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Tuesday July 23rd, 2024

Sri Lanka rated firms less exposed to sovereign downgrade, Fitch explains how

ECONOMYNEXT – Sri Lanka’s companies are less exposed to government credit risk than and banks and insurance companies, and have had generally higher local ratings following a re-caliberation of the domestic scale in the wake of a sovereign downgrade.

Fitch downgraded Sri Lanka’s sovereign rating to ‘CCC’ as money printing triggered forex shortages and which was worsened by a tax cut.

“The performance of Fitch-rated corporates has remained robust despite the weak macroeconomic environment,” the rating agency said.

“Even during the ongoing pandemic, almost all rated corporates have performed better than our expectations, with earnings of most reaching pre-pandemic levels by the quarter ending September 2020.

“A sovereign default can be significantly more disruptive to the domestic economy and funding markets than the impact of the sovereign downgrades seen over the last few years.”
In a Q and A Fitch has answered frequent questions raised.

Related

Sri Lanka insurer asset risk rise due to sovereign downgrade: Fitch

Scale Recalibrated on Sovereign Downgrade

The recalibration of Fitch Ratings’ Sri Lankan National Rating scale following the downgrade of the Sri Lanka sovereign rating to ‘CCC’ from ‘B-’ on 27 November 2020 has resulted in the National Ratings of most corporates being grouped at the upper end of the rating scale. The revised relationship between international and national scale ratings is shown in the table on the left.

This reflects our view that most rated corporates are less vulnerable to any sovereign financial distress than most financial institutions. Top corporates have strong business profiles, low leverage and sound liquidity that underpin our view. They have limited exposure to the government compared with financial institutions, unless linked directly or indirectly to the sovereign.

Sri Lanka’s national scale ratings are denoted by the unique identifier ‘(lka)’. National scales are not comparable with Fitch’s international ratings scales or with other jurisdictions’ national rating scales.
Sri Lanka Telecom PLC (AA-(lka)/Stable) and Ceylon Electricity Board (AA-(lka)/Stable), whose ratings are driven by the sovereign, are now at the highest point on the national scale that corresponds to an international scale rating of ‘CCC’. The National Ratings of other corporates, while influenced by the macroeconomic environment, are not constrained by the sovereign rating.

The following are some recent questions from investors about the recalibration and impact on corporate ratings in Sri Lanka:
What Investors Want to Know: Impact of Sri Lanka National Scale Recalibration on Corporate Ratings

Corporates with Strong Business Models and Solid Liquidity Less Vulnerable to a Sovereign Default than Financial Institutions

Why did Fitch Recalibrate the National Rating Scale?

Fitch recalibrates National Rating Correspondence Tables to limit rating movements in the national scale that result from systemic factors. For instance, a sovereign rating change could drive multiple international rating changes, which would affect a large number of issuers on the national scale if a reassessment of the rating relationship between international and national ratings is not undertaken.

As per Fitch’s National Scale Rating Criteria, the starting point to derive a National Long-Term Rating (NLTR) is a local currency international scale rating or Issuer Default Rating (IDR), which reflects an issuer’s ability to repay local-currency obligations.

Upon the sovereign rating downgrade, Fitch re-assessed the Local-Currency IDRs of local corporates in line with its criteria. IDRs of corporates that are directly linked to the sovereign were lowered to reflect the revised sovereign rating (as per our Government Related Entities Rating Criteria). For others, any changes reflected changes to the trading performance, forecast cash generation and liquidity following the downgrade of the sovereign rating.

The agency then recalibrated the national rating scale to best reflect the relative credit strength between local corporates, banks and non-bank financial institutions, and insurance companies, keeping the ‘AAA(lka)’ reference point at ‘B-‘ on the international rating scale in line with the National Rating Criteria.

Are Some Corporates Less Vulnerable to a Sovereign Default than Banks?

Corporates’ credit profiles are impacted by the wider, non-sector specific context in which it operates. However, corporates with strong business risk profiles, low leverage, and the ability to continue to access domestic banks and other funding channels following a sovereign default are less vulnerable, although not immune, to a post-default environment than banks.

The impact of a recessionary environment on a corporate’s cash generation, including impact of changes in currency-exchange rates, are factored into our financial forecasts that are used in determining corporate ratings. Liquidity is a key component of corporate rating analysis; international scale credit assessments of issuers with weak business profiles and/or high short-term debt maturity profiles which could be easily starved of liquidity during a sovereign financial distress will be assessed at the lower-end of the rating scale.

