Moody’s sounds alarm bells; says downgrade possible if fiscal reforms ineffective

Sri Lanka appears to be walking a tight rope before it being stumped by a rating downgrade as the global rating agency Moody’s Investor Services yesterday warned of a possible downgrade of the Sri Lankan sovereign, unless they see a credible fiscal reform programme.
According to Moody’s, ineffective fiscal reforms or wavering commitment by the authorities towards lasting fiscal consolidation could lead to higher debt burden for longer and thus put negative pressure on the country’s rating. 
“Signs that the fiscal consolidation measures are ineffective or that the authorities’ commitment towards fiscal consolidation is wavering would point to a higher debt burden for longer and put negative pressure on the rating. 
In particular, if such developments were accompanied by a marked fall in foreign exchange reserves and lack of market access, a downgrade of the rating would be possible,” Moody’s said announcing its rating on the US $ 1.5 billion sovereign bond Sri Lanka issued last week. 
Last year, Moody’s affirmed Sri Lanka’s sovereign rating at B1 but cut the outlook to ‘Negative’ from ‘Stable’ due to expectations of further weakening in some of Sri Lanka’s fiscal metrics in an environment of subdued gross domestic product (GDP) growth, which could have led to renewed balance of payments pressure. 
The rating action was further underpinned by the possibility that the effectiveness of the fiscal reforms envisaged by the government may have been lower than what Moody’s expected, which could have further weakened fiscal and 
economic performance.  
Sri Lanka cut its fiscal deficit to 5.4 percent of GDP in 2016 from 7.6 percent in 2015 after the fragile economy was let loose by the Sirisena-Wickremesinghe government to make good on their election promises. The fiscal deficit was 5.7 percent of GDP in 2014.
Sri Lanka’s three-year programme with the International Monetary Fund (IMF) also hangs in the balance because the Sirisena-Wickremesinghe coalition government is yet to pass the promised new income tax law.
According to provisional fiscal data, during the first two months, the government revenue as a percentage of GDP is estimated to have risen to 2.2 percent from 1.9 percent recorded the corresponding period of 2016. 
The average monthly revenue during the period was around Rs.145.2 billion compared to Rs.114.1 billion in the same period of 2016. 
Sri Lanka’s belligerent Finance Minister Ravi Karunanayake takes credit for the somewhat improved fiscal conditions but such achievement could never have been possible without the constant pressure exerted by the IMF, which even went to the extent of delaying the programme until the public was slapped with a higher value-added tax. 
Similarly, now the IMF is putting pressure on the government to pass the new income tax bill as much of the future of the loan programme depends on revenue-based fiscal consolidation.