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Tuesday March 28th, 2023

Sri Lanka rupee debt in US$20bn IFR hair cut as economy inflates

ECONOMYNEXT – Sri Lanka government and government guaranteed domestic currency debt broadly considered in debt review has shrunk by a 19.6 billion US dollar equivalent as the economy inflated in the worst currency crisis in the history of the island’s intermediate regime central bank.

Sri Lanka’s central government rupee debt fell to the equivalent of 32.4 billion dollars from 50.5 billion dollars, a phenomenon labeled High Inflation and Financial Repression (IFR).

Sri Lanka had rupee debt of 53.5 billion US dollar equivalent by end December 2021, made up of 50.5 billion US dollars of central government debt and 3.1 billion SOE guaranteed debt, included in an update to creditors on data up to December 2021.

Sri Lanka had 47.3 billion US dollars of central government forex debt with 5.4 billion US dollars of guaranteed state enterprise debt and 3.0 billion dollars of central bank debt included.

In the next six months the rupee collapsed from around 200 to 360 to the US dollar in a float botched with a surrender rule (forced dollar sales to the central bank), sterilized interventions and too low policy rates amid raging domestic credit.

By end June 2022, rupee debt had shrunk to 34.0 billion US dollars equivalent from 53.6 billion US dollars equivalent by end December 2021 in a severe High Inflation and Financial Repression (IFR) event or real ‘haircut’ according to the latest update to creditors.

Sri Lanka’s dollar debt considered in the update had also fallen marginally to 46.6 billion US dollars by end June 2022 from 47.3 billion US dollars in December 2021 made up of 5.5 billion US dollars of SOE guaranteed debt and 3.2 billion US dollars of central bank debt.

The monetary authority however has more forex debt than included in the update according to other data. Considered in the update were 1.1 billion US dollars owed to the International Monetary Fund (negative SDR position excluded) and 2.0 billion dollars in external swaps only.

The treatment of Asian Clearing Union deferred liabilities and domestic swaps are not immediately clear.

The wiping out of the rupee debt to 34.5 billion US dollars by June 2022 from 53.6 billion US dollars six months earlier reduced total public sector debt considered in the compilation to 80.5 billion US dollars from 100.9 billion US dollars over the six months.

There appears to be classification differences between the two updates.

The new update said forex debt was 70 percent out of public debt of 122 percent of GDP in June 2022 compared to 27 percent of 114 percent of GDP public debt in 2020 before the currency collapse.

Sri Lanka’s economy is expected to inflate to at least 23.8 trillion rupees in 2022 from 16.8 trillion rupees in one of the biggest inflationary blow offs since the 1980s when rupee began to be rapidly depreciated in response to money printing, triggering high inflation and social unrest.

An inflating rupee economy boosts nominal tax revenues, bringing automatic ‘debt sustainability’ through IFR as long as the public sector is not expanded and there is wage restraint.

Tax revenues were up 25 percent in the six months to June 2022.

Related Sri Lanka budget 2022, tax revenues surge 25-pct up to June in inflation

On top of the usual flexible exchange rate IFR there are now fears that a domestic debt re-structure (DDR) would also take place.

A DDR will hurt banks, Sri Lanka authorities have said.

In addition pension funds and other debt holders who will in any case pay more tax under contemplated reforms will also be hit on a second hair cut on top of IFR.


Sri Lanka has no final decision yet on domestic debt re-structuring

Sri Lanka rates elevated amid failed float and DDR fears

Sri Lanka’s rupee collapses repeatedly due to the country’s intermediate regime central bank which does not have a consistent monetary anchor but practices discretionary and conflicting policy in line with what is generally known as the ‘impossible trinity’.

Over the past 7 years highly discretionary policy was operated under ‘flexible inflation targeting’ where floating rate monetary tools (open market operations for stimulus) were applied to a reserve collecting peg, in policy comparable or worse than the 1980s, according to critics.

However in the last decade Sri Lanka had become a market access country unlike in the 1980s and the country defaulted in April 2022 after running out of reserves.