Conversely, bank ratings are usually constrained by the sovereign rating, due mainly to the strong correlation between sovereign and bank credit profiles. This is because banks typically have high exposure to the government, the wider domestic economy and local financial markets.

In a stressed environment that follows a sovereign default in particular, we believe stronger corporates with sufficient on-balance sheet liquidity can weather some period of financial market stress, although accessibility to external capital may be limited (but not completely shut out), and may come at a high cost.

A corporate’s ability to repay its foreign-currency obligations is nevertheless subject to the transfer- and convertibility risk (T&C risk) of a country. T&C risk, which is closely related to sovereign ratings, captures the risk of imposition of exchange controls that would prevent or materially impede an issuer’s ability to convert local currency for the repayment of foreign-currency obligations. As such, most corporates’ foreign-currency international ratings are constrained by the Country Ceiling, which for Sri Lanka is level with its IDR at ‘CCC’.

T&C considerations therefore apply only to foreign-currency ratings and may not directly be relevant for national ratings assessments. However, the inability to service debt or if operations of a corporate are severely affected by T&C restrictions imposed by a sovereign, could have an impact on its local-currency ratings, and therefore its National ratings as well.

What are Key Credit Drivers of Top-Rated Corporates?

Most Fitch-rated corporates at AA(lka) or above benefit from strong business models, and should therefore continue to be able to access local bank funding following a sovereign default.

Corporates rated ‘AA(lka)’ or higher benefit from leading market positions in their respective industries. In addition, issuers rated higher at ‘AA+(lka)’ and ‘AAA(lka)’ benefit from more ‘defensive’ demand for their products and services – such as telcos, pharmaceuticals, grocery retail, alcoholic beverages – or operate in protected industries with high entry barriers such as local crude palm oil producers. Demand for these goods and services are more resilient to a recessionary environment.

Furthermore, corporates rated ‘AA+(lka)’ and ‘AAA(lka)’ have low leverage and solid liquidity, which act as buffers against a prolonged deterioration in operating cash flows in the event revenues fall.

Some issuers benefit from a degree of support from stronger shareholders based overseas, which is not affected by challenges in the domestic economic environment.

How is the Macroeconomic Environment Factored Into Corporate Ratings?

Fitch evaluates the risks of rated entities and structures under a variety of scenarios to ensure rating stability. The ratings-case and stress-case forecasts help to determine the amount of headroom in a company’s credit ratings, and inform the appropriateness of a rating change or change in rating Outlook.

Scenarios are developed based on the potential risks an issuer may encounter through both ratings and stress cases. Financial projections are based on the issuer’s current and historical operating and financial performance, its strategic orientation and analysis of wider industry trends. The macroeconomic backdrop for the ratings case may be supported by Fitch’s latest Global Economic Outlook commentary and forecasts
How is the Operating Environment Incorporated into Corporate Ratings?

In assessing corporate ratings, Fitch takes into consideration country risk in the form of operating environment (OE) and transfer and convertibility (T&C) risk. Our OE assessment captures Fitch’s view of a particular country’s economic environment and financial market development, and World Bank scores for systemic governance.
T&C risk, which is closely related to sovereign ratings, captures the risk of imposition of exchange controls that would prevent or significantly impede the private sector’s ability to convert local currency for the repayment of foreign-currency obligations. T&C considerations therefore only apply to foreign-currency ratings, and are not relevant in national ratings assignment.

The OE reflects the wider context in which the rated issuer operates, irrespective of its sector. In emerging markets especially, the OE can result in a lower rating profile depending on the level of challenge posed by that environment. The OE is a blend of Fitch’s assessment of the Economic Environment, Financial Access, and Systemic Governance of the issuer and the major jurisdictions in which the issuer operates.

The latest published OE sub-factor scores for Sri Lanka are Economic Environment (bb), Financial Market Development (b), and Systemic Governance (bbb).

Fitch holds the OE to be an asymmetric consideration. Companies can both succeed and fail in the most hospitable environments, rendering that environment a neutral consideration, but a higher-risk environment can actively constrain a company’s potential.

An OE score of ‘b+’ would be a drag if a corporate’s intrinsic IDRs were in the ‘BB’ category or above. A ‘b’ or ‘b-‘ OE could also be a drag for ratings in the high ‘B’ category, but an OE score by itself does not drag corporate ratings down to the ‘CCC’ category or below.

Why are Most Sri Lankan Corporates Not Rated ‘CCC’ or Below on the International Scale?

