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Sri Lanka bank operating conditions weaken, sovereign risk limit ratings: Fitch

ECONOMYNEXT – The operating environment is continuing to weaken amid a Coronavirus pandemic and sovereign credit which had already been downgraded to ‘B-‘ putting a ceiling on bank credit, Fitch, a rating agency said.

Fitch is expecting Sri Lanka’s economy to contract 1.3 percent in 2020 and bad loans to rise from the 5.1 percent reported in the first quarter of 2020, though regulatory relief will keep classification low.

“Fitch believes that there is a strong link between the sovereign credit profile and the operating conditions for banks in Sri Lanka,” the rating agency said.

“This is because our forecast 1.3 percent GDP contraction in 2020 will constrain the banks’ growth and recovery prospects and the increased risk of sovereign debt distress will limit banks’ access to and cost of foreign funding.”

Fitch recently changed Sri Lanka’s domestic rating scale to match the sovereign rating which was downgraded from ‘B’ to ‘B-‘.

A sovereign international rating of ‘B-‘ translates to a ‘BB+(lka)’ domestic rating. Bank ratings are in part driven by state support.

Banks also hold government debt in their balance sheets.

“Sri Lankan commercial banks also have significant exposure to the state mostly through investments in government securities,” the rating agency said.

“Total exposure was over 25 percent at end-2019. This underscores our view that it is unlikely that a domestic bank would be rated above the sovereign rating.

High exposure to bonds will in generate capital gains amid falling rates, analysts say.

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Several companies in Sri Lanka including Dialog Axiata, Melstacorp, Lion Brewery and Hemas Holdings are rated above the sovereign at ‘AAA(lka)/stable.

Fitch believed that Sri Lanka’s “economy is more susceptible to negative shocks after having previously experienced significant volatility in economic variables, such as interest rates and exchange rates in times of stress.”

“We believe that should the sovereign credit profile deteriorate further, the operating environment will also worsen, including weakening of public- and private-sector balance sheets, funding market dislocations and macroeconomic volatility.”

Sri Lanka’s 5-year growth rate was below the median for ‘B’ rated countries and credit growth was also slow, Fitch said.

A strong 5.1 percent growth in the first quarter had been hit by the Coronavirus pandemic and Fitch expected credit growth to be ‘muted’. (Colombo/July20/2020)