In all previous currency crises coming from flexible monetary policy, debt sustainability was reached with High Inflation and Financial Repression. At the moment government rupee debt yields are around 30 percent with historical inflation running close to 70 percent.

But in this currency crisis a debt re-structure is required after the country was locked out of markets by sovereign bond holders from around 2020 and downgrades later in the year.

A new monetary law which will allow discretion to override rules as in the past seven years, legalizing both a ‘flexible’ exchange rate and ‘flexible’ inflation targeting (a modernized version of attempting to defy the impossible trinity of monetary policy objectives with policy errors compensated by depreciation) is to be enacted as a prior action in a deal with the IMF according to critics. (Sri Lanka’s central bank needs accountability and restraint, not independence: Bellwether)

Due to the promotion of flexible policy pegs, a central bank that goes to the IMF keeps going to the Fund again and again in a phenomenon classical economists call recidivism – or in jest, ‘many happy returns’. Sri Lanka is going to the IMF for the 17th time.

Flexible or discretionary policy is a doctrinal foundation of classical Mercantilism (John Law, James Steuart as well as Anti-Bullionists and the Banking School) which was given a new lease of life under Keynesianism and forms the foundation of non-credible soft-pegs (intermediate regimes).

Washington based promoters of neo-Mercantilism including Robert Triffin (propagation of Argentina style Prebisch-Triffin central banks), John H Williams (key currency), and later John Williamson (basket band crawl/REER targeting) peddled impossible trinity flexible regimes to hapless third world nations that did not have a strong domestic classical economic doctrinal foundation.

Flexible monetary policy rejects the rule based principles advocated by classical economists like David Hume, David Ricardo outright as well as Henry Thornton.

Flexible exchange rates – which are neither clean floats nor hard pegs – also reject more modern classicals like F A Hayek, Ludwig von Mises and Wilhelm Ropke whose ideas drove the Federal Republic and Japan from 1948 and later East Asia firm and hard pegs (Why Singapore chose a currency board over a central bank), GCC firm pegs and also ideas of others like Milton Friedman and Bertil Ohlin.

Their ideas drove monetary policy in the US, UK and Sweden in the ‘Great Moderation’ period from the early 1980s until around 2001, and still drive policy in several countries with German speakers including Switzerland.

Germany itself is now under the European Central Bank which printed money to boost jobs riding the ‘supply bottleneck/transient inflation’ bandwagon, taking refuge in non-monetary explanations, along with the US and is now suffering the effects of the Powell Bubble.

In Sri Lanka, there is a strong belief among policymakers that a part of the inflation in a country is non-monetary and the claim is used to delay rate hikes, unleash open market operations to suppress market rates and drive up credit, triggering currency crises.

That inflation is non-monetary (wage-spiral, interest rates, forward market speculation, hoarding) stem from ideas of classical Mercantilists like James Steuart.

That inflation comes from a monetary and non-monetary soup is an idea articulated by talking heads in popular financial media, and persons like Fed Chief Arthur Burns who broke a centuries old gold standard in 1971-73, creating fiat money.

Broadly speaking, cost-push theory argues that prices or costs drive money supply changes, not that there is a causal soup involving an x percent of cost push inflation and y percent of monetary inflation.

In a country with a flexible-policy-reserve-collecting peg, nominal interest rates are high and long term real growth is low due to trade and exchange controls imposed by the soft-pegged central bank which curtail economic freedoms, as well as output shocks that follow currency crises.

In an IMF or other Debt Sustainability analysis, low growth and generally higher nominal interest rates have to be assumed with no exit from anchor conflicting flexible policy that has prevailed from 1950 compounded by depreciation from BBC policy from 1980s and market access over the past decade.

In a four to five year Federal Reserve cycle, a flexible policy soft-pegged country will lose about two years of growth due to monetary instability. The compounding effects of low growth (output shocks) have severe impacts on long term growth and prosperity.

In Sri Lanka’s current currency crisis which led to sovereign default, growth is to become positive in 2024 and remain about 3.0 percent until 2027 according to the update creditors. (Colombo/Sept25/2022 – Update II)

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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.


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.

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.


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


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.


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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