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Wednesday July 24th, 2024

Fitch downgrades Sri Lanka sovereign rating to ‘CCC’ after budget

ECONOMYNEXT – Fitch Ratings has downgraded Sri Lanka’s sovereign rating to ‘CCC’ from ‘B-‘ after a budget for 2021 showed too steep revenue projections after earlier tax cuts and a higher deficit for 2021 than 2020.

“In our view, the budget lacks a credible fiscal consolidation strategy and provides only limited details on the potential revenue impact of some of the measures announced, raising uncertainty about the government’s planned reduction in government debt and budget deficit,” Fitch Ratings said.

“Sri Lanka’s 2021 budget targets a widening deficit of 8.9 percent of GDP, from 7.9 percent of GDP for 2020.

Fitch said there is no outlook or notches after a downgrade to CCC.

Analysts say the deficit target for 2021 is an improvement if past accounting practices were followed, but spending for 2020 was controversially pushed back to 2019.

“In the 2021 budget, the authorities have planned external borrowings of project and programme loans mostly through bilateral and multilateral sources (about USD1.8 billion), as well as foreign commercial loans (about USD1.4 billion) for budget support,” the rating agency said.

“The authorities do not currently anticipate a financing arrangement with the IMF.”

The full statement is reproduced below:

Fitch Downgrades Sri Lanka to ‘CCC’

Fri 27 Nov, 2020 – 4:29 AM ET

Fitch Ratings – Hong Kong – 27 Nov 2020: Fitch Ratings has downgraded Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC’.

Fitch typically does not assign Outlooks or apply modifiers to sovereigns with a rating of ‘CCC’ or below.

KEY RATING DRIVERS

The downgrade reflects Sri Lanka’s increasingly challenging external-debt repayment position over the medium term. In particular, a sharp rise in the sovereign debt to GDP ratio associated with the coronavirus shock and narrowing financing options have heightened debt sustainability risks.

Sri Lanka’s external funding needs are substantial over the medium term, and in our view, risks to the sovereign’s ability to meet its external-debt service obligations have increased. The government’s external-debt obligations amount to USD23.2 billion between 2021 and 2025 or about USD4 billion annually, against FX reserves at end-October of just USD5.9 billion. The sovereign’s financing and debt service challenges are exacerbated by its existing financing model, which has resulted in very high general government interest to revenues ratios. The average interest to revenue ratio from 2016 to 2020 is about 50%, substantially above the ‘CCC’ peer median of about 11%.

The authorities plan to meet their external-debt obligations in 2021-2025 through a combination of sources, including bilateral, multilateral and commercial financing, but in Fitch’s view, access to such external financing options will become more challenging against the backdrop of already high debt levels and an expected further weakening of government debt dynamics. Meanwhile, Fitch believes that financing conditions for potential market issuance have tightened materially, notwithstanding the reduction in political and policy uncertainty following the completion of parliamentary elections in August 2020 and submission of the draft 2021 budget in November.

We think there are now increasing risks to Sri Lanka’s ability to meet its external-debt repayments as reflected in our forecast of a steady decline in FX reserves in 2021 and 2022. We expect Sri Lanka’s external liquidity ratio, defined as liquid external assets/external liabilities, will remain low at about 63%, against a ‘CCC’ median of about 68% in 2021.

In the 2021 budget, the authorities have planned external borrowings of project and programme loans mostly through bilateral and multilateral sources (about USD1.8 billion), as well as foreign commercial loans (about USD1.4 billion) for budget support. The authorities do not currently anticipate a financing arrangement with the IMF.

Fitch estimates Sri Lanka’s government debt to GDP ratio to increase to about 100% in 2020 from 86.8% in 2019, and to rise further under our baseline scenario to around 116% in 2024.

This trajectory is in sharp contrast to the authorities’ medium-term fiscal strategy, which envisages a reduction in the debt to GDP ratio to 75.5% in 2025 from their estimate of 95.1% in 2020. The authorities are forecasting a pick-up in revenues to 14.2% of GDP by 2025, from their estimate of 9.5% in 2020, with GDP growth picking up to 6% or higher over the medium term. They also project a primary surplus by 2025.