Liquidity and refinancing risk of a corporate issuer become key differentiators between corporate IDRs in the lower ‘B’ category versus those in the ‘CCC’ category and below (i.e. ‘CCC+’, ‘CCC’, ‘CCC-’, and ‘CC’). Within the ‘CCC’ category (international scale rating definition: substantial credit risk, a default is a real possibility), a case of deteriorating liquidity buffers and high degree of refinancing risk may be reflected by ‘CCC+’ IDRs; and if the assessed default risk is greater, then corporates would be assessed at lower levels in the ‘CCC’ category, or even at ‘CC’ (international rating definition: very high levels of credit risk – a default of some kind appears probable).

Sierra Cables PLC (AA-(lka)/Stable) is the lowest publicly rated Sri Lankan corporate issuer. Its debt is mostly working capital-related and will be self-unwinding in the event its sales fall, given its tory coverage of total working-capital debt was around 150% at end-December 2020. Sierra has LKR82 million of term loans due in the 12 months from end-2020, and we estimate that its funds from operations (FFO) will be sufficient to meet its repayments.

Sierra has also shown adequate access to local bank debt in the last six months notwithstanding the onset of the Covid-19-led downturn. Its rating is constrained by its small operating scale and the susceptibility of its operating cash flows to business cycles, as demand stems mainly from infrastructure projects.

Issuers rated at ‘AA(lka)’ such as DSI Samson Group Limited, Abans PLC and Singer (Sri Lanka) PLC have more comfortable liquidity positions than Sierra. Their ratings also benefit from stronger business profiles as they are market leaders in their respective industries. Consequently, we expect these ‘AA(lka)’ rated issuers to be well-banked in a local context.

Furthermore, none of the Fitch-rated local corporates have cross-border debt issuance which is more susceptible to capital-market disruptions in the event of a sovereign default.

Why are Sri Lankan Corporates now Rated at ‘AA-(lka)’ or Above on the National Scale?

As per the new national ratings correspondence table published on 22 December 2021, a local-currency international rating of ‘CCC+’ and above now maps to ‘AA-(lka)’ and above on the national scale, while the upper-bound of ‘CCC’ IDRs also corresponds to ‘AA-(lka)’.

Corporates whose credit profiles are driven by the sovereign, such as Ceylon Electricity Board, and those which are constrained by sovereign ownership such as Sri Lanka Telecom, have ratings at ‘AA-(lka)’ – the highest level corresponding to a ‘CCC’ IDR.

As a result, the majority of Sri Lankan corporates’ ratings have been revised to ‘AA-(lka)’ or above to reflect the latest relationship between international and national scale ratings.

If a particular corporate’s international rating corresponds to more than one notch on the national scale, for example ‘B-’ maps to ‘AAA(lka)’ to ‘AA(lka)’, such a corporate will be rated on the national scale based on how its credit profile compares with other local peers.

How Have Corporates Performed Amid Multiple Sovereign Downgrades in the Past?

Sri Lanka’s sovereign rating has been downgraded by five notches since early 2016, owing primarily to its weak external finances. Over this same period, the country’s GDP growth weakened to the low-single digits from the mid-single digits.

The performance of Fitch-rated corporates has remained robust despite the weak macroeconomic environment. The revenue of Fitch-rated corporates has grown at a CAGR of around 10% over 2016-2020 compared with an annual average inflation of around 4.8%. EBITDA has risen at a CAGR of 13% over the same period, resulting in improved profitability. At the same time, most Fitch-rated corporates’ balance sheets have strengthened, with leverage – defined as net adjusted debt / operating EBITDAR – improving.

Even during the ongoing pandemic, almost all rated corporates have performed better than our expectations, with earnings of most reaching pre-pandemic levels by the quarter ending September 2020.

A sovereign default can be significantly more disruptive to the domestic economy and funding markets than the impact of the sovereign downgrades seen over the last few years. The national rating assessments and the relativities reflect their relative ability to perform and service debt obligations. Should the operating environment or funding conditions deteriorate significantly, the international -scale credit assessments would be changed to reflect any increase in credit risk, and national ratings adjusted in line with our criteria.

Comments (2)

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  1. sacre blieu says:

    Some have shown profits with salary cuts and even zero levels, taking advantage of the new conditions. There are those who have gained by producing covid virus related protective gear, and those who manufacture rubber gloves.

  2. Ajith says:

    Such an inverse relation against the expected norms..hence this questioned the validity of sovereign rating as a whole…

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  1. sacre blieu says:

    Some have shown profits with salary cuts and even zero levels, taking advantage of the new conditions. There are those who have gained by producing covid virus related protective gear, and those who manufacture rubber gloves.

