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Thursday December 8th, 2022

Sri Lanka CCC+ sovereign rating outlook downgraded to negative by S&P as reserves fall

ECNOMYNEXT – Standard and Poors’, a rating agency has cut the outlook of Sri Lanka’s CCC+ rating to negative as foreign reserves fell below two months of imports.

“We revised our outlook on Sri Lanka to negative to reflect our views that the government may face an increasingly challenging financing environment over the next 12 months,” S&P said.

“The negative outlook reflects our expectation that Sri Lanka’s financing environment may get more difficult over the next 12 months,” S&P said.

“This would affect Sri Lanka’s ability to service its debt. The country’s external position remains a key vulnerability on the rating.”

The rating agency said reserves had fallen below 3 billion US dollars or less than two months of import cover.

Though an International Monetary Fund is giving 800 million dollars in special drawing rights to boost reserves, and a number of currency swaps have been signed “the adequacy of reserves will still be tenuous without additional means to boost reserves,” the statement said.

There was about 5 billion US dollars in debt due in 2022.

In 2021 the budget deficit is expected to be around 10.2 percent of gross domestic product.

“The government has been increasing the share of domestic financing to fund the fiscal deficit,” the rating agency said.

“At the same time, domestic interest rates have been kept extremely low through massive liquidity injections by the central bank.

“While this has reduced the effective interest rate on the government’s domestic debt, an increase in domestic liquidity will also pressure the exchange rate.”

The government had cut value added taxes and had said it would keep the low rates.

Sri Lanka Outlook Revised To Negative; ‘CCC+/C’ Ratings Affirmed


Sri Lanka’s external position has weakened due to falling reserves and weak demand for Sri Lanka Development Bonds (SLDBs).

These developments continue to affect investor confidence and increase external financing difficulties.

We revised our outlook on Sri Lanka to negative to reflect our views that the government may face an increasingly challenging financing environment over the next 12 months.

We affirmed our ‘CCC+/C’ long- and short-term sovereign credit ratings on Sri Lanka.

Rating Action

SINGAPORE (S&P Global Ratings) Aug. 27, 2021–S&P Global Ratings revised its outlook on Sri Lanka’s long-term ratings to negative from stable. We also affirmed our ‘CCC+’ long-term sovereign credit ratings and ‘C’ short-term ratings on Sri Lanka.

The negative outlook reflects our expectation that Sri Lanka’s financing environment may get more difficult over the next 12 months. This would affect Sri Lanka’s ability to service its debt.

Downside scenario

We could lower our ratings if Sri Lanka’s attempts to boost reserves through the issuance of SLDBs, asset sales, and other means fall short of the government’s expectation, leading to higher risk on its ability to service debts.
Upside scenario

We may revise the outlook to stable, or raise the rating, if external buffers can be significantly boosted, or if Sri Lanka’s economic recovery is much stronger than we expected. This could lower the risks associated with the government’s debt-servicing capacity.

We revised the outlook to negative to reflect our assessment that risks to Sri Lanka’s debt-servicing capacity are rising, and the government’s access to external financing is increasingly dependent on favorable economic and financial conditions. The country’s relatively modest income levels, vulnerable external profile, sizable fiscal deficits, heavy government indebtedness, and hefty interest payment burdens reflect weak and evolving governance and institutional settings. These factors significantly constrain our ratings. While expansionary macroeconomic policies have provided some relief to the pandemic-hit economy, they have weakened the government’s fiscal position and worsened the risks associated with the government’s already high debt burden.

Institutional and economic profile: Pandemic uncertainty still hinders growth

While the economy is set to recover modestly this year, the ongoing pandemic continues to constrain mobility and shut out international tourists.

The Delta variant of COVID-19 is contributing to a third wave of infections and has put the country’s healthcare system under severe strain.

We expect economic policies to remain expansionary, while the government maintains a strong parliamentary majority.

Like most other countries, Sri Lanka’s economy continues to be affected by the COVID-19 pandemic. Real GDP growth rebounded strongly by 4.3% year on year in the first quarter of this year, given COVID-19 cases were more subdued and external demand, particularly for garments and medical gear, recovered. However, COVID infections surged again in May, resulting in the government re-imposing movement restrictions and closing the country again to international travel. Following the discovery of the infectious Delta variant in June, Sri Lanka is experiencing another, even more severe wave of infections, forcing the government to further tighten social mobility restrictions. Meanwhile, vaccination progress has ramped up in recent weeks, with more than 50% of the population receiving at least one dose.