Our baseline projections are based on more conservative, and we believe, realistic, assumptions for economic growth, revenue and interest payments. Sri Lanka lacks a track record of sustained primary surpluses, its revenue-to-GDP ratio has stayed low and GDP growth has been weak (growth averaged 3.7% in 2015-2019). Accordingly, our baseline assumptions for 2021-2024 incorporate average annual growth of about 4%, a primary deficit of about 2% of GDP, and revenue-to-GDP of about 11%.

Sri Lanka’s 2021 budget targets a widening deficit of 8.9% of GDP, from 7.9% of GDP for 2020.

The budget contains numerous tax incentives for the agricultural sector, and policies to facilitate private investment. It also includes reforms to improve tax collection and administration, and the introduction of a special goods and services tax for alcohol, betting and gaming, telecommunication and vehicles.

In our view, the official revenue projection of nominal revenue growth of about 28% in 2021 is highly ambitious given the lack of major revenue-raising measures and the numerous tax incentives, coupled with the tax cuts announced towards end-2019. The budget also targets a large increase in spending, particularly public investment, raising it from an estimated 2.6% of GDP in 2020 to 6.1% of GDP in 2021.

In our view, the budget lacks a credible fiscal consolidation strategy and provides only limited details on the potential revenue impact of some of the measures announced, raising uncertainty about the government’s planned reduction in government debt and budget deficit. As such, we project the budget deficit to widen to about 11.5% of GDP in 2021 and 2022. This forecast is based on our GDP growth assumption of 4.9% in 2021 compared to the authorities’ 5.5%. Sri Lanka’s low revenue-to-GDP ratio has remained a key weakness in the fiscal profile and we expect it to remain below the ‘CCC’ median of 23% in 2021.

Sri Lanka’s economic performance has been affected by the COVID-19 pandemic through multiple channels, even though the virus has been relatively well contained domestically. Travel and tourism, which is an important driver of the economy has been hard hit and the outlook for its recovery remains uncertain and dependent on the evolution of the pandemic. The direct contribution of tourism to GDP is about 4%, but the indirect spill-over effect is much higher.

Private consumption, which accounts for about 70% of GDP, was weakened by the domestic lockdown in place between March and May2020. GDP contracted by 1.6% in 1Q20, and we expect an even sharper contraction in 2Q (publication of the 2Q GDP data has been delayed).
Overall, we expect GDP to contract by 6.7% in 2020 and to begin recovering in 2021 by 4.9%, partly driven by the low-base effect.

Our forecasts are subject to a high degree of uncertainty related to the path of the pandemic globally and in Sri Lanka. However, recent positive news on vaccine development initiatives has highlighted the potential for the gradual roll-out of a medical solution to the pandemic from early 2021, which could facilitate a return to economic normalisation and mitigate the downside risks to macro forecasts.

Remittances have performed unexpectedly well during the pandemic, growing by about 2.7% yoy between January-October, and have helped support the external position. However, we view this increase as temporary, due to factors such as workers repatriating their savings before returning home, and a shift towards more formal remittance channels. The stronger remittance inflows alongside a decline in imports due to various import controls, has kept Sri Lanka’s current account from deteriorating significantly in 2020. We expect the current account deficit to remain manageable at 2% -3% of GDP in 2021 and 2022 as some of those import controls are likely to remain in place.

Sri Lanka’s basic human development indicators, including education standards, are high compared with the ‘CCC’ median, based on the UN Human Development Index Score, which positions Sri Lanka in the 63rd percentile, well above the 27th percentile for the ‘CCC’ median. The country’s per capita income of USD3,775 estimated by Fitch at end-2020 is above the ‘CCC’ median of USD2,661.