  2. Ajith says:

    Such an inverse relation against the expected norms..hence this questioned the validity of sovereign rating as a whole…

Sri Lanka to introduce digital program for foreign workers facing problems

ECONOMYNEXT – Sri Lanka will introduce a digital program via smart phones for migrant workers to report any concerns while employed abroad, Minister of Labor and Foreign Employment Manusha Nanayakkara said.

“We will have a digital program that is accessible from their smart mobile phones where domestic workers can notify us if they have not got their salary or if they have fallen into some trouble,” Nanayakkara said in parliament on Tuesday.

Sri Lanka has sent 301,000 domestic workers and 360,000 skilled workers abroad, Nanayakkara said.

Several workers, especially domestic workers, face abuse at the hands of foreign employers.

Nanayakkara said that the government only receives 0.001 percent of complaints with regard to abuse.

“We can only act on complaints received from people who go through legal channels. We are educating those who go through the Foreign Employment Bureau on how to escalate complaints.” (Colombo/Jul23/2024)

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Sri Lanka cabinet approves apology from Muslims for COVID-19 cremation ahead of election

ECONOMYNEXT – Sri Lanka’s Cabinet of Ministers approved a proposal to tender apology for the grievance caused for ethnic minority Muslims due to the cremation of bodies during the Covid-19 pandemic, Foreign Minister Ali Sabry said.

The move comes ahead of the upcoming presidential poll in which Muslim votes are likely to become crucial for all candidates.

The government of former President Gotabaya Rajapaksa led by current ruling party Sri Lanka Podujana Peremuna (SLPP) forced Muslims and Christians to cremate the dead bodies of those who died of Covid-19 in 2020.

The   Organisation of Islamic Cooperation (OIC) which includes Islamic states globally raised the forced cremations issue at the 46th United Nations Human Rights Council (UNHRC) in February 2021 after the SLPP government rejected repeated requests by local and global Islamic bodies.

The policy was later reversed, but the move hit diplomatic ties with Middle Eastern and OIC nations which is the highest source of employment for Sri Lankan expatriates.

Former President Gotabaya Rajapaksa later said the decision was based on expert advice. Rajapaksa who was seen as an anti-Muslim leader was heavily criticized for his decision ahead of 2020 parliamentary polls while his elder brother and then Prime Minister Mahinda Rajapaksa declined to discuss the issue with Muslim parties which asked to reverse the decision.

Hundreds of Muslims were cremated during the Covid-19 period before Rajapaksa government allowed a separate burial ground for Muslim Covid-19 victims in the Eastern town of Oddamavadi.

“A joint Cabinet Paper presented by Ministers Ali Sabry, Wijeyadasa Rajapakshe & Jeevan Thondaman apologising for the grievance caused to the Sri Lankan Muslim community due to the cremation of bodies during the Covid-19 pandemic, approved by the Cabinet,” Minister Sabry  tweeted quoting Cabinet Spokesman.

Already President Ranil Wickremesinghe and Estate Infrastructure Minister Jeevan Thondaman had tendered an apology in the parliament. The latest cabinet move is a formal and official apology.

BURIAL OR CREMATION

Along with the apology, the Cabinet approved proposed law on burial or cremation of dead bodies on religious discretion.

“As stipulated in the guidelines published by the Ministry of Health on the Clinical Management of COVID19, cremation was made compulsory in removal of the dead bodies of the persons who died due to the COVID-19 virus. The decision created displeasure among the various religious groups and human right activists especially Muslim religious persons,” a government document on the cabinet decision showed.

“The studies made in this respect have been confirmed that the faeces and the urine are the primary source of transmission the virus but not with the safe burial. Therefore, in order to prevent arisen of such condition in future, attention has been drawn to introduce a law, a certain person or relations to be selected the burial or cremation of the dead person at their discretion.”

“Further, it has been seemed that introduction of new laws is appropriate to donate the dead bodies to the Medical Faculty, if necessary.”

“Accordingly, Cabinet of Ministers has approved the joint proposal presented by the Minister of Justice, Prison affairs and Constitution Reforms, Minister of Foreign affairs to instruct legal Draftsman in order to prepare a draft for the introduction of new law.”

Rajapaksa’s arrogant policy led the OIC and Middle East nations to reject Sri Lanka’s repeated requests for credit lines and loans to buy oil before the country collapsed following an unprecedented economic crisis in 2022.

