Sri Lanka among most vulnerable to rising interest rates: Moody’s

ECONOMYNEXT – Sri Lanka one of the sovereigns that are most sensitive to rising global interest rates given forthcoming debt repayments that are more than its foreign exchange reserves, Moody’s Investors Service said.

The rating agency said Sri Lanka’s high external vulnerability is reflected in an External Vulnerability Indicator (EVI), the ratio of external debt payments due over the next year to foreign exchange reserves, of nearly 160%.

“Renewed financial market correction highlights vulnerability of some emerging and frontier markets,” Moody’s said in its just-released report, "Sovereigns – Global Contagion risks greatest where external vulnerability, weak debt affordability meet low policy credibility".

The report examines the countries that have been worst hit by a tightening in financing conditions this year.

It draws on Moody’s previous analyses of where — aside from Turkey — vulnerability to a sharp and sustained deterioration in financing conditions is greatest.

Moody’s said the fallout from the correction in Turkey’s exchange rate and asset prices highlights again the external vulnerability and sensitivity to a rise in the cost of debt of some emerging and frontier market nations.

“Those economies most sharply hit by weakening exchange rates, wider risk premia and lower capital inflows so far this year share the characteristic of twin current account and budget deficits, while country-specific factors — often relating to policy credibility — have likely also fueled the financial market sell-off.”

Looking at the size and composition of their balance of payments and the amount of financial buffers in the form of foreign exchange reserves, Moody’s identified Argentina, Ghana (B3 stable), Mongolia (B3 stable), Pakistan (B3 negative), Sri Lanka (B1 negative) and Zambia, beside Turkey, as the emerging and frontier market sovereigns most vulnerable to dollar appreciation.

Among countries Moody’s identified as most vulnerable to an appreciation of the US dollar, Argentina and Pakistan’s currencies have xperienced particularly marked falls against the dollar, of nearly 40% and around 10% year to date respectively.

“Ghana and Sri Lanka have seen smaller declines in their currencies, of around 6% and 4% respectively,” the report said.

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In Sri Lanka’s case, while foreign exchange reserves have increased over the past year, pressure on them will likely persist absent sustained capital inflows, as external debt repayment requirements increase materially in 2019-22.

“The government’s gross borrowing requirement of about 18.5% of GDP and foreign currency composition of outstanding debt at about 46% also contribute to making Sri Lanka one of the sovereigns that are most sensitive to tightening external financing conditions,” Moody’s said.

“Mitigating this exposure somewhat, the average maturity of government debt at 5.7 years implies moderate rollover risk. However, similar to Pakistan, we find that Sri Lanka’s debt affordability would weaken further should the cost of new debt rise and stay at higher levels.”
(COLOMBO, 24 August, 2018)
 

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