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Sri Lanka companies rated above implied sovereign after ‘stimulus’ linked downgrade

ECONOMYNEXT – Several publicly trade firms in Sri Lanka which operate in ‘defensive’ sectors that can weather downturns have been rated higher than an implied domestic rating of the sovereign in the wake of a downgrade that came after a fiscal and monetary stimulus in 2020.

Sri Lanka’s international sovereign rating used to rate dollar debt was downgraded from ‘B’ to ‘B-‘ by Fitch in 2020 after tax cuts (fiscal stimulus) undermined tax revenues and unprecedented money printing (monetary stimulus), hit the exchange rate and renewed fears over foreign loan default.

Fitch then ‘re-calibrated’ the domestic (lka) rating scale to reflect the latest sovereign rating.

The implied domestic rating of the sovereign then fell from AAA/AA+ to a range between AA+ to BB+ indicating an implied maximum of ‘AA+(lka)’, after 2020 downgrade.

But Dialog Axiata Plc, Melstacorp Plc, Distilleries, Lion Brewery Plc and Hemas Holdings are now rated ‘AAA(lka)/stable’, which is above the implied domestic rating of the sovereign.

For a company to have a domestic rating higher than the sovereign its business and financial risks should be similar to a ‘B’ rated global peers, Fitch said.

“The corporate has to be able to withstand domestic operating environment pressures and still maintain a credit profile in the international rating of ‘B’ or higher,” Fitch said.

However a domestic company’s ability to meet foreign currency obligations usually cannot exceed the country ceiling.

A soft-pegged central bank that prints money will usually also imposes exchange controls, analysts say.

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Fitch said Dialog Axiata was the market leader in mobile and pay TV and there was “defensive demand for its products and services through economic cycles,” strong cash flows.

Lion Brewery was the market leader in beer and had high entry barriers partly coming from regulation, strong brand, distribution network and cash flows.

Melstacorp was also a market leader in spirits, which had entry barriers. It had inelastic demand in off-premises demand for spirits and strong cash flows.

Hemas Holdings was in defensive healthcare and consumer sectors.

Sri Lanka’s banks which have high exposure to the government and also depend on support are not rated above the sovereign.

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It had market leadership in pharmaceutical distribution, stationary and some personal care products and had a conservative approach to expansion, Fitch said.

Sri Lanka has a highly unstable ‘flexible’ exchange rate (soft-peg) regime, driven by contradictory money and exchange rate policies coming from targeting both the exchange rate and interest rates.

A collapse of the ‘flexible’ exchange rate in 2018 was also accompanied by a credit downgrade, despite gains in containing the budget deficit and tax hikes.

There have been to call to reform the central bank, which was set up by an expert from the Latin America department of the New York Fed in 1950, with extensive money printing powers, so that monetary stability would be restored and Sri Lanka can grow. (Colombo/July21/2020)