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Wednesday March 29th, 2023

Sri Lanka continues monetary financing of imports, pegging after ‘running out’ of reserves

ECONOMYNEXT – Sri Lanka’s central bank has spent 222.73 million US dollars defending a peg and engaging in monetary financing of imports in June 2022, three months after apparently ‘running out’ of reserves, official data show.

Sri Lanka defaulted in April 2012 after two years of money printing to suppress interest rates combined with tax cuts in the worst currency crisis triggered by the central bank in its history.

At the time officials said the country had run out of reserves.

In March the rupee collapsed from 200 to 360 to the US after a botched attempt at floating (suspending convertibility) with a surrender rule (forced dollar sales to the central bank) and too low policy rates to curtail credit.

However the central bank continued to intervene in forex markets in both sides of a peg (now around 360 to the US dollar). When interventions are made with borrowed ACU dollars from India the central bank gets deeper into debt.

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Sri Lanka central bank deep in debt, dollar shortages at ‘guidance’ rate : Wijewardena

In June the central bank had bought 68 million dollars from banks, which are experiencing severe forex shortages due to a dysfunctional peg, down from 76.6 million US dollars a month earlier, putting pressure on the peg.

The central bank then sold 222.74 million dollars to defend the peg, engaging in monetary financing of imports.

The central bank gets deferred payments from the Reserve Bank of India and spends them on monetary financing of imports getting deeper into debt.

After giving dollars for imports, a pegged central bank then sterilizes the intervention injecting new money to maintain a policy rate and prevent reserve money from shrinking, effectively monetary financing imports by replacing lost rupee reserves in banks.

Related

Sri Lanka imports surge to US$2.2bn in Dec 2021 after reserves sales

However June reserve money growth slowed amid high interest rates, and is appearing to be shrinking in July as the economy is smashed by high interest rates and forex shortages.

In Sri Lanka there is a strong belief among economists who have rejected classical theory and also the business community that reserves should be used to finance imports and help the country live beyond its means due to the rejection of classical economics.

There were widespread calls for monetary financing of imports in Sri Lanka despite the country running low in early 2021 and imports having shot up over 2.0 billion US dollars by December after three months of sterilized interventions between 300 to 400 million US dollars a month.

Interventions are sterilized with the acquisition of government securities in banks, not private securities unlike in the days of the classical greats when central banks operated a floating policy rate against bankers acceptances, and it appears as budget financing to later observers. (Sri Lanka, world’s poor suffers from Fed’s accidental discovery)

After printing money to create forex shortages Sri Lanka’s economists in authority also have a habit of importing fuel on credit, further boosting imports and getting state enterprises in to debt.

However after a default in April 2012 the time honoured tactic of indebting the CPC is no longer possible and oil imports have been settled quickly or pre-paid like any other import. However attempts are still being made to consume on borrowed money through credit line.

Sri Lanka also tried to get 6.0 billion US dollars of ‘bridging finance’ for imports and other spending in 2022 after defaulting in April 2012.

Since defaulting in April and running out of reserves, 337 million dollars had been spent on interventions with energy sector officials in particular pressing the central bank for money to import oil via pegging (weak side convertibility).

Clean floating central bank do not give a cent for imports.

Economists in authority Sri Lanka got the ability to create currency crises on August 28, 1950 with the creation of a money printing soft-peg after abolishing a hard peg that had kept the country stable for almost 70 years.

Analysts had warned that contradictory policy and a botched float would lead to continued monetary instability and high interest rates with damaging effects on the banking system unless a working monetary regime is established. (Colombo/July18/2022)

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Sri Lanka stocks weaken for the second session on profit taking

ECONOMYNEXT – Sri Lanka’s stocks closed weaker on Tuesday for the second consecutive session mainly driven by month-end profit-taking by investors, according to brokers.

The main All Share Price Index (ASPI) closed down 0.56 percent or 51.81 points to 9,233.40.

The market has been on a downward trend since last week as investors are adopting a wait-and-see approach until more clarity is given regarding local debt restructuring after the International Monetary Fund approved the extended loan facility.

“The market is down as the selling trend continues,” said Ranjan Ranatunga of First Capital Holdings, speaking to EconomyNext.

“As there is a price decline in all shares across the board, combined with the month ending followed by margin calls, the market continued on a downward trend.”

The market generated a slow and thin turnover of 860 million rupees.

The main contributor to the turnover is Lanka IOC, following news that the Sri Lanka cabinet has granted approval for three oil companies from China, the United States, and Australia in collaboration with Shell Pl to lease 150 fuel stations for each company to operate in the local market.

The fears of debt restructuring mainly affected the banking and financial sectors, which dragged the index down for the day.

The market saw a net foreign inflow of 30.9 million rupees, and the total offshore inflows recorded so far in 2023 are 1.01 billion rupees.

The most liquid index, S&P SL20, closed 0.81 percent or 21.68 points down at 2,656.30.