The operating environment for banks in Sri Lanka remains challenging and we expect banks’ financial profiles to come under stress. The sector regulatory non-performing loan (NPL) ratio rose to 4.7% by end-2019, prior to the economic disruptions from the pandemic, and reached 5.4% by end-1H20. Underlying asset-quality stress could continue to build, despite the regulatory relief in the form of a moratorium for affected customers that has to a large extent halted the recognition of credit impairment. Sri Lankan banks could also face increased challenges in the access to – and pricing of – foreign-currency funding stemming from the deteriorating sovereign credit profile.

ESG – Governance: Sri Lanka has an ESG Relevance Score of ‘5’ for Political Stability and Rights as well as for the Rule of Law, Institutional and Regulatory Quality and Control of Corruption, as is the case for all sovereigns.

These scores reflect the high weight that the World Bank Governance Indicators have in our proprietary Sovereign Rating Model. Sri Lanka has a medium World Bank Governance Indicator ranking in the 46th percentile, reflecting a recent record of peaceful political transitions, a moderate level of rights for participation in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.

RATING SENSITIVITIES

The main factors that could, individually or collectively, lead to positive rating action/upgrade are:
-External Finances: Improvement in external finances, supported by higher non-debt inflows or a reduction in external sovereign refinancing risks from an improved liability profile.

– Public Finances: Stronger public finances, accompanied by a sustained decline in the general government debt to GDP ratio, closer to the ‘B’ median, underpinned by a credible medium-term fiscal consolidation strategy

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

The main factors that could, individually or collectively, lead to negative rating action/downgrade:

– Increased signs of a probable default event, for instance from severe external liquidity stress, potentially reflected in an ongoing erosion of foreign exchange reserves and reduced capacity of the government to access external financing.

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  1. VELUPPILLAI Thangavelu says:

    Sri Lanka is engulfed in an ethnic crisis long after the war ended in May. 2009. Though the President is considered a technocrat who wants to modernize the economy, he cannot do it when the country is facing internal conflicts and divisions. In fact, he speaks just like a tribal leader when he says that he is the President of the majority Sinhala – Buddhists who voted for him to office. Even African tribal leaders do not speak openly in such terms. The government of Sri Lanka little realizes that it cannot make economic progress unless there is political stability. Today, the country is divided along ethnic lines pulling the country apart.

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  1. VELUPPILLAI Thangavelu says:

    Sri Lanka is engulfed in an ethnic crisis long after the war ended in May. 2009. Though the President is considered a technocrat who wants to modernize the economy, he cannot do it when the country is facing internal conflicts and divisions. In fact, he speaks just like a tribal leader when he says that he is the President of the majority Sinhala – Buddhists who voted for him to office. Even African tribal leaders do not speak openly in such terms. The government of Sri Lanka little realizes that it cannot make economic progress unless there is political stability. Today, the country is divided along ethnic lines pulling the country apart.

Fitch confirms ‘A(lka)’ domestic rating of Sampath Bank Plc

ECONOMYNEXT – Fitch Ratings said it was confirming a national long-term A(lka) rating on Sri Lanka’s Sampath Bank Plc with a stable outlook, amid an improvement in operating environment, indicated by headline macroeconomic indicators.

The bank had stage 3 loans of nearly 17 percent at end-1Q24 (2023: 16.6 percent).

Fitch expected this ratio to decrease in the near- to medium-term alongside focused recoveries.

“We expect Sampath’s impaired (stage 3) loans ratio to decline gradually in the medium term, due to its recovery efforts, improvements in repayment capacity of borrowers from the stabilisation in economic conditions, and moderate loan book growth.”

The bank also had defaulted sovereign bonds. “Defaulted foreign-currency sovereign bonds, which accounted for 1.9% of assets, had impairments amounting to 52% of its holdings as of end-1Q24.”

The full statement is reproduced below:

Fitch Affirms Sampath Bank at ‘A(lka)’; Outlook Stable

Fitch Ratings – Colombo – 22 Jul 2024: Fitch Ratings has affirmed Sri Lanka-based Sampath Bank PLC’s (Sampath) National Long-Term Rating at ‘A(lka)’. The Outlook is Stable. Fitch also affirmed Sampath’s outstanding Sri Lankan rupee-denominated subordinated debt at ‘BBB+(lka)’.

