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Sri Lanka rupee fall, import controls to hurt 60-pct of companies Fitch says

ECONOMYNEXT – About 60 percent of Sri Lanka’s companies would be hit from fall in the rupee, Fitch Ratings said while imports control slapped after large ‘helicopter drops’ of printed money would hit some firms harder.

Analysts have warned Sri Lanka to reform its soft-peg and block the ability of its domestic operations department to inject large volumes of cash below the ceiling policy rate to stop monetary instability.

In the past sovereign rating downgrades – even without an external shock – have come from liquidity injections made while operating a soft-pegged exchange rate.

After money was printed a series of import controls have been placed, due to a belief that imports, not liquidity injections are the case of monetary instability (currency falls and reserve losses).

“Around 60 percent of companies have ‘Moderate’ to ‘High’ exposure to a prolonged weakening of the local exchange rate, because a significant portion of inputs are imported and sold domestically,” Fitch Ratings said.

“The recent negative rating action on the two consumer durable retailers Singer (Sri Lanka) PLC (Singer: BBB+(lka)/Negative) and Abans PLC (BBB+(lka)/Negative) reflects our view of the weak demand for non-essential goods in the current economic environment, and potential supply disruptions stemming from a prolonged ban on the importation of consumer durables to the country.”

“Fitch-rated Sri Lankan corporates in consumer goods retail, construction and hotels will be among the most affected by the coronavirus pandemic in Sri Lanka, says Fitch Ratings.

“Companies in consumer goods retail and construction-related activities also have lower rating headroom than in most other sectors.”

Fitch said companies may find it difficult to pass on currency costs amid weak demand and it expected the rupee to be around 190 to the US dollar. Rating agencies in general do not understand pegged exchange rates well and Sr Lanka’s monetary policy errors in particular, analysts.

Sri Lanka’ credit rating was upgraded in 2011, just before a currency crises was triggered with liquidity injections and all downgrades have happened just before corrective measures (limiting liquidity injections through rate hikes and/or floats) stopped balance of payments crisis.

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“Most Sri Lankan corporates that Fitch rates could see substantial currency-related cost pressures in the next 12-18 months, with the Sri Lanka rupee already having depreciated by 7 percent since the
beginning of the pandemic to LKR194 versus the US dollar,” the agency said.

“Fitch expects the exchange rate to average LKR190 per US dollar in 2020 compared with LKR181 in 2019. Even though most corporates had previously been able to pass on the currencyrelated cost increases to end-customers over a period of time, we believe it will be more difficult in the current environment due to weak demand.”

While the central bank has been printing money to target a call money rate and de-stabilize the external sector Sri Lanka’s military and the health sector has been aggressively contact tracing, though the lack of voluntary private testing has stopped the discovery of non-symptomatic Coronavirus patients, analysts say.

“Even sales of essential items may suffer from supply-chain disruptions, at least in the near term. We currently expect a gradual moderation of the impact in 3Q and 4Q – provided that the pandemic is brought under control, with a full recovery in operating cash flow at least 12-18 months away.

The government’s debt to GDP levels (which are already high) and lower revenues stemming from slower economic activity could leave little fiscal room for infrastructure development in the next two years, Fitch said.

The full statement is reproduced below:

Sri Lankan Consumer Retail, Construction, Hotels Most Affected by Coronavirus

Tue 21 Apr, 2020 – 21:35 ET

Fitch Ratings-Colombo-21 April 2020: Fitch-rated Sri Lankan corporates in consumer goods retail, construction and hotels will be among the most affected by the coronavirus pandemic in Sri Lanka, says Fitch Ratings.

Companies in consumer goods retail and construction-related activities also have lower rating headroom than in most other sectors.

The ultimate impact on ratings over the next one to two years is highly uncertain and will depend on its eventual spread, the knock-on effects of measures introduced to control it, and how long these effects last.

Our current base case is that demand for non-essential goods and services will be severely hit in 2Q20, given the economic impact of strict social distancing requirements.

Even sales of essential items may suffer from supply-chain disruptions, at least in the near term. We currently expect a gradual moderation of the impact in 3Q and 4Q – provided that the pandemic is brought under control, with a full recovery in operating cash flow at least 12-18 months away.

Almost 50% of Fitch-rated Sri Lankan corporates operate in sectors that have ‘Moderate’-to-‘High’ levels of exposure to the effects of the coronavirus outbreak, and ‘Low’ or only ‘Moderate’ rating headroom to weather a prolonged downturn.

Around 60% of companies have ‘Moderate’ to ‘High’ exposure to a prolonged weakening of the local exchange rate, because a significant portion of inputs are imported and sold domestically

The recent negative rating action on the two consumer durable retailers Singer (Sri Lanka) PLC (Singer: BBB+(lka)/Negative) and Abans PLC (BBB+(lka)/Negative) reflects our view of the weak demand for non-essential goods in the current economic environment, and potential supply disruptions stemming from a prolonged ban on the importation of consumer durables to the country.

We have downgraded Sierra Cables PLC (BB(lka)/Rating Watch Negative), as we expect it will face a prolonged decline in cash flows as both state and private-sector construction projects will be likely to face delays until economic conditions stabilise.

The government’s debt to GDP levels (which are already high) and lower revenues stemming from slower economic activity could leave little fiscal room for infrastructure development in the next two years in our view.

Hotels will be one of the hardest-hit sectors, with tourist arrivals unlikely to resume to pre-pandemic levels until the COVID-19 spread is contained worldwide. However, Fitch-rated Sri Lankan corporates which are exposed to hotels such as Melstacorp PLC (AAA(lka)/Stable) and Hemas Holdings PLC (AA-(lka)/Stable), also have exposure to other diversified business segments which are more defensive, and/or have high rating headroom, which mitigates the impact.

We also assessed companies by examining how close they were to breaching their issuer-specific negative rating sensitivities prior to the pandemic.

Companies with limited rating headroom to withstand our base-case assumptions or a more prolonged disruption could be subject to negative rating action if we expect rating sensitivities to be breached for a sustained period. Corporates facing liquidity pressure could also see some stress on their ratings. (Colombo/Apr22/2020)