Fitch says rising interest rates to hurt Lankan corporates

Lankan corporates are likely to experience some headwinds in the next 12 months as a result of rising interest rates in the economy, the Sri Lankan unit of global credit rating agency, Fitch Ratings said yesterday.  
“Fitch Ratings expects rising domestic interest rates to hurt Sri Lankan corporates over the next 12 months,” the rating agency said in a statement. 
Fitch said the borrowings costs the Lankan companies have increased by around 200 basis points (bp) over the past 12 months in response to the 125bp increase in the Central Bank’s policy rates, and the 150bp increase in the banking industry’s statutory reserve ratio—two monetary policy decisions taken to rein in aggressive credit growth.
The ratings agency does not expect upward pressure on interest rates to subside in the short-term due to rising inflationary pressures and weak external finances of Sri Lanka.
Some economists are expecting the Central Bank to increase policy rates further going forward in tandem with the recent monetary tightening by the US Federal Reserve.
Fitch said corporates with high short-term working capital requirements, such as retail and manufacturing companies, will get hurt the most from the interest rates rise. 
“The two large consumer-durable retailers, Singer (Sri Lanka) PLC (A-(lka)/Stable) and Abans PLC (BBB+(lka)/Stable), are the most affected of the entities we rate as most of their borrowings consist of short-term working capital financing and will have to be rolled over at higher rates,” Fitch said.
“Singer has more headroom in its current rating to withstand these challenges compared with Abans,” Fitch added.
Both retail giants realize 30-40 percent of their sales through high-purchase schemes, which could slow down due to rising interest rates, and weaken earnings growth, Fitch said. 
However, some retail and manufacturing companies are likely to remain resilient.
“Fitch believes Hemas Holdings PLC (AA-(lka)/Stable) and Sunshine Holdings PLC (A(lka)) to be the least affected due to their low refinancing requirements during the next 12 months,” Fitch said.
Some of the country’s younger conglomerates, which aren’t rated by Fitch, and are engaged mainly in trading and retail, are heavily leveraged, placing downward pressure on their future 
earnings as well.
Fitch said that among the corporates that it rates, the interest coverage (EBITDA/gross interest expense) deteriorated to 6.9x on average in the 12 months ended March 2017 from 9.2x YoY due to rising interest rates and higher debt, with a further 100bp rate increase in the future likely to push the figure down to 5.2x.

It noted that the increase in debt was used to enhance capacity in mostly retail and manufacturing sectors, which will likely generate meaningful cash flows in the long-term, although around 50 percent of the debt was in short-term working capital, which will require refinancing and attract modest interest rate risk.
“We have assumed that 100 percent of corporates’ short-term debt and 40 percent of long-term debt will be re-priced at higher rates immediately. Most of the long-term debt stems from banks and around half of such debt are at a variable interest rate,” Fitch said.
It added that only 12 percent of the outstanding borrowings of its clients consisted of debenture financing, which is predominantly on fixed rates. Fitch had recommended greater financing through debentures last year due to rising interest rates.