The settlement of the foreign currency debt issued by the Sri Lankan government during the last decade would become the real test for the country’s liquidity position and external vulnerability, Moody’s Investors Service recently said.
Sri Lanka’s debt dynamics are such that the domestic debt repayments will reach a peak next year, following which there is a bunching up of external debt repayments from 2019 onwards, every year for three years.
These debt repayments put enormous pressure on both the government and market liquidity with knock-on effects on interest rates, inflation and exchange rate. They could also erase the country’s foreign reserves, worsening already volatile external front.
The data show that as much as US $ 5.0 billion worth of sovereign bond maturities are coming up for due from 2019 to 2022.
“In particular, large volumes of external government debt maturing in 2019-22 will test government liquidity and external vulnerability”, Moody’s said last week in its annual credit analysis on the Sri Lankan economy.
Concessional borrowings dried up for Sri Lanka as the country gained lower middle income status in 2010, forcing the authorities to resort to international capital markets, which offer liquidity at a higher cost, for its funding purposes.
Moody’s has a speculative B1 rating on Sri Lanka with a ‘Negative’ rating outlook which is supported by the economy’s robust medium-term GDP growth prospects, relatively large economy, and high income levels when compared with similarly rated sovereigns. Nevertheless, the rating outlook would only be returned to ‘Stable’ if evidence of effective implementation of reforms that lead to significant and lasting improvements in tax collection, and more stable external financing conditions become visible,
These remarks on the Lankan sovereign come at time when Sri Lanka’s credit profile is already under stress due to the country’s large debt pile and very low debt affordability, which could further be deepened from the contingent liabilities from the state-owned enterprises (SoEs).
Sri Lanka’s public debt as a percentage is already very high at 79.3 percent as opposed to 53 percent for B rated peers in the Moody’s rating universe.
Since it is unlikely that the debt burden could be brought down fast, the government is likely to refinance the bonds maturing from 2019 onwards as the country’s foreign reserves are inadequate to settle the debt.
Hence, Moody’s expects the public debt to GDP ratio to only edge down to 78 percent by end of 2018, which is fairly insignificant. Sri Lanka’s progress on reducing external vulnerability has also been slower. External and foreign currency debt account for about 43 percent of total government debt, giving rise to significant exposure to external financing conditions.
What also concerns Moody’s are the signs of less effective fiscal consolidation measures and the diminished commitment from the authorities towards taking steps toward that direction at a time when the foreign exchange reserves remain low and the re-financing of market debt is challenging.
“Sri Lanka’s low tax efficiency and tax collection provide significant scope to broaden the tax base and increase the tax revenue/GDP ratio, which was only 12.4 percent in 2016”, said William Foster, a Vice President and Senior Credit Officer at Moody’s.
The Central Bank forecasts to end this year with about US $ 7.2 billion in foreign reserves, little up from the current US $ 7.0 billion, which is only sufficient to support around 4 months of imports.
Since March through June, the Central Bank has bought around US $ 700 million directly from the market as part of its ongoing engagement with the International Monetary Fund (IMF), which requires to build foreign exchange reserves through non-debt creating flows.
The Central Bank is likely to buy a further US $ 500 million with minimal impact on the market during the next six months to meet its target of US $ 1.2 billion set for this year.
“Further measures to build foreign-exchange reserves would help establish buffers against external pressure, in particular ahead of 2019”, Moody’s added.
Meanwhile, Moodys expects Sri Lanka to grow no more than 4.6 percent in 2017, largely in line with the Central Bank’s projections but expects the growth to average ‘a robust’ 5.2 percent a year from 2017 to 2021.