Sri Lanka likely to face marked weakening in debt metrics: Moody’s

• Island nation in further trouble due to impending bond redemptions 
• Foreign exchange reserves to remain low due to slowdown in tourism and apparel income

Sri Lanka (B2 stable) is among low-rated emerging markets with large near-term international bond repayments that are likely to face a marked weakening in debt metrics following the coronavirus outbreak and sharp commodity price declines, international credit rating agency, Moody’s Investor Services warned. 

“As for the potential deterioration in debt and debt-affordability dynamics arising from capital outflows that weaken local currencies and tightened domestic financing conditions, Sri Lanka, Pakistan (B3 stable) and Egypt (B2 stable) would see a marked weakening in debt metrics because of large gross borrowing needs that raise interest payments when borrowing costs rise, and/or narrow revenue bases that push fiscal deficits wider when interest payments rise,” Moody’s said in their latest report.

Further, Sri Lanka along with Honduras (B1 stable), Turkey (B1 negative) and Tunisia (B2 stable) are particularly in a susceptible position given the size of upcoming international bond redemptions as a share of foreign-exchange reserves.

According to the Treasury, Sri Lanka has US$ 4.5 billion in external debt servicing for the year including a settlement of US$ 1 billion international sovereign bond (ISB) in October. 
Moody’s noted that maturing US$ 1 billion ISB alone accounts for 15.1 percent of the country’s 2019 official foreign-exchange reserves. 

“The coronavirus outbreak and sharp commodity price declines are triggering significant financial market volatility and risk aversion that few emerging market sovereigns are immune to,” said a Moody’s Assistant Vice President and Analyst, Christian Fang. 

On a positive note, Sri Lanka was recently able to secure a US$ 500 million loan facility from China Development Bank (A1 stable) with the full facility being US$ 1 billion, bolstering the country’s foreign-exchange reserves ahead of the upcoming US$ 1 billion payment in October.

However, Moody’s pointed out that weaker dollar inflows from subdued tourism activity and textile receipts are likely to keep foreign exchange reserves low through the remainder of the year.

Further, a persistent tightening in financing conditions are expected to increase debt burdens, weaken debt affordability and intensify external vulnerability risks for the low-rated emerging markets.

“Should the risk-off environment persist for some time, leading to capital flight, sharp local currency depreciation and higher domestic interest rates, credit metrics are likely to deteriorate significantly for some sovereigns,” Moody’s said.
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In addition, the rating agency also highlighted that governments facing the largest potential deterioration in debt dynamics may also find it challenging to raise additional financing to mitigate the economic slowdown due to their stretched fiscal positions, which may compound the weak investor sentiment and spark further capital outflows.

Meanwhile, the rating agency insisted that policymakers have limited capacity to mitigate capital flight and/or the sharp increase in credit risk premia in foreign currency.

Sri Lanka’s Central Bank has cut its policy rate by 75 basis points so far during the year.

“These cuts may not sufficiently offset the tightening in financing conditions related to local-currency depreciation,” Moody’s said.