The market saw a turnover of 860 million on Tuesday, below this year’s daily average of 1.8 billion rupees.

Top losers were Vallibel One, John Keells Holdings, and Hatton National Bank.

Analysts said the downward trend is expected to continue for the rest of the week as profit-taking is expected to continue. (Colombo/March28/2023)

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Sri Lanka rupee closes weaker at 325/328 to dollar, bond yields up

ECONOMYNEXT – Sri Lanka’s treasury bond yields were up at close on Tuesday and the rupee closed weaker in the spot market, dealers said.

A 01.07.2025 bond was quoted at 31.20/60 percent on Tuesday, up from 30.75/31.00 percent on Monday.

A 15.09.2027 bond was quoted at 28.25/29.00 percent, up from 28.10/60 percent from Monday.

Sri Lanka rupee opened at 325/328 against the US dollar steady, from 322/325 from a day earlier. (Colombo/ March28/2023)

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Sri Lanka Telecom on track rating upgrade track on planned stake sale: Fitch

ECONOMYNEXT – Sri Lanka Telecom has been place on watch for a possible rating upgrade after the government, which has defaulted on its sovereign debt said it will sell down its majority stake.

“The rating reflects the potential rating upside due to weakening linkages with SLT’s parent, the government of Sri Lanka (Long-Term Local-Currency Issuer Default Rating: CC), due to the government’s plan to sell its 49.5 percent stake in the company,” the rating agency said.

“Fitch will resolve the RWP when the proposed disposal becomes practically unconditional, which
may take more than six months.”

The agency said it expect SLT’s revenue growth to slow to a low single-digit percentage in 2023 amid weakening consumer spending due to consumers increasingly prioritising essential needs, such as food and medicine, as real income has fallen significantly following the currency depreciation and unprecedently high inflation.

The full statement is reproduced below;

Fitch Places Sri Lanka Telecom’s ‘A(lka)’ Rating on Watch Positive

Fitch Ratings – Colombo – 27 Mar 2023: Fitch Ratings has placed Sri Lanka Telecom PLC’s (SLT) National Long-Term Rating of ‘A(lka)’ on Rating Watch Positive (RWP).

The RWP reflects the potential rating upside due to weakening linkages with SLT’s parent, the government of Sri Lanka (Long-Term Local-Currency Issuer Default Rating: CC), due to the government’s plan to sell its 49.5% stake in the company. Fitch will resolve the RWP when the proposed disposal becomes practically unconditional, which may take more than six months.

SLT’s ratings are currently constrained by its parent’s weak credit profile under Fitch’s Parent and Subsidiary Linkage (PSL) Rating Criteria. SLT’s Standalone Credit Profile (SCP) is stronger than that of the state, reflecting the company’s market leadership in fixed-line services, second-largest share in mobile, ownership of an extensive optical fibre network and a strong financial profile. The extent of SLT’s rating upside, following the proposed disposal, will depend on the credit profile of its new parent, the linkage strength with SLT according to our PSL criteria, and the proposed funding structure.

KEY RATING DRIVERS

Disposal Plan: SLT announced on 20 March 2023 that the Sri Lankan cabinet has granted in-principle approval to sell the 49.5% stake in SLT held by the state. The disposal is part of a plan to restructure state-owned entities (SOEs) to improve the state’s financial position. SLT said steps have yet to be taken to identify potential buyers and it will take at least eight to 12 months to finalise the transaction. We believe the government will push through the disposal as SOE restructuring is an integral part of the IMF’s financial support to Sri Lanka.

Sovereign Ownership Pressures Rating: We assess the legal ring-fencing and access and control between SLT and the state as ‘Open’ under the PSL criteria, given the absence of regulatory or self-imposed ring-fencing of SLT’s cash flow and the government’s significant influence over the subsidiary’s operating and financial profile. SLT’s second- biggest shareholder, Malaysia-based Usaha Tegas Sdn Bhd with a 44.9% stake, has no special provisions in its shareholder agreement to dilute the government’s influence over SLT.

Higher Rating: However, the PSL criteria allows for a stronger subsidiary to be notched above the weaker parent’s consolidated profile in extreme situations, such as when a parent is in financial distress but the subsidiary continues to operate independently and its banking access appears unaffected. We do not believe SLT is at risk of default in the next 12 months, as it has sufficient liquidity and its debt does not carry cross-default clauses that can be triggered by the parent’s distress.

SLT’s ‘A(lka)’ rating therefore reflects its relativities with national peers, but is still below its SCP due to the drag from state ownership. We apply our PSL criteria because our Government-Related Entities (GRE) Rating Criteria states that in cases where the SCP of the GRE is higher than the government’s IDR, the relevant considerations of the PSL criteria will be applied to determine whether the IDR of the GRE is constrained or capped at the government’s rating level.

