Standard & Poor’s Ratings Services (S&P) yesterday affirmed its ‘B+’ long-term and ‘B’ short-term sovereign credit ratings on Sri Lanka. The outlook remains Stable.
S&P said the rating on Sri Lanka reflects the country’s relatively low wealth, improving but still moderately weak external liquidity, and a high government debt and interest burden.
“In addition, uncertainty over the government’s commitment to reforms after the August 17 Parliamentary elections, and gaps in institutional capacity, pose risks to Sri Lanka’s institutional and governance effectiveness, which we consider to be a credit weakness.”
However S&P stressed that these rating constraints weigh against what it considered to be robust growth prospects, which are above average for sovereigns at similar levels of development.
S&P projects Sri Lanka’s external liquidity measured by gross external financing needs as a percentage of current account receipts (CAR) plus usable reserves will average 101 percent over 2015-2018, with an improving trend.
They also forecast the country’s external debt (net of official reserves and financial sector external assets) will be about 109 percent of CAR this year.
“In our view, the external net debt stock measure will gradually decline to below 100 percent by 2018.”
S&P also said the risks associated with the country’s moderately weak external settings are mitigated by growing reserve buffers that improve Sri Lanka’s external resilience.
“We expect Sri Lanka’s gross international reserves (US$7.5 billion at June 2015) to remain at more than four months’ coverage of current account payments during 2016-2018.
We expect the growth in foreign currency reserves to outpace the expansion of current account payments, given the increasing remittances by overseas Sri Lankans and the country’s rising earnings from tourism.”
Other factors that mitigate Sri Lanka’s external risks include its low banking sector external borrowings; adequate market access and pricing; some exchange rate flexibility; and a contingent currency-swap facility of US$ 1.1 billion with the Reserve Bank of India.
After completion of the International Monetary Fund’s Standby Loan Program in July 2012, Sri Lanka agreed with the IMF for “Post-Program Monitoring.”
“We expect the country to continue to secure new external liquidity support from the IMF or bilateral sources, if needed,” S&P stated.
The rating agency further noted that fundamental weaknesses remain in the government’s fiscal metrics despite continuing improvements over the past five years.
“We project annual growth in general government debt to average 6.1 percent of GDP for 2015-2018, compared with 7.6 percent over 2010-2014. In view of Sri Lanka’s robust nominal GDP growth and some fiscal consolidation, we expect net general government debt to fall to 66% of
GDP by year-end 2018, from 70 percent in 2013.
However, the rate of decline could slow if the new government departs from the current fiscal consolidation path, efforts to improve revenue disappoint, or if the rupee depreciates further against major currencies (as 61 percent of government debt was denominated in foreign currencies as of May 2015).”
In addition, the rating agency expects only slow progress in reducing debt-servicing costs, which accounted for 37 percent of government revenue in 2014.
This is the second-highest ratio among all 129 sovereigns that Standard & Poor’s rates, second only to Lebanon. S&P said Sri Lanka’s growth outlook continues to be underpinned by government investment (including rebuilding the war-torn northern districts), rising tourist arrivals, garment sector activity (typically the production of high-quality knits and woven apparels), and declining inflation, which we expect to remain in the single digits.
“The gaps we observe in Sri Lanka’s policymaking capacity partly reflect the political uncertainty associated with two election cycles within seven months.
We believe this hinders responsiveness and predictability in policymaking and weighs particularly on business confidence, investment plans, and overall growth prospects.
Elsewhere, we believe the Central Bank of Sri Lanka’s (CBSL) ability to sustain economic growth while attenuating economic or financial shocks has improved somewhat.
Although CBSL is not independent of other policymaking institutions and we continue to consider monetary policy credibility and effectiveness as a weakness, the central bank is building a record of credibility, shown in reducing inflation through the use of market-based instruments to conduct monetary policy,” S&P said.
“We continue to expect Sri Lanka’s growth prospects to be favourable. We believe the country will most likely maintain growth in real per capita GDP of 5.4 percent
per year over 2015-2018 (6% real GDP growth),” S&P added. Stronger growth may be possible if the business environment improves after the August election, European export markets pick up, the government addresses shortfalls in labour skills, and net foreign direct investment rises above its current pace of about 1 percent of GDP.
“Combining our view of Sri Lanka’s state-owned enterprises and its financial system, we view the country’s contingent fiscal risks as limited, as defined in our criteria.
The stable outlook reflects our expectation that Sri Lanka’s credit metrics will remain broadly unchanged in the next 12 months,” S&P noted.