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Tuesday February 27th, 2024

S&P downgrades Sri Lanka sovereign rating to ‘CCC+’, over budget, excess liquidity

ECONOMYNEXT – Standard and Poor’s, said it was downgrading Sri Lanka to ‘CCC+’ saying a high budget deficit and excess liquidity is likely put pressure on the exchange rate and make it more difficult to repay debt.

“The latest expansionary budget measures are likely to further weaken the government’s fiscal position,” the rating agency said.

“High fiscal deficits and excessive domestic liquidity will put downward pressure on the exchange rate and worsen the risks associated with the government’s already-high debt burden. ”

Sri Lanka had in the recent past had seen political infighting hurting policy predictability.

“While the current administration’s clear victory in August’s parliamentary election is likely to ease such uncertainty over policy direction, further consolidation of power in the executive may increase institutional risks,” S&P said.

“This could affect the stability of the legislature or the judiciary system, and in turn, hit policy predictability and business confidence. Social stability could also be undermined, if divisions along religious or ethnic lines persist. ”

The full statement is reproduced below:

Sri Lanka Downgraded To ‘CCC+/C’ On Increasing External Financing Risks And Fiscal Deterioration; Outlook Stable

Overview

• With the implementation of expansionary budget measures in Sri Lanka, we expect the country’s fiscal position to deteriorate materially over the next few years in the absence of favorable economic and financial conditions.

• Existing funding support from official sources do not appear sufficient to cover financing needs. This means that Sri Lanka may need external commercial funding, which can be difficult and costly.

• As a result, we are lowering our long-term sovereign credit ratings on Sri Lanka to ‘CCC+’ from ‘B-‘.

• The outlook is stable, reflecting the risks of external deterioration balanced against accommodative policies over the next 12 months.

Rating Action

On Dec. 11, 2020, S&P Global Ratings lowered its long-term foreign and local currency sovereign credit ratings on Sri Lanka to ‘CCC+’ from ‘B-‘. We also lowered our short-term foreign and local currency credit ratings to ‘C’ from ‘B’. The transfer and convertibility assessment is revised to ‘CCC+’ from ‘B-‘. The outlook is stable.

Outlook

The stable outlook reflects that, at this lower rating level, risks to Sri Lanka are relatively balanced over the next 12 months. Risk of external deterioration is partially offset by accommodative policies that are likely to boost domestic demand recovery.

Downside scenario

We could lower our ratings if external buffers decline substantially more than we currently forecast, or access to external financing proves extremely difficult. This would hurt Sri Lanka’s debt servicing capacity.

Upside scenario

We would raise the rating if external buffers can be significantly boosted, or if the economic recovery is much stronger than we expected, thus helping to improve government revenues and stabilizing debt levels.

Rationale

We lowered our ratings on Sri Lanka based on our assessment that risks to debt servicing capacity have risen, as the government’s access to external financing has become increasingly dependent on favorable business, economic, and financial conditions.

The downgrade stems in part from the impact of COVID-19, which has significantly narrowed the government’s fiscal space and its capacity to generate earnings through sectors such as tourism.

The latest expansionary budget measures are likely to further weaken the government’s fiscal position.

High fiscal deficits and excessive domestic liquidity will put downward pressure on the exchange rate and worsen the risks associated with the government’s already-high debt burden.

Our ratings on Sri Lanka reflect the country’s relatively modest income levels, weak external profile, sizable fiscal deficits, heavy government indebtedness, and hefty interest payment burdens.

Institutional and economic profile: Economy expected to contract sharply in 2020

• We expect a severe economic contraction this year as COVID-19 has devastated external demand and constrained domestic activity.

• A fresh wave of infections in October underscored the fragility of any economic revival prior to widespread availability of a vaccine.

• While parliamentary elections produced a more unified government, recent changes to the constitution will likely further concentrate powers in the president, weakening checks and balances.

Sri Lanka’s economy is suffering another major blow in 2020. Tourism and export activities declined due to COVID-19, and the recovery has been taking longer than expected. The economy entered the pandemic on a weak footing, with growth consistently languishing below potential in recent years, due to a confluence of exogenous shocks and intractable political difficulties.

We forecast the economy will contract sharply by 5.3% in 2020 largely due to the COVID-19 pandemic. Although the negative economic impact likely peaked in the second quarter of 2020, the nascent recovery was derailed by another wave of infections in early October. While the country has not reimposed stringent lockdown measures, leading indicators, including the Purchasing Managers Index, showed a sharp pullback in activity. Given that COVID-19 developments could be unpredictable, with many neighboring countries experiencing repeated waves of infections, any economic recovery before widespread availability of a vaccine is likely to be muted and prone to reversals.

