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Tuesday April 23rd, 2024

Fitch downgrades Sri Lanka sovereign rating to CC

ECONOMYNEXT – Fitch has downgraded Sri Lanka to ‘CC’ from ‘CCC’ saying there was an increased probability of default as liquidity injections made to sterilize interventions and enforce a 6.0 percent policy rate continue to drain reserves and create forex shortages.

“The downgrade reflects our view of an increased probability of a default event in coming months in light of Sri Lanka’s worsening external liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows,” the rating agency said.

“The severity of financial stress is illustrated by elevated government-bond yields and downward pressure on the currency.”

In addition to repaying debt, the central bank is also spending reserves for current imports and printing money to sterilize the interventions, adding more rupee reserves to the banking system to enforce a 6.0 percent policy rate, preventing the monetary base from contracting, short term rates rising, and reducing credit.

Related Sri Lanka overnight injections top Rs400bn amid sterilized interventions

Below ‘CCC’ Fitch does not use notches (+ or – notations) and downgrades by entire levels.

“We believe it will be difficult for the government to meet its external debt obligations in 2022 and 2023 in the absence of new external financing sources.

“Obligations include two international sovereign bonds of USD500 million due in January 2022 and USD1 billion due in July 2022.”

Fitch Downgrades Sri Lanka’s Long-Term Foreign-Currency IDR to ‘CC’

Fri 17 Dec, 2021 – 11:31 AM ET

Fitch Ratings – Hong Kong – 17 Dec 2021: Fitch Ratings has downgraded Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CC’, from ‘CCC’. Fitch typically does not assign Outlooks or apply modifiers for sovereigns with a rating of ‘CCC’ or below.

A full list of rating actions is at the end of this rating action commentary.

Key Rating Drivers

The downgrade reflects our view of an increased probability of a default event in coming months in light of Sri Lanka’s worsening external liquidity position, underscored by a drop in foreign-exchange reserves set against high external debt payments and limited financing inflows. The severity of financial stress is illustrated by elevated government-bond yields and downward pressure on the currency.

We have affirmed the Long-Term Local-Currency IDR at ‘CCC’, as authorities have continued access to domestic financing, despite high and still-rising government debt and an elevated debt service burden.

Sri Lanka’s foreign-exchange reserves have declined much faster than we expected at our last review, owing to a combination of a higher import bill and foreign-currency intervention by the Central Bank of Sri Lanka.

Foreign exchange reserves have declined by about USD2 billion since August, falling to USD1.6 billion at end-November, equivalent to less than one month of current external payments (CXP).

This represents a drop in foreign-currency reserves of about USD 4 billion since end-2020.

We believe it will be difficult for the government to meet its external debt obligations in 2022 and 2023 in the absence of new external financing sources. Obligations include two international sovereign bonds of USD500 million due in January 2022 and USD1 billion due in July 2022.

The government also faces foreign-currency debt service payments, including principal and interest, of USD6.9 billion in 2022, equivalent to nearly 430% of official gross international reserves as of November 2021.

Cumulative foreign-currency debt service, including interest and principal, amounts to about USD26 billion from 2022 through to 2026.

The timing and availability of external resources is unclear and may not be readily available for debt service. The central bank published a six-month roadmap in October that outlined plans to raise additional external borrowings through a number of channels, including bilateral and multilateral sources, syndicated loans and through the monetisation of under-utilised assets in 1Q22.

A drawdown on the existing currency swap facility with the People’s Bank of China (PBOC) could boost reserves by up to CNY10 billion (USD1.5 billion equivalent). However, even with resources from the swap facility, foreign exchange reserves are likely to remain under pressure, in our view.

Additional sources of financing could come from an economic support package from India, which contains a swap facility under the South Asian Association for Regional Cooperation currency framework of USD400 million, a swap facility with the Qatar Central Bank, remittances securitisation and a revolving credit facility with the Bank of China Limited (A/Stable).

However, even if all these sources are secured, we believe it will be challenging for the government to maintain sufficient external liquidity to allow for uninterrupted debt servicing in 2022.

Press reports suggest the government may be contemplating IMF financing; an IMF programme would unlock multilateral financing, but we believe the Fund could well suggest restructuring to bring about debt sustainability.

Sri Lanka’s external finances are further challenged by a persistent current account deficit, resulting in downward pressure on the exchange rate. We estimate that the deficit widened to about 5.7% of GDP in 2021 and expect it to remain at about 4.0% in 2022, before falling to 2.1% by 2023.

