Moody’s says recent revenue measures not adequate to improve SL’s credit profile

• Says Sri Lanka’s narrow revenue base and high debt burden are credit constraints
• Politically- and economically-achievable fiscal consolidation won’t be large enough to significantly alter fiscal strength
• Cautions on crystallization of contingent liabilities of SOEs that could add significant fiscal costs

Despite the recent measures towards strengthening the fiscal front, Moody’s Investors Service is of the opinion that such action would not drastically alter Sri Lanka’s fiscal strength and thereby improve the country’s credit profile.
Moody’s maintains a B1 rating with a ‘Negative’ outlook on Sri Lanka. The ‘Negative’ outlook was assigned in June 2016 over expectations of further weakening in government finances and a potential shortfall in the effectiveness in fiscal reforms.“Sri Lanka’s narrow revenue base and high debt burden are credit constraints. 

Whilst the government is implementing a number of measures, we do not think that politically- and economically-achievable fiscal consolidation will be large enough to significantly alter the sovereign’s fiscal strength,” Moody’s said in an issuer in-depth report released this week. 

As part of its three-year International Monetary Fund (IMF) Extended Fund Facility programme, the government aims to achieve fiscal consolidation through revenue measures.

To this end, the value-added tax (VAT) was increased from 11 percent to 15 percent and the new Inland Revenue Act (IRA) was introduced to broaden the tax base and simplify the tax administration. It is scheduled for implementation in April 2018. 

Under the IMF programme, the government expects to reduce the fiscal deficit to 3.5 percent of gross domestic product (GDP) by 2020, from 7.6 percent in 2015. 

To achieve this, the IMF estimates that Sri Lanka will need a primary surplus of about 2.2 percent of GDP by 2020, from a primary balance of 0.0 percent in 2017 and a primary deficit of 2.2 percent in 2015.

Moody’s said thus far the government has made material progress in advancing fiscal consolidation driven mainly by the VAT rate hike and tax administration reforms that have enhanced collection.

“If the government’s revenue reforms, including the new IRA, are implemented successfully, we expect general government revenues to increase to just over 15 percent by 2018,” Moody’s said.

The IMF projects revenue to rise further to over 16 percent of GDP by 2021.

“Overall, the government’s revenue reforms will play an important role in bolstering fiscal consolidation given Sri Lanka’s weak fiscal position, the need for public spending on infrastructure and development programmes and political constraints in restraining expenditure,” the rating agency noted.

Meanwhile, Moody’s said they expect Sri Lanka’s general government debt to stabilize near current levels through 2018, before declining gradually thereafter.

It also said persistent large budget deficits, combined with slower nominal GDP growth, have resulted in a rise in general government debt to 79.6 percent of GDP in 2017, up from recent low of 69 percent in 2012.

“While we expect the policymaking process to remain slow, due to the need for consensus building, we believe that the commitment to fiscal consolidation is in place. Nonetheless, the debt burden will remain well above the median of about 55 percent for B-rated sovereigns and at a high level for an economy of the size and income levels of Sri Lanka’s,” Moody’s said.

The rating agency also highlighted the threats that stem from state-owned enterprises (SOEs), which pose additional risks to the government’s balance sheets, should financial support be needed.

The IMF estimates that non-financial SOE debt is worth nearly 12 percent of GDP.

“SOE reforms, including the Statement of Corporate Intents and impending energy pricing reforms, underpin the efforts to reduce fiscal risks to the government. 

At this stage, the effective implications of the reforms for SOEs’ financial strength are unclear. Crystallization of some contingent liabilities could add significant fiscal costs,” Moody’s noted.