Moody’s warns of post-IMF economic fallback

Hot on the heels of Moody’s revising the outlook of Sri Lanka’s sovereign rating to ‘negative’ from ‘stable’, the rating agency yesterday reminded the policy makers not to take eyes off the reforms to ensure the full benefits of the 3-year programme with the International Monetary Fund (IMF), as complacency  could push the country’s economy back into bad shape. 

The international rating agency drew examples from Sri Lanka’s 2009-12 post-stand-by-arrangement (SBA) period and also from similar rated peers, who were forced to seek IMF bail-out after plunging into fiscal and balance of payment crises. 

“Generally, an initial narrowing of deficits diminished or reversed after a few years and the government’s debt burden continued to rise,” Moody’s said in a research note titled, ‘Government of Sri Lanka - Reform implementation key to ensure lasting fiscal, external improvement from IMF Programme’. Fiscal and state-owned enterprise (SoE) reforms are always politically challenging to implement as they are extremely sensitive to the masses. Hence, the governments conveniently tend to forget key reforms to remain popular and be in power. Generally, after securing a facility from IMF, the government pretends it is reforming and the IMF too pretends the government is reforming but both parties kick the can down the road, economists have repeatedly shown.  Moody’s remains skeptical if the Sri Lankan government could go the whole hog of the reforms because the past evidence as well as other countries with similar programmes with the IMF suggests otherwise. 

A cross country survey by the rating agency showed that only Romania and Jordan standing out for implementation of the reforms—which were endured through several governments—and upgrading themselves to materially stronger fiscal positions.  

Moody’s is  of the view that a fiscal deficit of 3.5 percent of the GDP set for 2020 in agreement with the IMF’s reform programme is ambitious and the rating agency forecasts a more conservative number slightly under 5.0 percent. 

The US $ 2.6 billion post-SBA period shows that Sri Lanka has reversed its sustained increase in revenue while the government has also resorted to expenditure cuts into capital spending which are less politically-challenging to lower deficits. 

Meanwhile, the rating agency also noted that the progress of state-owned enterprise (SoEs) reforms has also been uneven during post-programme period despite posing a significant contingent liability risks. 

Due to the limited improvement in fiscal balances, in some cases crystallization of contingent liabilities and mostly the subdued nominal GDP growth, none of the countries in the sample showed a sustained fall in debt-to-GDP, instead the debt continued to rise during the programme and in the years after it.  
In Sri Lanka, while the strong nominal GDP growth in 2010-2012 also helped to reduce the debt burden, the slowdown in economic expansion increased the level of debt rapidly again over the last three years, Moody’s said. 
On the external front, the Moody’s observed that while an IMF programme generally stabilized the foreign reserves, external vulnerability persists. 
“However, in several cases, reserves increased by less than the amount of IMF loans, suggesting that the countries’ competitiveness or attractiveness to foreign investors did not improve significantly,” the rating agency said.  Overall the country’s credit profile depends on the extent to which the fiscal, monetary and structural reforms agreed with the lender are implemented. 

“Whether the government is able to implement the ambitious reforms agreed with the IMF will be key in determining whether the government’s credit profile gets a temporary or more enduring boost,” Moody’s said. 
This echoes the Fitch’s assertions last week where the rating agency drew parallels between the reform implementation and the sovereign rating.