A plunge in remittances, a weak tourism recovery and rising imports have contributed to the wider current account deficit. Travel and tourism, an important economic driver, has been hit hard by the COVID-19 pandemic and the outlook for a recovery remains uncertain given the emergence of new highly transmissible virus variants.

The Sri Lankan rupee/US dollar spot exchange rate depreciated by 7%-8% since end-2020, and the central bank intervened to support the currency, exacerbating the decline in reserves.

Wide fiscal deficits continue to worsen the outlook for debt sustainability. The 2021 fiscal deficit target of 8.9% of GDP was missed by a wide margin, and we expect the government deficit to widen to about 11.5% of GDP in 2022.

We believe 2022 revenue targets are optimistic, especially in light of our expectation of weak economic activity. We forecast general government debt to reach about 110% of GDP by 2022, and to keep rising under our baseline, absent major fiscal consolidation.

We also believe it is unlikely that Sri Lanka will meet its 2025 government debt reduction target of about 89% of GDP or narrow the fiscal deficit to 4.8% of GDP. Rising interest payments are a major driver of the widening deficit and the interest/revenue ratio of at about 95.0% is well above the peer median of 11.3%.

Sri Lanka’s economic performance is likely to weaken in 2022, as the challenging external position and exchange-rate pressure will have knock-on effects on economic activity. Foreign currency shortages in 2021 hampered food and fuel imports, and continued external liquidity stress could worsen supply shortages, hurting economic activity.

We expect growth to slow to 2.0% in 2022, from an estimated 3.6% in 2021, before recovering to 4.3% in 2023 partly due to base effects and a gradual easing of domestic pressures, although downside risks to our forecasts remain. Sri Lanka’s economy was expanding at a modest pace prior to the pandemic, which led real GDP to contract by 3.6% in 2020.

ESG – Governance: Sri Lanka has an ESG Relevance Score of ‘5’ for Political Stability and Rights. This reflects the high weight that the World Bank Governance Indicators (WBGI) have in our proprietary Sovereign Rating Model. Sri Lanka has a medium WBGI ranking at the 47th percentile, reflecting a recent record of peaceful political transitions and a moderate level of rights for participation in the political process. As Sri Lanka has a percentile rank below 50 for the governance indicator, this has a negative impact on the credit profile.

ESG – Governance: Sri Lanka has an ESG Relevance Score of ‘5[+]’ for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption. This reflects the high weight that the WBGI has in our proprietary Sovereign Rating Model. Sri Lanka has a medium WBGI ranking at the 53rd percentile, reflecting moderate institutional capacity, established rule of law and a moderate level of corruption. As Sri Lanka has a percentile rank above 50 for the respective governance indicators, this has a positive impact on the credit profile.

Sri Lanka has an ESG Relevance Score of ‘5’ for Creditor Rights, as willingness to service and repay debt is relevant to the rating and is a rating driver for Sri Lanka, as for all sovereigns. Given the increasing possibility of default reflected in the CC rating, this has a negative impact on the credit profile.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Failure to service bonded debt obligations within grace periods stipulated in relevant documentation, or unilateral declaration of a debt moratorium

– Launch of a formal debt renegotiation process by authorities or the start of a process that Fitch deems to constitute a default or default-like event
Factors that could, individually or collectively, lead to positive rating action/upgrade:

-External Finances: Improved external liquidity, supported by higher non-debt inflows or lower external sovereign refinancing risk from an enhanced liability profile that allows for smooth servicing of liabilities

– Public Finances: Implementation of a credible medium-term fiscal consolidation strategy that supports a sustained decline in the general government debt/GDP ratio, increasing financing options and reducing the probability of default

– Structural: Improved policy coherence and credibility, leading to more sustainable public and external finances and a reduction in the risk of debt distress

Sovereign Rating Model (SRM) and Qualitative Overlay (QO)

In accordance with its rating criteria, Fitch’s has not utilised the SRM or QO to explain the ratings in this instance. Ratings of ‘CCC+’ and below are instead guided by the rating definitions.
Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR. Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
Best/Worst Case Rating Scenario

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Sri Lanka single borrower limits cut to 25-pct of bank capital, SOEs also included

ECONOMYNEXT – Sri Lanka’s central bank has issued directions limiting loans to a singe borrower or a group of connected customers to 25 percent of Tier I capital, with state enterprises which turned out to be the biggest borrowers, also included.

In a 2007 direction, banks were allowed to give loans up to 30 percent of capital for a single customer and 33 percent for a group but the rules were widely violated in the case of state enterprises, which were used as off-budget vehicles to give energy and other subsidies.

