Fitch Ratings in a brief statement yesterday said greater clarity over economic policy is more important than the party composition of Sri Lanka’s next government.
“The establishment of a new government with a clear electoral mandate following parliamentary elections on August 17 should mitigate some political uncertainty, though the direction of economic policy and the stability of the likely coalition remain unclear,” Fitch said.
Improved economic policy credibility and coherence would strengthen Sri Lanka’s resilience to growing investor uncertainty towards emerging Asia.
The rating agency recognized that the new administration inaugurated in January under President Maithripala Sirisena had been able to address some of the perceived governance shortcomings through amending the Constitution and launching anti-corruption investigations.
However, it pointed out that equal effort had not gone into strengthening the economic management of the country.
Following the presidential election win, a populist budget was introduced in February that raised public sector wages and reduced publicly administered prices.
However, the government has also disclosed that the 2014 budget deficit was around 1pp higher than previously thought, owing to revenue shortfalls, indicating that fiscal consolidation has stalled.
Fitch noted that Sri Lanka has the fourth-highest share of government debt—72 percent of gross domestic product (GDP)—of any country in the ‘BB’ range, after Portugal, Hungary and Croatia.
Sri Lanka’s monetary policy has also been accommodative, allowing credit growth to accelerate sharply to 17.6 percent year-on-year (YoY) in May 2015, from almost 0 percent in 3Q14.
This has fuelled a 45 percent YoY rise in consumer goods imports in the first five months of the year at a time when exports were unchanged owing to stagnant agriculture and textiles.
A rise in tourism receipts and remittances has acted as a buffer, although the trade deficit widened to US $ 3.4 billion in May, up from US $ 3.1 billion in May 2014.
The current account deficit had narrowed to 2.7 percent of GDP in 2014 from 7.8 percent in 2011 but is likely to widen back to 3.0 percent this year.
Gross foreign reserves had dropped sharply to US $ 6.8 billion by end-May 2015 from US $ 7.5 billion a month earlier, further highlighting pressures on external balances.
The authorities indicated that reserves had been bolstered back up to US $ 7.5 billion by end-June through a US $ 650 million sovereign dollar debt issue and US $ 338 million Sri Lanka Development Bond, though the latest data for end-July show reserves had fallen back down to US $ 6.9 billion.
External liquidity has been buffered by a US $ 1.1 billion swap facility with the Reserve Bank of India in July.
Fitch however noted that though these factors have buffered external liquidity recently, it is not a sustainable way of improving the stability of the external accounts.