Despite the pandemic being much more severe in Sri Lanka this year compared with last year, we still expect economic activity to recover from the low base in 2020. So far, the government has avoided a nationwide lockdown, which resulted in real GDP plunging 16.4% year on year in the second quarter of 2020. While the hospitalization rates are high and the healthcare system has been under severe strain, the vaccination rate is starting to accelerate. External demand, which has been fairly robust this year, is also expected to support the economy. However, the country has tightened various social restrictions, and that could dampen domestic economic activity in the second half of this year. We do not expect any meaningful recovery in tourism this year.

Downside risks to growth are still substantial, particularly given the unpredictable nature of the pandemic and the emergence of new infectious variants. A steep escalation in new infections could overwhelm Sri Lanka’s healthcare system and increase the risk of even stricter movement restrictions. Weakening external demand, particularly if the pandemic worsens in end-demand markets, could also remove an important source of support for the economy.

We forecast the economy will expand by 4.2% in real terms in 2021, following the 3.6% contraction in 2020, and average 4.2% from 2022-2024. This will bring per capita income to about US$3,900 in 2021, translating into real GDP per capita growth of 2.1% on a 10-year weighted-average basis. Although this growth is in line with peers at a similar income level, we believe that it is substantially below Sri Lanka’s potential.

Sri Lanka’s institutional setting is a credit weakness, in our view. Recent years have seen frequent political infighting that had occasionally hindered policy predictability. We believe these developments weigh on business confidence. While the current administration’s clear victories in both the presidential and parliamentary elections are likely to ease such uncertainty over policy direction, there has been further consolidation of power in the executive. In our view, this could lead to social tension, particularly if divisions along religious or ethnic lines persist.

Flexibility and performance profile: Falling reserves and uncertain financing conditions increase external funding difficulties

The external profile has weakened, with reserves falling below US$3 billion and financing conditions becoming more uncertain.

Sri Lanka’s fiscal deficit is likely to remain elevated while the pandemic continues to affect growth.

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

The country’s external position remains a key vulnerability on the rating. With the bullet repayment of the US$1 billion International Sovereign Bond in July 2021, the central bank’s reserve holdings have fallen below US$3 billion, or less than two months import cover. We expect the infusion of the newly approved Special Drawing Rights allocation by the IMF will boost reserves by about US$800 million.

However, this will not be sufficient for the government to meet upcoming maturities of more than US$5 billion till the end of 2022. Although the central bank has signed a number of bilateral currency swap arrangements with partnering central banks, including a 10 billion Chinese renminbi swap line with the People’s Bank of China, the adequacy of reserves will still be tenuous without additional means to boost reserves. The ability of the government to secure foreign financing over the next two quarters will be crucial to preventing an external liquidity crisis in 2022.

Financing conditions on the international capital markets remain challenging for Sri Lanka. These conditions are unlikely to improve in the short term due to rising inflation pressures, and prospects of a faster-than-expected policy tightening in advanced economies. While the government has been able to issue SLDBs to domestic creditors, demand for these SLDBs could be uncertain. Success in rolling over SLDBs is crucial to the government’s debt-servicing capacity. In turn, this will heavily depend on domestic creditors’ ability to access external financing under favorable terms.

Due to wide-ranging import restrictions and stable exports growth, the current account deficit has narrowed substantially to 1.3% of GDP in 2020 from 2.2% in 2019. We estimate the current account deficit will rise marginally to 1.6% of GDP in 2021. While most of the import restrictions will likely remain in place, higher fuel prices this year will lead to a larger import bill, offsetting the earnings from workers’ remittances. Latest high frequency data shows a strong recovery in imports alongside sustained improvements in exports. We expect these trends to be sustained despite new waves of the pandemic.

Sri Lanka’s external liquidity, as measured by gross external financing needs as a percentage of current account receipts plus usable reserves, is projected to average 129% over 2021-2024. We also forecast that Sri Lanka’s external debt net of official reserves and financial sector external assets will remain elevated at around 173% in 2021.

Persistent deficits in Sri Lanka’s fiscal position also remain a rating constraint. The government’s heavy debt burden limits its ability to accumulate policy buffers, which are crucial in times of stress. The COVID-19 pandemic has further devastated government finances by dampening domestic economic activity and lowering excise duty earnings.

In the last budget, the government 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. Instead of affecting the fiscal position only temporarily, these expansionary measures are likely to increase the deficit for an extended period, in our view. In the absence of extremely favorable economic and financial conditions, these measures are expected to constrain revenue growth and could be only partially offset by new revenue measures, such as the Special Goods and Services Tax.