Nevertheless, we believe Sri Lanka’s economy will recover in 2021, boosted by a stabilization in domestic activity and expansionary monetary and fiscal settings. External demand should also recover more strongly, particularly if tourism flows could restart.

We expect real GDP growth to accelerate to 4.3% in 2021, albeit from a low base, and average 4.5% in 2021-2023. Our estimate for real per capita income is about US$3,900 in 2021. This translates to real GDP per capita growth of 1.8% on a 10-year weighted average basis. Although this growth is in line with peers at a similar income level, it is substantially below Sri Lanka’s growth potential.

Sri Lanka’s institutional setting has been a persistent credit weakness over the past few years. Frequent political infighting and at-times unpredictable developments have hindered policy predictability and weighed on business confidence, in our view.

While the current administration’s clear victory in August’s parliamentary election is likely to ease such uncertainty over policy direction, further consolidation of power in the executive may increase institutional risks.

This could affect the stability of the legislature or the judiciary system, and in turn, hit policy predictability and business confidence. Social stability could also be undermined, if divisions along religious or ethnic lines persist.

S&P Global Ratings believes evolution of the coronavirus pandemic remains highly uncertain. Reports of vaccines that are highly effective gaining approval in more countries are promising, but this is merely the first step toward a return to social and economic normality; equally critical is the widespread availability of effective immunization, which could come by the middle of next year.

We use this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Flexibility and performance profile: Fiscal position has deteriorated further and risk over debt sustainability has increased

• Sri Lanka’s fiscal deficit is likely to remain elevated due to medium-term measures announced in the budget.

• This will likely worsen the government’s heavy indebtedness and add to repayment burden.

• The external profile remains weak, given that the high share of dollar-denominated debt exposes the government to shifts in risk sentiments.

Persistent deficits in Sri Lanka’s fiscal and external positions remain rating constraints. The government’s heavy debt limits its ability to accumulate policy buffers, which are crucial in times of stress.

COVID-19 has further devastated government finances by dampening domestic economic activity and lowering excise duty earnings. Instead of one-off measures to counter the economic impact of COVID-19, the expansionary measures introduced in the Sri Lanka’s 2021 budget are likely to increase the deficit for an extended period, in our view.

In the latest budget, the government has committed to keeping the wide-ranging tax cuts, including a lower value-added tax (VAT) rate, increasing the VAT turnover threshold and removing the 2% Nation Building Tax, for five years.

In addition, the government also plans to provide various tax exemptions and incentives to boost domestic production and encourage import substitution.

In the absence of extremely favorable economic and financial conditions, these measures are expected to constrain revenue growth and could only be partially offset by new revenue measures, such as the Special Goods and Services Tax.

On the expenditure front, the government is planning to significantly ramp up infrastructure spending over the next few years. While recurrent expenditure will be relatively contained, room for further cuts is limited due to the high interest burden. Healthcare and security-related spending may also increase fiscal pressure.

We expect the fiscal deficit to remain elevated at 10.2% of GDP in 2021 and narrow gradually to 8.4% in 2023.

A high portion of Sri Lanka’s government debt is denominated in foreign currency, and the country’s exchange rate may weaken further. Higher fiscal deficits over a longer period will add to the government’s extremely high debt stock. For those reasons, we expect the increase in net general government debt to average 11% over 2020-2023. By our estimate, net general government debt will exceed 100% of GDP in 2021 and remain elevated over the next five years.

The government intends to increase the share of domestic financing to fund the fiscal deficit. At the same time, domestic interest rates have been kept extremely low through massive liquidity injection by the central bank. This has reduced the effective interest rate on the government’s domestic debt. We estimate interest payments to reach 60% of government revenues in 2020, slightly lower than what we expected previously. Nevertheless, this is one of the highest ratios among the sovereigns we rate.

We assess the government’s contingent liabilities from state-owned enterprises and its relatively small financial system as limited. However, risks continue to rise due to sustained losses at the Ceylon Petroleum Corp. (CPC), Ceylon Electricity Board (CEB), and the Sri Lankan Airlines (SLA).

Although CPC and CEB have improved their financial positions as a result of the drastic decline in global oil prices, SLA is likely to continue accumulating losses due to the impact on air travel.

Also, Sri Lanka’s financial sector has a limited capacity to lend more to the government without possibly crowding out private-sector borrowing, owing to its large exposure to the government sector of more than 20%.

The country’s external position has deteriorated compared with our last review due to current account receipts declining more than we had expected. However, lower oil prices and wide-ranging import restrictions imposed by the government have also kept the import bill under control. We estimate the current account deficit will widen marginally to 2.7% of GDP in 2020.

