Fitch affirms SL’s ‘B+’ rating; revises outlook to stable

Fitch Ratings yesterday revised Sri Lanka’s outlook to stable from negative while affirming the country’s credit rating at ‘B+’ largely due to fiscal side improvements, stable growth prospects and policy coherence stemming from the loan arrangement with the International Monetary Fund (IMF).
Fitch estimates that Sri Lanka’s 2016 fiscal performance was better than in 2015, following strong revenue growth that was supported by a Value-Added Tax (VAT) hike. 
“This, along with lower government spending, should narrow the deficit in 2016 to around 5.6 percent of GDP, from 7.4 percent in 2015,” Fitch noted. 
The rating agency believes the 2016 VAT hike to 15 percent from 11 percent and other revenue reforms announced in the 2017 budget are likely to support further fiscal deficit reductions in 2017. As a result Fitch revised its 2017 deficit forecast to 4.7 percent of GDP against its earlier estimate of close to 7 percent. 
The government’s budget deficit estimate of 4.6 percent is below Fitch’s estimates as it has higher growth assumptions. However, Fitch expects authorities to lower spending if there is a large revenue shortfall to keep the fiscal deficit under control. The rating agency also noted that the three-year fund facility to the tune US $ 1.5 billion with the IMF has improved Sri Lanka’s policy coherence and credibility and has eased some near-term balance of payment pressure. 
Fitch expects the country’s external funding profile to benefit from support by multilateral agencies, although its external liquidity position remains weak compared with peers. 
The IMF-supported programme sets ambitious fiscal targets and the authorities have made steady progress, meeting their quantitative performance targets for the first review in November 2016. 

Progress on some structural benchmarks has also been made, including passage of the 2017 budget in line with programme targets.
According to Fitch stable growth prospects have also have played a role in the upward revisioning of the outlook
“Sri Lanka’s growth performance remains favourable. Fitch estimates the country’s five-year (2012-2016) average real GDP growth at 5.3 percent, which is stronger than some of its ‘B’ category peers,” Fitch noted. 
However, the rating agency has revised its 2016 growth estimate to around 4.5 percent, from 5.3 percent (forecast at the time of the last review) due to weaker than expected growth in the first half of 2016 caused by the May, 2016 floods. 
Fitch also said the 100 basis point increase in interest rates in 2016 by the Central Bank to curb credit growth and private consumption will have a bearing on growth though it has improved the country’s macro stability. 
Commenting on the downside, the rating agency flagged the high government debt which is estimated at 77 percent of GDP by end-2016. Fitch noted at this level, government debt remains above the 56 percent ‘B’ median and 51 percent ‘BB’ median.
“Further, foreign currency debt, which is close to 40 percent of GDP, weakens Sri Lanka’s fiscal finances, as it increases the risk of higher debt in local currency terms if the rupee depreciates sharply,” Fitch said.
The rating agency also noted that Sri Lanka’s external liquidity position is weakened by low foreign-exchange reserves and high external debt service payments. 
Measured by Fitch’s external liquidity metric, this ratio is far below the ‘B’ and ‘BB’ median. As per the agency’s estimate, the external liquidity ratio was close to 58 percent at end-2016, against around 163 percent for the ‘B’ median and 155 percent for the ‘BB’ median. 
Sri Lanka’s external finances are vulnerable to a sell-off in treasury bills and bonds by foreign investors, which currently account for nearly 30 percent of foreign-exchange reserves. 
Outflows from treasury bills and bonds in October and November 2016 led to a fall in foreign-exchange reserves, although the reserves improved by around US $ 419 million from end-November 2016 to around US $ 6 billion by end-2016.