An Echelon Media Company
Saturday June 15th, 2024

Sri Lanka post-default rating linked to IMF debt reduction path: Fitch

ECONOMYNEXT – Sri Lanka’s post default ratings would depend on the speed at which the debt is reduced under an International Monetary Fund program, while a ‘restricted default’ label would be taken off after commercial debt is re-structured, Fitch, a rating agency said.

Sri Lanka’s foreign currency rating was lowered to restricted default (RD), after the country defaulted on bilateral and private debt but continued to service multilateral loans.

The RD rating would be removed after a successful “completion of a commercial debt restructuring that we judge to have normalised the relationship with the international financial community,” the rating agency said.

A slower debt reduction path would make it easier to re-structure debt, but it may result in higher debt levels for a longer period, delaying quick upgrades.

“Sri Lanka’s post-default ratings would depend upon our assessment of its credit profile,” the agency said.

“If the key parameters for returning to debt sustainability under the IMF programme allow for a moderate and extended debt reduction process, this could facilitate debt restructuring talks, but may weigh on the sovereign’s post-default credit ratings.”

Sri Lanka is planning to reduce debt and return to ‘debt sustainability’ under an IMF program.

According to data in a debt assurance letter given by India, Sri Lanka plans to reduce the debt to GDP ratio to 95 percent of GDP by 2032 from around 140 percent now and the annual gross financing requirement to around 13 percent of GDP from the current 30 percent.

Sri Lanka has high interest rates and high levels accumulated foreign and local debt after operating a so-called flexible inflation targeting framework with an ad hoc pegged arrangement called a ‘flexible exchange rate’ which triggered serial currency crises and output shocks.

After large volumes of money were printed and taxes were cut to end what economic bureaucrats called a ‘persistent output gap’ the country ran out of reserves and defaulted, leaving the central bank also in debt.

Other countries with similar monetary arrangements including but no tax cuts including Ghana, Zambia and Pakistan, have also defaulted or are near default after they also cut rates amid a post-covid recovery.

The full statement is reproduced below:

Sri Lanka’s Probable IMF Support Deal Positive for Debt Negotiations

Fri 10 Mar, 2023 – 1:56 AM ET

Fitch Ratings-Hong Kong-10 March 2023: Fitch Ratings believes Sri Lanka is likely to secure financing support from the IMF after the fund’s Executive Board set a date of 20 March to review the USD2.9 billion staff-level agreement that the country signed with the IMF in September 2022. IMF funding should improve Sri Lanka’s external liquidity, but the timing of any debt restructuring agreement with official and private creditors remains uncertain.

We view the announcement of a date for the Executive Board review as an indication that the IMF regards the financing assurances it has received from key official creditors as sufficiently credible to move forward. Sri Lanka’s president on 7 March indicated that China had provided its support, following earlier assurances from India and Paris Club official creditors. The president also indicated that Sri Lanka had completed all prior actions required under the IMF programme, although the IMF Board will make its own assessment on this in deciding whether to approve the package.

Board approval of the programme would release IMF funding and should unlock additional financing from multilateral creditors. This would bolster official foreign-exchange reserves, which have already risen 30% from their trough in October 2022. Nonetheless, reserves remain very low, at USD2.2 billion in February, equivalent to around one month of imports.

We expect improved external liquidity to support a broader strengthening of macroeconomic stability. The exchange rate has appreciated since late February 2023. Month-on-month inflation had already moderated over 2H22, but the strengthening of the currency should further restrain price growth if it is sustained.

Nonetheless, potential upsides to Sri Lanka’s economic outlook will remain constrained until its debt restructuring is agreed upon. The prospects for a deal with creditors remain unclear for now. We view recent developments as positive for debt negotiations, partly because they suggest that official creditors’ financing assurances are consistent with the parameters of the IMF’s programme that seeks to return debt to sustainable levels. However, restructuring talks could continue for a long time yet.

The example of Zambia (Restricted Default, or RD), where an IMF support package was approved by the Board in August 2022 but debt restructuring talks are still ongoing, highlights this risk. We believe that even if official creditors are more aligned in Sri Lanka’s case, talks with private-sector creditors could raise further complications.

The issue of whether to include local-currency debt in any restructuring will be one of the factors complicating debt negotiations. We downgraded Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to ‘CC’, from ‘CCC’, in December 2022, reflecting our view that a local-currency debt default is probable in light of an untenably high domestic interest payment/revenue ratio, high interest costs, tight domestic financing conditions and rising local-currency debt/GDP in the context of high domestic fiscal financing requirements, which authorities forecast at about 8% of GDP in 2022. The Long-Term Local-Currency IDR would be further downgraded if the government announces plans to restructure or defaults on its local-currency debt.