Sri Lanka’s external liquidity, as measured by gross external financing needs as a percentage of current account receipts (CAR) plus usable reserves, is projected to average 117% over 2020-2023. We also forecast that Sri Lanka’s external debt net of official reserves and financial sector external assets will rise sharply to 206% in 2020, partly due to poor export earnings.

The government’s external financing conditions have become more challenging, and uncertainty over access to official creditors has increased, in our view. The government has received US$500 million in official loans for budgetary support so far this year. Credit lines with other central banks have also helped to augment foreign exchange reserves to some extent.

However, we see increasing indications that funding from multilateral or bilateral partners will not be sufficient to cover external financing needs over the next 12 months. The government has had to repeatedly draw on reserves to meet its external debt obligations.

As of end-October 2020, foreign exchange reserves stood at US$5.9 billion, down from US$7.6 billion at the start of the year. This might be enough to cover maturities over the next 12 months, but it would bring reserves down to a dangerously low level.

If economic and financial conditions turn even more negative, we believe the government’s external debt-servicing capacity could be severely impaired.

Sri Lanka’s monetary settings remain a credit weakness, although it has seen some structural improvements in recent years. The Central Bank of Sri Lanka is preparing to transition to a flexible inflation-targeting regime under the proposed Monetary Law Act. The passage of this act, which enshrines the central bank’s autonomy and capacity, will be crucial to improving the quality and effectiveness of monetary policy, in our view.

Environmental, social, and governance (ESG) credit factors for this credit rating change:
• Health and safety

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Sri Lanka parliamentary committee says electricity tariffs should be reduced by 20 pct

ECONOMYNEXT — A parliamentary Sectoral Oversight Committee on Alleviating the Impact of the Economic Crisis has recommended to the Public Utilities Commission of Sri Lanka (PUCSL) that electricity tariffs be reduced by at least 20 percent.

A statement from parliament said on Monday February 26 that, following an analytical review of the figures presented by the Electricity Board, Public Utilities Commission, etc. and taking into consideration all other factors affecting the price of electricity, including considering the opinion given by experts that the existing electricity price can be reduced by about 33%, price of electricity should be reduced by at least 20% in the year 2024 so that the state-run Ceylon Electricity Board (CEB) will not suffer any loss.

PUCSL officials have informed the Committee that by the end of this month, they can submit the necessary recommendations to reduce the electricity bill, according to the statement.

The matter was taken up for discussion when the committee, chaired by MP Gamini Waleboda, met in the Parliament on February 22.

Officials from the Ministry of Industry, Ministry of Finance, Central Bank of Sri Lanka, Public Utilities Commission, Industry Development Board, Enterprise Development Authority, Department of Population and Statistics, Department of Inland Revenue and from government institutions including the Micro, Small and Medium Scale Industries Board and a group of industrialists had also been called for the meeting.

“The Committee gave several directives to the relevant institutions and officials to identify the micro, small and medium scale industries that are directly affected by the economic crisis and to activate the local economy and increase the foreign exchange earnings by reviving the industry sector.

“The Committee pointed out that due to the increase in electricity bills, the number of electricity connection cuts reported across the island has exceeded one million. It was also emphasised that in order to alleviate the pressure on the industry and the society, it should be arranged to provide electricity connections again by charging only 50 percent of the outstanding charges at the initial stage with the concessional basis of payment of outstanding electricity charges on installment basis,” the statement said.

The committee was also of the view to allow the customer to pay the connection fee in installments so as to avoid discouraging new entrepreneurs to start micro, small and financial industries due to high charges for getting fixed electricity connection and instructed to review the new connection fee and work to reduce it as much as possible.

The committee chair has instructed the PUCSL to conduct an audit on the electricity consumption in the public sector as an approach to ensure energy security.

“The Committee recommended to the Ministry of Finance and the Central Bank to start a loan scheme at subsidised interest for the purchase of solar panel systems with a view to promoting solar energy as a source of energy supply to industries. The Ministry of Finance expressed its agreement to provide refinancing facilities subject to a maximum as per the proposal made by the Committee to implement a loan scheme targeting micro, small and medium scale industrialists under subsidized interest rates.

The committee has also recommended that raw materials that must be imported from abroad and impose tax concessions on such raw materials be identified to ensure the supply of raw materials required for the smooth running of micro, small and medium scale industries. Copper, lead, aluminum and other industrial scraps used as raw materials in various domestic industries currently being sold by the CEB to external buyers and other entities should also be issued to micro, small and medium scale industrialists recommended by the Ministry of Industry and the Industrial Development Board, the committee has recommended.