Minister Sabry faced harsh criticism from human rights defenders and from members of the Muslim community for what they claimed was his silence in the face of the inhumane, unscientific decision by the Rajapaksa government.

The Rajapaksa government’s stubborn insistence on cremating Muslim and Christian victims of the Covid-19 virus was against the communities’ religious beliefs and drew widespread condemnation and concern of Muslim countries and leaders.

Rajapaksa, after the economic crisis hit the country, was forced to flee in the face of massive protests against him in July 2022. (Colombo/July 23/2024)

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Fireworks erupt in parliament over Sri Lanka’s VFS Global controversy

ECONOMYNEXT – Sri Lanka’s parliament erupted in heated debate after government legislators raised a privilege issue against Committee on Public Finance Chair Harsha de Silva, who last week tabled report on a controversial visa deal with the IVS-GBSVFS Global, consortium.

Justice Minister Wijedasa Rajapaksa questioned the propriety of raising a privilege issue against a Committee chairman, who was acting under powers derived from the Constitution, saying it amounted to challenging the Speaker himself.

Related Sri Lanka visa deal with IVS-VFS be cancelled or revised, forensic audited: COPF Chief

Sri Lanka’s Department of Immigration had awarded a visa issuing monopoly to IVS-GBS-VFS Global without tender which was charging 25 dollars per visa compared to an earlier 1 dollar by Mobitel, and it should be terminated or revised, de Silva said presenting a report earlier this month.

Privilege Over VFS Report

State Minister Shehan Semasinghe said de Silva had presented a defective and false report misleading parliament saying among other things that the report was unanimously approved by the COPF membership.

As a result, privileges of 16 members had been broken, and misleading a parliamentary committee was a punishable offence and de Silva should be referred to the privileges committee.

De Silva said he severally and individually rejected the charges and all views of the members were attached to the final report and he would stand down as COPF chair until the matter was decided.

“This was not done secretly. There were three weeks for members to respond,” de Silva said.

“There was a debate about the tourism arrival numbers, which was included. If I am to be imprisoned, do it. I am not afraid. Give me an opportunity and I will show how each word is true.

Semasinghe said there was no desire on the part of government members to remove de Silva from the COPF.

Government member Nimal Lanza said that he was under the impression that tourist arrivals had fallen due to the VFS deal but there was an increase this year. There was no desire to imprison de Silva, he said.

Verbal Exchange

Public Security Minister Tiran Alles said five years of data was given, and there was an increase in tourism arrivals. And after April there were 53,000 tourists under new categories, which brought revenues of 1.4 billion rupees.

The report was also attached as an addendum, de Silva said.

Minister Alles questioned why the Deputy Speaker was allowing a debate over the VFS deal which would now attract media headlines.

“If you are allowed, all our members must be allowed to speak,” he said.

Opposition leader Sajith Premadasa said if competitive tenders were called, there would not have been a charge of 25 dollars per visa as Mobitel was charging only one dollar.

Premadasa said he was responding due to charges made against de Silva and claims that he had committed a punishable offence. The opposition leader questioned how his microphone was muted.

Justice Minister Wijedasa Rajapaksa said while it was fair to allow de Silva to respond to the initial charge, a long debate should not have been allowed on the matter and also the contents of the report.

“The second bad precedent is this. It is not important whether it is Harsha de Silva or not. There are many committees. Can the Chairman of a Committee be called over a privileges issue?

“Under the Constitution there are powers to make standing orders. It is implemented through the 1953 Privileges Act. The Chairmen have certain powers. The Chairman has acted under the limits of his powers.

Parliament Undermined

Minister Rajapakshe said while there may be errors in a report, the Parliament’s powers were diminished if privilege questions were raised against Chairmen of a committee who carried out there duties.

“There may be errors in the report. We have seen that. But I am raising a question on the constitution.

“In this way, in whatever Committee, if he did his official duties, if he is made an accused in another committee of the same parliament and there is an investigation, it is the parliament’s power that is degraded.

“So it is the confidence people have in the parliament that is reduced. There is a legal question here. The Chair should consider whether it is possible to raise a question like this

“Ultimately the final responsibility of all these Committees rests with the Speaker. It is the Speaker’s powers that are delegated to the Chairman of a Committee.

“So, this challenge is made against the Speaker. How is the Speaker doing this?

“If the next day, the COPE, or COPA issues a report, someone asks to put him in the punishment log (dandu kanda) or to do whatever and calls him to the privileges committee.

“What are you going to ask at the Privileges committee? What punishment are you going to give? (Colombo/July23/2024)

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