Weak Demand in 2023: We expect SLT’s revenue growth to slow to a low single-digit percentage in 2023 amid weakening consumer spending. Consumers are increasingly prioritising essential needs, such as food and medicine, as real income has fallen significantly following the currency depreciation and unprecedently high inflation. SLT’s subscriber numbers and minutes of usage have already fallen in 2022. Competition has also intensified, especially in the mobile segment, leading to lower realisation of recently introduced tariff hikes.

Weak demand should be offset to an extent by increased migration to SLT’s fibre-to-the- home (FTTH) network, from its own copper network, and subscriber additions. FTTH carries higher revenue per user than the copper network. SLT had 475,000 FTTH connections, a 35% increase yoy, by end-2022.

Weakening Profitability: We expect SLT’s EBITDA margin to narrow to around 34% in 2023 (2022: 35.6%) amid lower demand and ongoing cost escalations. All telecom operators increased tariffs by 20%-25% in late 2022 to tackle falling margins. However, the realisation into revenue remains weak, especially in the mobile segment, due to deep price cuts by one of the smaller operators and falling demand. SLT’s fixed-line business is able to maintain stable EBITDA margins due to the recent tariff hike and the FTTH segment’s higher revenue per user.

Leverage to Stabilise: We expect SLT’s EBITDA net leverage to remain around 1.3x in 2023 (2021: 0.9x, 2022: 1.3x) amid falling profitability. However, its leverage is strong for the rating. We expect capex of around LKR25.0 billion annually over 2023-2024 on network upgrades and expanding its fibre infrastructure.

Interest-Rate Hikes, Currency Depreciation Manageable: We expect SLT to maintain its EBITDA interest coverage closer to 4.0x over 2023-2024 (2022: 4.4x) despite interest rates rising almost threefold. Most of SLT’s debt is on variable interest rates, which will raise costs. SLT’s foreign-currency revenue, which accounts for 10%-12% of group revenue, is more than sufficient to meet the group’s foreign-currency operating expenses and interest costs. SLT had around USD10 million in foreign-currency debt at end-
December 2022, compared with USD40 million in foreign-currency cash deposits.

Sector Outlook Deteriorating: Fitch expects the average 2023 net debt/EBITDA ratio for SLT and mobile leader Dialog Axiata PLC (AAA(lka)/Stable) to remain around 1.3x (2022: 1.3x) amid weak margins and high capex. We expect sector revenue growth to slow to 8% in 2023 (2022: 15%), while the average 2023 EBITDA margin for SLT and Dialog should narrow to 31% (2022: 32%) amid low usage and high costs.

DERIVATION SUMMARY
SLT’s SCP benefits from market leadership in fixed-line services and the second-largest position in mobile, along with ownership of an extensive optical fibre network. SLT has lower exposure to the crowded mobile market and has more diverse service platforms than Dialog. However, Dialog has a larger revenue base, lower forecast EBITDA net leverage and a better free cash flow (FCF) profile than SLT. Dialog is rated at ‘AAA(lka)’, while SLT’s rating is under pressure because of the state’s weak credit profile.

SLT has a larger operating scale than leading alcoholic-beverage manufacturer Melstacorp PLC (AAA(lka)/Stable), which distributes spirits in Sri Lanka through its subsidiary, Distilleries Company of Sri Lanka PLC (AAA(lka)/Stable). Melstacorp is exposed to more regulatory risk in its spirits business because of increases in the excise tax, but this is counterbalanced by its entrenched market position and high entry barriers.

Consequently, the company can pass on cost inflation and maintain its operating EBITDA margin, supporting substantially stronger FCF generation than SLT.

KEY ASSUMPTIONS

Fitch’s Key Assumptions within Our Rating Case for the Issuer:

– Revenue growth to slow to 4% in 2023 amid falling subscriber numbers and lower usage due to weakening consumer spending;

– Operating EBITDA margin to narrow by 150bp to 34% in 2023 due to higher costs and lower volume;

– SLT to continue capex on expanding its fibre and 4G network with LKR25 billion spent annually in 2023 and 2024;

– Effective tax rate of 28% from 2023;

– Dividend payout of 33% of net income over 2024-2025

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

– Fitch will resolve the RWP when the proposed disposal becomes practically unconditional, which may take more than six months, and once Fitch has sufficient information on the new majority shareholder’s credit profile and linkages with SLT and the proposed funding structure.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– Fitch would remove the RWP and affirm the National Long-Term Rating at ‘A(lka)’ with a Stable Outlook if the proposed disposal does not proceed and the linkages with the state remain intact.

LIQUIDITY AND DEBT STRUCTURE

Manageable Liquidity: SLT’s unrestricted cash balance of LKR14 billion at end- December 2022 was sufficient to redeem its contractual maturities of around LKR11 billion. SLT’s short-term working-capital debt amounted to another LKR10.0 billion and we expect the company to roll over the facilities given its solid access to local banks.

Liquidity is further enhanced by about LKR15 billion in undrawn bank credit facilities, although these are uncommitted. SLT typically does not pay commitment fees on its undrawn lines, although we believe most banks will allow the company to draw down the funds because of its healthy credit profile.

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