Just days after the World Bank said possible plans by Sri Lanka to roll over its commercial debt or international sovereign bonds (ISBs) will be an uphill task come maturity, Moody’s Investors Service this week expressed similar concerns in an environment where global interest rates are rising and liquidity getting tightened. In a report on frontier markets (FMs) — highlighting the prospects and key risks — Moody’s showed how the FMs in the past have raised commercial US dollar sovereign bonds at relatively favourable rates when the global liquidity conditions were benign.
But the rating agency pointed out how the evolving global liquidity conditions and rising interest rates now could pose “key credit challenges” to FMs due to elevated debt-servicing costs and liquidity risks.
According to Anne Van Praagh, Moody’s Managing Director, although “the ability of individual FMs to handle rising interest rates and rollover of commercial debt is differentiated”, she said, “vulnerabilities are highest for those countries where high leverage combines with a constrained ability by domestic policymakers to ease monetary policy and preserve fiscal flexibility”.
Sri Lanka is a FM, which has the key characteristics of low per capita income, relatively fast gross domestic product (GDP) growth, open economy reliant on commodities exports and low institutional strengths.
Moody’s defines a frontier market as a sub-investment grade country that relies on concessional financing, for example, from international financial institutions, for more than 40 percent of its financing needs.
As a result of the recent higher commercial borrowings, FMs now pay more proportionally in interest payments than emerging markets.
“In 2016, the FMs’ median interest to revenue ratio was 8.9 percent compared with 7.7 percent for EMs,” said Moody’s adding that it could go further up with the rising global interest rates unless the revenues fail to keep pace. As concessional borrowings ran dry, Sri Lanka had to tap international capital markets multiple times since 2017 and the country is now in an external debt trap where the state revenue is barely sufficient to service such debt.
The latest such sovereign bond issue earlier this year raised US $ 1.5 billion.
According to Moody’s in July, Sri Lanka is due to settle an estimated US $ 13.8 billion in external debt from 2019 to 2022.
Moody’s meanwhile said the strength of institutions determines a sovereign’s ability to counter negative shocks, such as a rise in global capital costs but in the case of many FMs, weak institutions constrain their ability to buffer against shocks.
Out of the 36 FMs rated by Moody’s, 75 percent sovereigns are rated in the B1-B3 range.
Most have weak economic and fiscal fundamentals and weak institutions, suggesting low shock absorption capabilities.
Meanwhile, out of the 36 FMs, downgrades have dominated upgrades and none has climbed up to investment grade since a sovereign rating was initiated.
Moody’s has a B1 speculative grade rating on Sri Lanka and its outlook was revised to ‘Negative’ from ‘Stable’ in 2016 due to fiscal and external risks.
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