The definition used by the Department of Population and Statistics for micro, small and medium industries and the definition used by other institutions such as the Industrial Development Board and the Central Bank for those industries are different from each other, which is an obstacle in making policy decisions, the committee had noted, directing the Department of Population and Statistics to support to the policymakers by releasing statistical data based on a common definition.

“The committee also recommended that the Credit Information Bureau should take prompt action to remove their credit information from the blacklists so as to facilitate access to credit facilities for micro, small and medium scale industries facing financial crisis to activate their balance sheets and to review all existing laws and procedures for registration of micro, small and medium scale industries as well as to obtain licenses and introduce a simple system.

“The committee informed all the parties to establish a steering Committee headed by the Ministry of Industry to implement the recommendations given by the Committee and to report its progress within a week,” the statement said. (Colombo/Feb27/2024)

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Sri Lanka sets up fund to help children of Gaza

The United Nations Relief and Works Agency for Palestine Refugees in the Near East is mandated to provide education, health, relief and social services, and emergency assistance to refugees. (Pic courtesy UNWRA)

ECONOMYNEXT – Sri Lanka’s cabinet of ministers have approved a proposal by President Ranil Wickremesinghe to set up a fund to help children caught in the war in Gaza, a statement said.

The government will contribute a million US dollars and use funds allocated by state agencies for Ifthar celebrations.

Public contributions are also called.

The Presidential Secretariat is requesting public donations citizens for the “Children of Gaza Fund” to be contributed to account number 7040016 at Bank of Ceylon (7010), Taprobane Branch (747) by 11th April.

Deposit receipts should to be forwarded to 0779730396 via WhatsApp. (Colombo/Feb27/2024)

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Top US official calls for inclusive reforms, deeper defence ties with Sri Lanka

ECONOMYNEXT — United States Deputy Secretary of State for Management and Resources Richard Verma in discussions with Sri Lanka officials had called for inclusive reforms and stronger human rights and also discussed deeper defence and maritime cooperation.

The United States remains committed to the economic growth and prosperity of Sri Lanka, statement from the US Embassy in Colombo quoted the official as telling government, civil society and economic leaders during his February 23-24 visit to Sri Lanka.

“Verma met with President Ranil Wickremesinghe and Foreign Minister Ali Sabry to discuss progress on Sri Lanka’s IMF program, including inclusive economic and governance reforms aimed at keeping Sri Lanka on the path to sustainable economic growth.  Deputy Secretary Verma stressed the vital need to protect human rights and fundamental freedoms, including freedom of expression. They also explored opportunities to deepen defence and maritime cooperation between the United States and Sri Lanka, including strengthening the Sri Lanka Navy’s capabilities to safeguard national security and promote a more stable Indo-Pacific region,” the statement said.

 On February 23, aboard the SLNS Vijayabahu, one of three former U.S. Coast Guard cutters transferred by the United States to Sri Lanka, Deputy Secretary Verma said: “I am pleased to announce that the Department of State has notified Congress of our intent to transfer a fourth medium endurance cutter to Sri Lanka.  The Department obligated $9 million in Foreign Military Financing to support this effort.  We look forward to offering the cutter, pending the completion of Congress’ notification period.  If completed, this transfer would further strengthen defense cooperation between the United States and Sri Lanka.  The ship would increase Sri Lanka’s ability to patrol its Exclusive Economic Zone, monitor its search and rescue area, and provide additional security for ships from all nations that transit the busy sea lanes of the Indian Ocean.” 

 Participating in the announcement at Colombo Port were Sri Lanka State Minister of Defense Premitha Bandara Tennakoon, Commander of the Sri Lanka Navy Vice Admiral Priyantha Perera, and U.S. Ambassador to Sri Lanka Julie Chung, who remarked, according to the statement: “The United States has previously transferred three cutters to the Sri Lankan Navy, which deploys these ships for maritime operations and law enforcement missions, countering human trafficking and drug trafficking, while supporting humanitarian assistance and disaster response efforts. The eventual transfer of a fourth vessel would be just one more point in a long history of cooperation between Sri Lanka and the United States in preserving a free and open Indo-Pacific region.” 

Verma also visited the site of the West Container Terminal (WCT), a deepwater shipping container terminal in the Port of Colombo. The WCT, currently being constructed by Colombo West International Terminal (CWIT) Private Limited with 553 million US dollars in financing from the U.S. International Development Finance Corporation, will provide critical infrastructure for the South Asian region, the embassy said.

“Operating near capacity since 2021, the Port of Colombo’s new addition will be the port’s deepest terminal and aims to boost Colombo’s shipping capacity, expanding its role as a premiere logistics hub connecting major routes and markets, boosting prosperity for Sri Lanka without adding to its sovereign debt,” it said. (Colombo/Feb27/2024)

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