KEY RATING DRIVERS

Intrinsic Profile Drives Rating: Sampath’s National Long-Term Rating reflects its own financial strength, which is highly influenced by its exposure to the sovereign’s weak credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): RD; LongTerm Local-Currency IDR: CCC-) and the ongoing sovereign debt restructuring, which had been putting pressure on Sampath’s credit profile. The rating also reflects Sampath’s modest domestic franchise as Sri Lanka’s fifth-largest commercial bank.

Stabilising OE: Sri Lankan banks’ operating environment (OE) continues to show signs of stabilisation, as evident in sustained improvements in reported headline macroeconomic indicators, supporting the recovery in banks’ operational flexibility.

Further improvement to the bank’s OE remains contingent on successful execution of the sovereign’s external debt-restructuring exercise alongside the restoration of the sovereign’s creditworthiness, given the strong link between sovereign financial health and banks’ operating conditions.

Economic Stabilisation Aids Business Profile: We believe the gradual improvement in economic conditions should support Sampath’s ability to generate and defend business volumes, despite the vulnerabilities from the weak sovereign and economy. We expect a moderate resumption in lending alongside the gradual economic recovery, similar to peers. This should result in a higher loan book share of assets (net loans to assets of 48.0% at end-1Q24) in the medium term.

Sovereign Risk Remains: Sampath’s risk profile assessment continues to reflect its exposures to the weak sovereign and economic environment. Defaulted foreign-currency sovereign bonds, which accounted for 1.9% of assets, had impairments amounting to 52% of its holdings as of end-1Q24. In addition, local-currency-denominated treasury securities contributed to 34% of its assets at end-2023, of which 59% were treasury bonds and the remainder in treasury bills, which makes the bank susceptible to the sovereign’s repayment ability and liquidity status.

Impaired Loans Decline Gradually: We expect Sampath’s impaired (stage 3) loans ratio to decline gradually in the medium term, due to its recovery efforts, improvements in repayment capacity of borrowers from the stabilisation in economic conditions, and moderate loan book growth. Prolonged economic challenges that continued for most of 2023 led to a further impaired-loans accretion, which together with loan book contraction resulted in the bank’s impaired-loans ratio rising to 16.6% by end-2023 (end-2022: 11.6%), above the industry’s 12.8%.

Declining Risks to Profitability: We believe downside risk to profitability from the restructuring of sovereign bonds has diminished, and any incremental impairment, if necessary, will be manageable, given the existing provisions on the holdings. We expect Sampath’s operating profit/risk weighted assets ratio (1Q24: 4.8%, 4-year average 3.2%) to moderate over the medium term on account of the decline in interest rates. This will be partially offset by lower credit costs, alongside the increase in risk density from the growth in the share of loans.

Downside Risks to Capital Manageable: We believe downside risk to capital from the bank’s exposure to defaulted sovereign bonds (1.9% as of end-1Q24) is manageable, as per the announced restructuring terms – given the bank’s provisions on these instruments amounting to 52% on the exposure at end-1Q24. The regulatory common equity tier 1 (CET1) capital ratio declined marginally to 15.6% by end-1Q24 (excluding 1Q24 profit) from 16.7% at end-2023, following a cash dividend payment, but remains one of the highest among Fitch-rated large Sri Lankan banks.

Funding and Liquidity Risks Remain: We believe Sampath ‘s funding and liquidity stress has eased on both the foreign- and local-currency fronts relative to the crisis period.

This was due to favourable external sector flows and the bank’s focus on liquidity preservation, as reflected in its high liquidity coverage ratio. We believe these developments have reduced the risk of bank failure. However, its funding and liquidity profile – particularly in foreign currency – remains susceptible to sudden changes in creditor sentiment driven by adverse changes to the sovereign’s credit profile, similar to peers.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

The bank’s National Rating is sensitive to a change in its creditworthiness relative to other Sri Lankan issuers.