The government is planning to significantly ramp up infrastructure spending over the next few years. While recurrent expenditure has been relatively contained, room for further cuts is limited due to the high interest burden. Healthcare-related spending may also increase fiscal pressure, particularly if the hospital system comes under further strain.

We expect the fiscal deficit to remain elevated at 10.2% of GDP in 2021 and narrow gradually to 8.4% in 2024. If revenue growth disappoints, we believe the government has some flexibility to cut capital expenditure to contain the fiscal deficit.

High fiscal deficits over an extended period will worsen the government’s extremely high debt stock. We expect the increase in net general government debt to average 10.3% over 2021-2024. Net general government debt has exceeded 100% of GDP in 2020 and will continue to increase over the next five years, in our view.

Sri Lanka’s debt profile is also vulnerable due to the high share of the total debt being denominated in foreign currency, although this has been reducing over the past year. The government has been increasing 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 injections by the central bank.

While this has reduced the effective interest rate on the government’s domestic debt, an increase in domestic liquidity will also pressure the exchange rate. With the central bank starting to increase policy rates, this will worsen the government’s interest burden at the margin. The government’s interest payment as a percentage of revenues has already reached 68.8% in 2020–the highest ratio 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 Ceylon Petroleum Corp., Ceylon Electricity Board, and Sri Lankan Airlines. Also, Sri Lanka’s financial sector has 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%.

Sri Lanka’s monetary settings remain a credit weakness, although it has seen some structural improvements. The Central Bank of Sri Lanka has been preparing an updated Monetary Law Act in recent years. 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.

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Sri Lanka in deep talent drain in latest currency crisis

ECONOMYNEXT – Sri Lanka businesses are facing a drain of talent, top business executives said as the country suffers the worst flexible exchange rate crisis in the history of its intermediate regime central bank and people lose hope.

“We are seeing a trend towards migrating,” Krishan Balendra, Chairman of Sri Lanka’s John Keells Holdings told an economic policy forum organized by the Ceylon Chamber of Commerce.

“We have seen an impact mainly on the tourist hotels side, quite an exodus of staff (migrating) to countries we have not seen in the past. 

“We have seen people go to Scotland, Ireland. It has usually been the Middle East and Maldives. Australia seems like a red hot labor market at the moment.”

Sri Lanka’s rupee collapsed from 200 to 360 to the US dollar after macro-economists printed money to suppress rates.

Sri Lanka operates a ‘flexible exchange rate’ where errors in targeting interest rates are compensated by currency depreciation especially after the 1980s.

Classical economists and analysts have called for the power to mis-target rates and operate dual anchor conflicting monetary regimes should be taken away to prevent future crisis.

Currency crises are problems associated with flexible exchange rate central banks which are absent in hard pegs and clean floats.

“Something new we are seeing is that older people, even those in their 50s, which was a surprise, are looking at migrating,” Balendra said.

Businesses are trying to retain talent as real wages collapse.

Balendra said as businesses they see some stability returning and based on past experience growth is likely to resume, and they were communicating with the workers.

“We have a degree of conviction that the economy should get better, its the stability phase now and it will get better going forward so without the way our businesses are placed we should see good growth,” Balendra said.

“We can’t chase compensation that’s just not practical and we are not trying to do that especially if people are looking to immigrate but what we can do is show the career opportunities in the backdrop of the situation that people would rather stay here because its home.” 

Sri Lanka unit of Heineken says it is also trying to convince workers not to leave, with more success.

“We are all facing the effects of brain drain and it’s not just the lower levels… What we are doing is a balance of daring and caring,” Maud Meijboom-van Wel – Managing Director / CEO, Heineken Lanka Ltd told the forum.

“Why I say daring is, you have to be clear in what you can promise people, when you make promises you have to walk the talk. So with the key talents and everyone you need to have the career and talent conversations.

“I am a bit lucky because I am running a multinational company so my career path goes beyond Sri Lanka so I can say if you acquire certain skills here, then you can move out of here and then come back too, that is a bit easier for me but it starts with having a real open conversation with walking the talk – dare and care.” (Colombo/Dec7/2022)


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Despite losses, Sri Lanka to resume “park & ride” transport after complaints  

ECONOMYNEXT –  Sri Lanka’s state-run Transport Board will resume its loss-making City Bus service from January 15, 2022 Cabinet Spokesman Bandula Gunawardena said, after the service abruptly discontinued with the state-run firm’s director board citing losses.

