance sheets and improving their economic fundamentals could see positive rating action – and vice versa.”

The economic outlook for Emerging Asia in 2013 continues to be favourable, with GDP growth likely to be faster than the global emerging market average. Regional growth is forecast to run at 6%-6.5% per year out to 2014, faster than the global emerging-market average of 4.7%. However, forecasts have been revised down over 2012. Export-led slowdowns in a number of economies in H212 demonstrate that final demand from the high-income countries remains important for emerging Asia.

The region’s two giants, China and India, are major exceptions to the Stable Outlook. China’s Local Currency IDR of ‘AA-,’ which is on Negative Outlook, is more likely than not to be downgraded as the country works through the aftermath of the strong credit-led stimulus of 2009-2010, which will see total credit rise to 190% of GDP by end-2012 on Fitch’s estimate from 128% at end-2008. Fitch expects some of this debt to work its way onto the sovereign balance sheet.

China’s Foreign Currency IDR of ‘A+’ on Stable Outlook remains well-supported by an exceptionally strong foreign currency balance sheet and foreign reserves of US$ 3.3 trillion at end-September 2012.

The Negative Outlook on India’s ‘BBB-‘ IDRs reflects Fitch’s view that the country’s medium- to long-term growth potential will gradually deteriorate further if economic reforms are not hastened and the budget deficit is not narrowed. The agency notes recent Government reform initiatives and renewed commitment to fiscal consolidation, but remains cautious that progress may prove difficult ahead of national elections due in 2014.

Emerging Asian sovereigns demonstrated strong potential for accessing markets in 2012. Sri Lanka ‘BB-’/Stable and Mongolia ‘B+’/Stable joined regular issuers Indonesia ‘BBB-‘/Stable and Philippines ‘BB+’/Stable. Ability to access markets is positive in that it diversifies sovereign funding channels.

However, Fitch warns that sovereigns leveraging up amid abundant global liquidity could face difficulty refinancing their debts if and when market conditions shift against them. Sovereign ratings will balance the benefits of funding diversification against a negative impact from rising external and foreign-currency-denominated indebtedness.