Sri Lanka’s hopes for an upgrade in its credit profile will depend on how much it will comply with the International Monetary Fund (IMF) conditions, which the country agreed upon when entering the loan packages with the multilateral lender, credit rating agency Fitch Ratings said.
Fitch stated that the new programmes of the IMF in frontier markets such as Sri Lanka have helped such economies mitigate external liquidity risks and reduce medium-term default risks.
“Support from the IMF has helped to mitigate external liquidity risks and reduced the medium-term default risks in several frontier markets that entered into new programmes in 2016.
However, the potential improvements in sovereign credit profiles will depend on each country’s level of compliance with the IMF conditions and implementation risks are often high,” it said.
Fitch said that a lack of currency flexibility had been a factor in pushing Sri Lanka, Egypt and Suriname into the IMF agreements, since they had spent foreign exchange reserves at unsustainable levels trying to defend their currencies during a period where the dollar gained strength.
“However, they have allowed more flexibility since beginning discussions with the IMF, which has helped reduce pressure on their external balance sheets,” it added.
Fitch also noted that in the two years leading up to the IMF loans, it had taken negative rating action on five of the eight sovereigns, which availed themselves of the IMF funding, including Sri Lanka.
Finance Minister Ravi Karunanayake had not reacted in a calm manner following the ratings cut, calling a press conference during the same day, during which, in a populist stance, criticized the ratings agencies and the IMF of trying to dictate terms to Sri Lanka.
He had also said that Sri Lanka does not need advice or funding from such institutions, comments he occasionally makes presently as well.
Sri Lankan politicians are also treating the US $ 1.5 billion IMF facility as a foreign policy victory instead of as a remedy for an economy in a grave situation.
“The IMF loans should alleviate external liquidity pressures and reduce the risk of sovereign default, particularly where the IMF assistance has been supported by other multilateral assistance or has improved access to global bond markets,” Fitch said. However, it also noted that large current account and fiscal deficits may hamper with improvements in credit ratings.
Sri Lanka’s current account deficit had been slashed by more than half to Rs.111.05 billion in the first 10 months of last year, while the fiscal deficit for 2016 was reported in official data as 5.6 percent of gross domestic product (GDP), a fall from a 7.4 percent of GDP deficit in 2015.
However, Fitch warned that populist pressure to reforms could endanger the reform process.
“Without sustained commitment from the authorities, long-standing weaknesses may remain unaddressed and there is a risk that governments will back away from reforms in the face of public opposition,” it said.
Local economists have noted that Sri Lanka had followed such a pattern in the past with the 2010 IMF facility by cleaning up processes in the run up to signing the agreement, with reversals in attitude and reforms after getting the loan. In the latest round of funding, the IMF has forced Sri Lanka to commit to reforms and key macroeconomic performance indicators in order to remain eligible for future tranches of the loan.
Fitch also warned that protests and government instability could become obstacles to reform processes in the IMF-supported countries.
In a rhetorical fashion, Sri Lankan politicians have been saying that Sri Lanka’s reform processes are the reason why the IMF is funding Sri Lanka. (CW)