The City Bus service was introduced in 2021, under the government of former President Gotabaya Rajapaksa, from Makubura to Pettah and Bambalapitiya.

The service was started to reduce the number of automobiles travelling to and from Colombo and suburbs by providing a comfortable, convenient and safe public bus transportation for passengers and riders who use cars and motorcycles as their means of transportation.

During the time period in which the service was initiated, there were 800 hundred vehicles that would be parked and would use the system, Gunawardena, who is also the Transport Minister, said.

The service was later collapsed due to inconsistencies in scheduling and it was completely stopped after

“Without informing the Secretary or the Minister of the relevant Ministry, the Board of Directors have come to a conclusion that this is loss making route and must be halted,” Gunawardena said.

“The users of the City Bus service brought to our notice and therefore I gave the Secretary to the Ministry of Transport the approval to start the City Bus service from January 15.”

“If we stop all loss making transport services then massive inconveniences will occur to the people in far parts of the island.”

The chairman of the state run Ceylon Transport Board has been asked to handover the resignation letter by the Minister Gunawardana citing that the head has failed to implement a policy decision approved by the government. (Colombo/ Dec 06/2022)

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Sri Lanka may see rates falling next year: President

ECONOMYNEXT – Sri Lanka’s interest rates are high and hurting small businesses in particular but interest rates are required to maintain stability, President Ranil Wickremesinghe said.

“One is, all of you want to know what’s going to happen to the interest rates?,” President Wickremesinghe told an economic policy forum organized by the Ceylon Chamber of Commerce.

“I wish I know. The governor has told me that the inflation has peaked. It’s coming down. You all understandably want some relief with the interest rates to carry business on.”

“I understand that and appreciate the viewpoint. It’s not easy to carry business on with such high interest rates. On the other hand, the Central Bank also has to handle the economy. So maybe sometimes early next year we will have a meeting of minds of both these propositions.”

Sri Lanka’s interest rates are currently at around 30 percent but not because the central bank is keeping it up. The central bank’s overnight policy rate is only 15.5 percent but the requirement to finance the budget deficit and roll over debt is keeping rates up.

Rates are also high due to a flaw in the International Monetary Fund’s debt workout framework where there is no early clarity on a whether or not domestic debt will be re-structured.

After previous currency crises, rates come down after an IMF deal is approved and foreign loans resume and confidence in the currency is re-stabilished following a float.

This time however there has been no clear float, though the external sector is largely stable and foreign funding is delayed until a debt re-structure deal is made.

Sri Lanka’s external troubles usually come because the bureaucrats do not believe market rates are correct when credit demand picks up and mis-uses monetary tools given in 1950 by the parliament to suppress rates, blowing the balance of payments apart.

The result of suppressed rates by the central bank are steep spikes in rates to stop the resulting currency crisis.

A reserve collecting central bank has little or no leeway to control interest rates (monetary policy independence) without creating external troubles, which is generally expressed as the ‘impossible trinity of monetary policy objectives’.

However, it has not prevented officials from trying repeatedly to suppress rates, perhaps expecting different results.

After suppressed rates – supposedly to help businesses – trigger currency crises, the normalization combined with a currency collapse leads to impoverishment of the population.

The impoverishment through depreciation leads to a consumption shock, which also leads to revenue losses in businesses.

The suppressed rates then lead to bad loans.

In the 2020/2022 currency crisis the sovereign default has also led to more problems at banks. Several state enterprises also cannot pay back loans.

“…[T]he bad debt that is being carried by the banks is mainly from the private sector or the government sector,” President Wickremesinghe said.

“Keep the government sector aside. We’re dealing with it. How do you handle it? Look, one of our major areas of are the small and medium industries. You can’t allow them to collapse, but they’re in a bad way.”

Classical economists and analysts have called for new laws to block the ability to central bank to suppress rates in the first place so that currency crises and depreciation does not take place in the first place.

Then politicians like Wickremesinghe do not have to take drastic and unpopular measures to fix crises and there will be stability like in East Asia.

Sri Lanka had stability until 1950 when the central bank was created by abolishing an East Asia style currency board. The currency board kept the country relatively stable through two World Wars and a Great Depression.

In 1948 after the war (WWII) was over “we stood second to Japan” Wickremesinghe said.

“But we started destroying it from the sixties and the seventies,” he said. :We started rebuilding an economy, which was affected by a (civil) war, and thereafter the way we went, is best not described here.”

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