Banks will have to limit exposures to 25 percent starting from January 2026.

According to transitional provisions published in the direction seems to indicate that some banks may have single borrower exposures of 85 percent or more.

They will be required to bring exposures down to 60 percent by 2027 and 25 percent by 2028.

Download the direction from here Sri-Lanka-single-borrow-limit-direction-2024

Energy utilities were made to borrow from state banks to run off-budget subsidies under plan avoid a price formula during the Rajapaksa regimes.

Sri Lanka’s state banks ended up with large debts to Ceylon Petroleum Corporation partly due to flexible inflation targeting (printing money to cut rates as soon as inflation fall triggering forex shortages) even when fuel was market priced in 2018, analysts have shown.

When rates were cut with inflationary open market operations, triggering forex shortages, CPC was barred from buying dollars and forced to get suppliers’ credit denominated in dollars.

The suppliers’ credits were later converted to dollar loans from state bank loans, usually after the currency collapsed from the inflationary rate cuts or inflationary open market operations to sterilize interventions or both, analysts have shown.

The CPC loans have since been taken over by the government.

Banks have also funded roads and other state projects.

“Licensed banks shall gradually reduce the exposures to Public Corporations to meet the maximum limit,” by December 2030 according to the direction.

“Public corporation shall mean any corporation, board or other body which was or is established by or under any written law other than the Companies Act, with funds or capital wholly or partly provided by the Government.”

Many of the newer state enterprises however have been suddenly set up under the Companies Act, unlike earlier where a specific act was passed by the parliament to set up corporation or a statutory authority.

Borrowings of CPC and CEB eventually hit the financial stability of state banks while actual bad loans were under-reported. Now the bad loans are being covered with a state capital injection.

Under an International Monetary Fund and World Bank backed program, the so-called ‘sovereign bank nexus’ is being severed to protect the banking system.

Government securities, central bank sterilization securities, loans guaranteed by multilateral lenders or high rated foreign banks are excluded. (Colombo/Apr23/2024)

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Sri Lanka exceeds tax revenue target by 6% in first quarter

ECONOMYNEXT – Sri Lanka’s revenue collecting bodies have outperformed and exceeded tax revenue target by 6 percent for the first quarter ended on March 31, State Revenue Minister Ranjith Siyambalapitiya said.

“After many years of difficult challenges, it has been possible to exceed the expected state revenue in the first quarter of 2024,” he said in a statement.

The government expects a revenue collection of 4,106 billion rupees in 2024.

“The reason for the economic crisis in the past period was the reduction in the level of government revenue. Considering the achievement of higher than the target in the first quarter of this year and the revenue pattern, the 2024 will become a year in which the revenue targets can be achieved,” he said.

The three tax revenue collecting bodies – Sri Lankan Customs, Excise Department, and Inland Revenue Department have collected 834 billion Sri Lanka rupees in the first quarter.

“It is a 6% higher than the expected revenue target of 787 billion rupees,” Siyambalapitiya said.

He said the Inland Revenue Department exceeded its target by 13 percent to 430 billion rupees compared to the target of 381 billion rupees in the first quarter of 2024.

He also said Customs Department has managed to reach the target of 353 billion rupees and the Excise Department has also achieved 96% of the revenue requests and earned 51 billion rupees in the first quarter.

The island nation has raised Value Added Tax (VAT), imposed new taxes, and increased personal income taxes to boost the revenue under an International Monetary Fund-backed reforms in return of a $3 billion External Fund Facility.

People have started to grumble over the government’s higher taxes without reducing some of the state expenditures. The government has been in the process to privatize some key state-owned enterprises. However, that process faced delays amid gradually rising protests against the move. (Colombo/April 22/2024)

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Air Asia, SriLanka’s FITS, Hayleys bid for SriLankan Airlines

ECONOMYNEXT – Malaysia’s AirAsia group, FITS Aviattion of Sri Lanka and Hayleys are among bidders for state-run SriLankan Airlines, a statement from the State-owned Enterprises Restructuring Unit said.

Dharshaan Elite Investment Holding (Pvt) Ltd, . Sherisha Technologies Private Limited and Treasure Republic Guardians Limited are the other bidders.

The responses will be evaluated to choose qualified investors.

International Finance Corporation, as Transaction Advisors for the divestiture of SriLankan Airlines Limited, will continue to advise the government, the statement said. (Colombo/April22/2024)

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