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Moody’s puts Sri Lanka rating on watch for possible downgrade

ECONOMYNEXT – Sri Lanka’s B2 rating has been placed rating watch by Moody’s a rating agency for possible downgrade sayig the rupee and tax revenues have fallen, but the agency would watch for three months or more how the country will manage the shock from Coronavirus.

“The decision to place Sri Lanka’s ratings on review for downgrade is prompted by Moody’s assessment that the acute tightening in global financing conditions, fall in export revenue, and sharp slowdown in GDP,” the agency said.

“For Sri Lanka, the current shock transmits mainly through capital outflows, a marked local currency
depreciation, wider risk premia and a sharp drop in GDP growth that raise the sovereign’s debt burden,
liquidity pressures and cost of external debt servicing,”

“This shock occurs at a time when Sri Lanka’s credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt payments and very weak debt affordability.”

Moody’s also said the rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, and falling asset prices are creating a severe and extensive credit shock across many sectors, regions and markets.

“The combined credit effects of these developments are unprecedented,” the rating agency said.

“Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.”

Sri Lanka however has contained the Coronavirus outbreak from third countries up to April, after successfully nipping in the bud a Wave I from China.

However Sri Lanka has a soft-pegged regime which analysts warned would get the country in trouble in unless past pratices and liquidity injections were abandoned.

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Moody’s however said it would watch the situation for three months or more.

“The review period, which may extend beyond the usual three-month horizon, will allow Moody’s to assess the capacity of the government to secure financing at manageable costs and in a way that does not further weaken the country’s external position and threaten macroeconomic stability,” the agency said.

“The review will also assess the likelihood of the government being able to stabilize its debt burden and restore better debt affordability once the most acute phase of the shock has passed.”

The full statement is reproduced below:

17 Apr 2020

Singapore, April 17, 2020 — Moody’s Investors Service (“Moody’s”) has today placed the Government of Sri Lanka’s long-term foreign currency issuer and senior unsecured B2 ratings under review for downgrade.

The decision to place Sri Lanka’s ratings on review for downgrade is prompted by Moody’s assessment that the acute tightening in global financing conditions, fall in export revenue, and sharp slowdown in GDP growth as a result of the global coronavirus outbreak exacerbate Sri Lanka’s existing government liquidity and external vulnerability risks, raising risks of heightened financing stress and macroeconomic instability.

Moreover, the economic and financial shock will further dim medium-term prospects for reforms that would meaningfully strengthen Sri Lanka’s fiscal and external position.

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, and falling asset prices are creating a severe and extensive credit shock across many sectors, regions and markets.

The combined credit effects of these developments are unprecedented.

Moody’s regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety.

For Sri Lanka, the current shock transmits mainly through capital outflows, a marked local currency
depreciation, wider risk premia and a sharp drop in GDP growth that raise the sovereign’s debt burden,
liquidity pressures and cost of external debt servicing.

This shock occurs at a time when Sri Lanka’s credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt payments and very weak debt affordability.

At the same time, Sri Lanka’s relatively robust institutions and governance strength compared to similarly rated peers and a sizeable banking sector may support the government’s access to
funding at manageable costs.

The review period, which may extend beyond the usual three-month horizon, will allow Moody’s to assess the capacity of the government to secure financing at manageable costs and in a way that does not further weaken the country’s external position and threaten macroeconomic stability.

The review will also assess the likelihood of the government being able to stabilize its debt burden and restore better debt affordability once the most acute phase of the shock has passed.

Concurrently, Sri Lanka’s local currency bond and deposit ceilings remain unchanged at Ba2. The Ba3 country ceiling for foreign currency bond and B3 ceiling for foreign currency bank deposits also remain unchanged.

These ceilings act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.

RATINGS RATIONALE / FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE
RATINGS

RATIONALE FOR INITIATING A REVIEW FOR DOWNGRADE ON SRI LANKA’S B2 RATINGS
ACUTE TIGHTENING IN GLOBAL FINANCING CONDITIONS, ECONOMIC SHOCK, HEIGHTEN SRI
LANKA’S LIQUIDITY AND EXTERNAL VULNERABILITY

Like other emerging and frontier market sovereigns, Sri Lanka faces a severe tightening in financing
conditions and fall in revenue, including export revenue, from a sharp economic slowdown.

Compared to most other sovereigns, this shock occurs at a time when Sri Lanka’s credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt payments, and very weak debt affordability.

Prior to the coronavirus outbreak, the government’s fiscal position had already begun to weaken, amplifying long-standing debt affordability, liquidity and external credit weaknesses.

Tightening external financial conditions have resulted from large capital outflows and increased pressure on the exchange rate.

The Sri Lankan rupee has depreciated approximately 6% against the US dollar since the beginning of March, while spreads on Sri Lankan international sovereign bonds over US Treasuries have
widened sharply in recent weeks to around 1600 basis points, indicating significantly impaired market access.

These conditions are raising Sri Lanka’s cost of servicing external debt, weigh on foreign exchange reserves and jeopardize macroeconomic stability.

Meanwhile, the ongoing global shock will significantly curtail demand for Sri Lanka’s textile and garment
exports in major markets including the US and Europe