A deterioration in Sampath’s key credit metrics beyond our base-case expectations relative to peers would also lead to increased pressure on the rating, which is driven by its intrinsic financial strength.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Positive rating action on the sovereign may lead to an upgrade. A sustained improvement in key credit metrics beyond our base-case expectations relative to peers, could also lead to an upgrade.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS SUBORDINATED DEBT

Sampath’s Sri Lankan rupee-denominated outstanding subordinated debt is rated two notches below the National Long-Term Rating anchor. This reflects Fitch’s baseline notching for loss severity for this type of debt, and our expectations of poor recoveries.

There is no additional notching for non-performance risks, as the notes do not incorporate going-concern loss-absorption features.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

The subordinated debt ratings will move in tandem with the bank’s National Long-Term Rating.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Additional information is available on www.fitchratings.com (Colombo/Jul24/2024)

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Sri Lanka presidential candidate cash deposits not updated in 43 years: MP

MP Dullas Alahapperuma

ECONOMYNEXT — The cash deposits Sri Lanka’s presidential candidates are required to pay have not been revised in 43 years, opposition MP Dullas Alahapperuma said, calling for a significant increase in order to save money and to prevent proxy candidates.

Alahapperuma told parliament on Wednesday July 24 that, as per the Presidential Elections Act No. 15 of 1981, a candidate nominated by a recognised political party has to deposit only 50,000 rupees while an independent candidate, or a candidate nominated by any other party or by an elector, must pay only 75,000 rupees.

The MP said the cabinet of former president Gotabaya Rajapaksa had approved an amendment to the act to increase these amounts.

“The election commission proposed that this be increased to 2.5 million rupees for political parties and 3 million for independent candidates. This was a pertinent proposal. There were 35 candidates who contested the last election,” he said.

The Act notes that “Where the number of votes polled by any candidate does not exceed one-eighth of the total number of votes polled at the election, the deposit made in respect of such candidate shall be declared forfeit and shall be transferred by the Commissioner from the deposit account to the Consolidated Fund, and in every other case the deposit shall be returned to the person who made the deposit, as soon as may be after the result of the election is declared.”

At the 2019 presidential election, said Alahapperuma, the deposits made by all candidates besides the top two contenders were transferred to the Consolidated fund.

“The number of candidates might be 80 or 85 this election. Many candidates have no basis for contesting, and it costs a vast sum of money to print ballots and other expenses, not to mention the time consumed for counting votes. This is not just to prevent proxy parties from contesting but also to save a lot of national wealth,” he said.

Leader of the House Susil Premajayantha responding to Alahapperuma said, however, that it would not be possible to pass the proposed amendment in time for the 2024 presidential election.

“The election commission made this proposal some time ago. But we know that to gazette a bill, we need to first draft the bill, the cabinet has to decide on it, send it back to the Legal Draftsman, and receive clearance from the Attorney General. So there is no time to bring this amendment for the upcoming presidential election. You can propose it at the next one,” he said. (Colombo/Jul24/2024)

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Sri Lanka deaf driver license project to be expanded islandwide

ECONOMYNEXT – A pilot project that allowed hearing-impaired persons to obtain light-vehicle driving licenses has been successful and will be rolled out island-wide, Sri Lanka’s Motor Traffic Department said.

The project was implemented in the Gampaha District initially where 50 licenses were provided to drivers who qualified.

The project was expanded to the Kurunegala District, where 150 drivers obtained licences. The drivers were given a probation period.

“Actually, this was a very successful project. It has been almost a year and we haven’t received a single complaint yet,” Motor Traffic Department Commissioner – Driving Licence Wasantha Ariyarathna told reporters on Wednesday.

“We plan to roll it out to all 25 districts islandwide.”

The issuance of driver’s licenses to hearing impaired persons will be done on a bi-annual renewal basis.
(Colombo/Jul24/2024)

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