Fitch rates Sri Lanka’s Long-Term Foreign-Currency IDR at ‘RD’. We may move the IDR out of ‘RD’ upon the sovereign’s completion of a commercial debt restructuring that we judge to have normalised the relationship with the international financial community. Sri Lanka’s post-default ratings would depend upon our assessment of its credit profile. If the key parameters for returning to debt sustainability under the IMF programme allow for a moderate and extended debt reduction process, this could facilitate debt restructuring talks, but may weigh on the sovereign’s post-default credit ratings.

Leave a Comment

Your email address will not be published. Required fields are marked *

Leave a Comment

Leave a Comment

Cancel reply

Your email address will not be published. Required fields are marked *

Sri Lanka beats key IMF program targets for March 2024 amid rupee stability

ECONOMYNEXT – Sri Lanka has exceeded key quantitative targets set in an International Monetary Fund program for March 2024, based on preliminary data the Washington based agency said in a report.

The March data are not performance criteria on which reviews are conducted but are indicative targets which shows the progress of the program and are a stepping stone for a September review based on June data.

An indicative target for the primary balance (roughly overall deficit minus interest costs), was assessed at 316 billion rupees more than four times the 70 billion rupee target set in the program.

Primary balance can be a big surplus if the interest bill is high and capital expenditure is cut and is a type of crisis management tool after a central bank triggers a currency crisis by cutting rates with inflationary liquidity tools.

However, Sri Lanka’s Treasury has also kept a lid on most current spending. A state salary hike is however due after the currency collapse made life difficult for everyone.

Meanwhile more taxes have been collected from the people to finance the island’s bloated state.

A 750 billion rupees central government tax revenue floor has been exceeded to reach 837 billion rupees.

Central bank credit to government (outstanding stock) has been reduced to 2,691 billion rupees in March compared to a target of 2,800 billion rupees. In December the CB credit was calculated 2,742 billion rupees.

Net international reserves of the central bank were brought up to a negative 1,268 million US dollars exceeding the target of a negative 2,035 by almost 700 million dollars.

In order to collect foreign reserves, which is a type of appropriation of domestic savings of the people by the central bank (taking in deposits) and exporting it to the US and other countries to finance their deficits or by other agency debt in reserve currencies.

In order to collect such ‘deposits’ the central bank has to prevent them from being invested domestically.

It is achieved with deflationary policy through sell-downs of down its Treasuries holding to domestic banks or others, at a market rate, collecting interest from the government or repayments of re-finance credits, subject to any nominal changes in reserve money at a given exchange rate.

In 2024 the central bank allowed the exchange rate to appreciate, which can also reduce prices of traded goods boost real and nominal savings and make it easier to collect foreign reserves.

When domestic credit is weak it is easier to collect reserves. Reduced domestic credit and collection of reserves, including by private banks which then cannot be invested domestically, can push the external current account into surplus.

The central bank also met a 5 percent 12-month inflation target, with an achievement of 4.3 percent.

Sri Lanka’s economy grew 5.3 percent despite reserve collections, amid the stability provided by the central bank.

There were no central bank purchases of Treasuries from the primary market.

However the central bank injected overnight and term money to banks (not on a net basis) showing how easy it is for a rate-obsessed monetary authority to get around the requirement and create external instability again as soon as private credit recovered.

The central bank also allowed excess liquidity from dollar purchase to remain unsterilized for an extended period under its ad hoc pegging arrangement, getting a short term falls in rates, but triggering pressure on the rupee as a result in May and June.

It is not possible to collect reserves with a free floating exchange rate. (Colombo/June15/2024)

Continue Reading

Sri Lanka GDP grows 5.3-pct in first quarter of 2024 amid monetary stability

ECONOMYNEXT – Sri Lanka’s gross domestic product grew 5.3 percent in the first quarter of 2024 data from the state statistics office showed as the central bank continued to refrain from generating monetary instability.

Instead of printing money to cut rates under ‘flexible inflation targeting’ and printing money to boost growth by taking into account ‘potential output’ as permitted by its new monetary law, the central bank ran deflationary policy and also allowed the rupee to appreciate.

“The Sri Lanka economy experienced a more favorable economic condition[s] in the first quarter 2024, when compared to the first quarter in the year 2023,” the Department of Census and Statistics said.

“The high inflation had prevailed in the first quarter of year 2023, gradually reduced to a lower level by the first quarter of 2024 and this low inflation incentivized the economy by providing inputs at [a] much lower price.

The agriculture sector grew 1.1 percent in the first quarter of 2024, after also growing 1.6 percent last year.

Industry grew 11.8 percent in the first quarter, against a 24.3 percent last year.

The economy grew amid falling prices, the statistics office said in sharp contrast to the Anglophone macroeconomic claim that inflation is needed to boost growth, on which Sri Lanka has 5-7 inflation target has apparently been set.

Related Sri Lanka central bank pushing for high inflation target to boost growth

“Among ‘Industrial activities’, coinciding with the decline in input prices, the ‘Construction industry’ grew by 14.2 percent, parallel to this, the ‘Mining and quarrying’ industry too expanded by 18.3 percent during this quarter,” the Statistics Department said.

Sr Lanka’s services sector grew 2.6 percent, against a decline of 4.6 percent recorded last year.

The International Monetary Fund has also urged the central bank to give priority to stability.

Sri Lanka dropped the stability mandate in the earlier monetary law which was violated after the end of a civil war to push the country into serial currency crises especially after the International Monetary Fund gave technical assistance to calculate potential output.

Related Sri Lanka has a corrupted inflation targeting, output gap targeting not in line with monetary law: Wijewardena

Sri Lanka survived a 30-year civil war by giving priority to a stability mandate despite shortcomings in its operational framework but defaulted in peacetime amid activist monetary policy which denied monetary stability to the people. (Colombo/June12/2024)

Continue Reading

Sri Lanka’s NPP notes five-point crisis for economic growth sans details

Former JVP MP Sunil Handunneththi

ECONOMYNEXT — The leftist National People’s Power (NPP) has identified five crises that need resolving for Sri Lanka’s economy to progress, much of which emphasise a production economy targeting export growth though sparse on the detail on resource allocation.

NPP spokesman and former parliamentarian Sunil Handunneththi speaking at an event in Mulaitivu on Thursday June 13 said Sri Lanka is grappling with firstly, a collapse of the production economy, second, a budget deficit, third, a balance of payment crisis which has, fourthly, created a debt crisis, and finally, a resultant gap between haves and have-nots.

“We must first understand the crisis. We reocgnise five main crises that have the same impact irrespective of differences between the north and south.

“The first is the collapse of the production economy. We can see this historically. Agriculture that used to be some 30 percent of gross domestic product (GDP) has now fallen to 8 percent. Essential food is imported. We cannot produce the rice needed for the small population here. Things that can be made here are also imported.

“Second is the income crisis. For the people, their expenses are twice their income. The budget deficit is two or three-fold every day. Banks cannot give loans to businesses and industries because the government takes funds to address the budget deficit. The government takes most of the people’s savings for this,” he said.

The balance of payment crisis Sri Lanka is facing the third crisis, according to Handunneththi, which has triggered a debt crisis, in turn leading to a crisis of income disparity among the people.

“Third is the balance of payments crisis. Imports are two or three fold export income. The government has to take 11 to 12 billion US dollars in loans from foreign countries. When GDP is 80 billion US dollars, debt has gone over 100.”

“All this creates a massive gap between haves and have-nots. Without finding solutions to these crisis, there is no point distributing goods,” he said.

Handunnethi’s remarks appear to be departure from the NPP’s anti-corruption rhetoric which had centred its economic development policy agenda primarily on fighting corruption.

‘Fighting corruption’ and ‘recovering stolen assets’ have been popular slogans since the Aragalaya protests in Sri Lanka and the NPP has made it its central theme in its bid for power. The leftist outfit had also adopted a position that’s cautiously critical of the International Monetary Fund (IMF) and the reforms the international lender has prescribed for Sri Lanka in exchange for a 2.9 billion-dollar bailout.

However, NPP leadership had recently acknowledged the need to continue the IMF programme since the agreement has already been signed.

The Marxist-Leninist Janatha Vimukthi Peramuna, which controls the NPP, though it was never in government barring a brief stint in an Sri Lanka Freedom Party (SLFP)-led coalition in the early 2000s, has been instrumental in driving popular support against privatisation.

Three key policy pillars articulated by the JVP from 2001-2004 and embraced by mainstream politician Mahinda Rajapaksa’s administration in 2005 onward have been highlighted by experts.

From 2005, Sri Lanka halted privatisation, started recruiting tens of thousands of unemployed graduates into the public service every year with lifetime pensions, expanding an already bloated public sector and denying any benefit of a peace dividend to the country.

Sri Lanka also abandoned a price formula for fuel that had helped keep the rupee stable and inflation low from 2001 to 2003 even as global commodity prices went up from the ‘mother of all liquidity bubbles’ fired by the Federal Reserve from 2001.

From 2001 to 2003, state workers fell from 1.164 million to 1.043 million. By 2020, the public sector cadre has grown to 1.58 million with another batch of 53,000 unemployed graduates being paid tax money. (Colombo/Jun14/2024)

Continue Reading