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Wednesday July 24th, 2024

Sri Lanka sovereign rating outlook downgraded to ‘negative’ by Fitch over tax cuts

ECONOMYNEXT – The outlook on Sri Lanka’s sovereign credit has been downgraded to ‘negative’ from ‘stable’ over recent tax cuts, but has confirmed an underlying rating of ‘B’.

“Revision of the Outlook to Negative from Stable reflects rising risks to debt sustainability from a significant shift in fiscal policy and the potential for roll-back of fiscal and economic reforms in the aftermath of November’s Presidential elections,” Fitch said in a statement.

“We believe the departure from the previous revenue-based fiscal consolidation path has created policy uncertainty and increased external financing risk for the sovereign, particularly given the large external debt repayments due in 2020 and beyond.”

Fitch said the value added tax cut and nation building tax could result in a loss of revenue of up to 2 percent gross domestic product and national debt is likely to move up.

“Following the tax cuts, Fitch projects that gross general government debt, currently at about 85% of GDP, will be on an upward trajectory over the medium-term in the absence of off-setting measures,: the rating agency said.

“Fitch believes the authorities still aim to reduce the deficit to below 4.0% of GDP over the medium-term in line with their previous consolidation plans.

However, the announced tax measures create uncertainty about the feasibility of these plans.”

Sri Lanka is expecting the cut spending mainly on capital projects.

“Fitch expects these offsetting measures, such as adjustments to excise taxes and spending cuts on non-priority public investment and recurrent expenditure, to mitigate part of the revenue loss from the tax announcement,” the rating agency said.

“However, the agency nevertheless expects the deficit to widen by about 1.5% of GDP relative to our previous forecasts.

Fitch is expecting a deficit of 6.5 percent for 2020 and 6.2 percent for 2021.

The full statement is reproduced below

Fitch Revises Outlook on Sri Lanka to Negative; Affirms at ‘B’

18 DEC 2019 09:04 AM ET

Fitch Ratings – Hong Kong – 18 December 2019:

Fitch Ratings has revised the Outlook on Sri Lanka’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to Negative from Stable and has affirmed the IDR at ‘B’.

KEY RATING DRIVERS

Revision of the Outlook to Negative from Stable reflects rising risks to debt sustainability from a significant shift in fiscal policy and the potential for roll-back of fiscal and economic reforms in the aftermath of November’s Presidential elections. We believe the departure from the previous revenue-based fiscal consolidation path has created policy uncertainty and increased external financing risk for the sovereign, particularly given the large external debt repayments due in 2020 and beyond.

Newly appointed President Gotabaya Rajapaksa announced sweeping tax cuts soon after taking office, including a revision of the value-added tax (VAT) rate to 8% from 15% (the rate applicable to financial services has been kept at 15%), an increase in the liable limit for VAT registration to LKR300 million, scrapping of the nation building tax, lowering the income tax rate for the highest income bracket to 18%, from 24%, and changing the withholding tax regime, among others.

Fitch’s preliminary estimates show that the VAT rate change and the scrapping of the nation building tax could alone lower revenue by as much as 2% of GDP in the absence of off-setting measures; VAT accounted for 24% of government revenues in 2018.

The authorities have identified offsetting revenue and expenditure measures that they believe would make these tax cuts revenue neutral. These include a hike in the excise duty on liquor and cigarettes, which accounts for about 10% of VAT revenue, and an increase in the Ports and Airports Development Levy to 10.0%, from 7.5%. In addition, financial services, which account for 15% of VAT, will not be affected by the rate cut.

The authorities project the expenditure adjustment to come mainly from a cutback in public investment.

Fitch expects these offsetting measures, such as adjustments to excise taxes and spending cuts on non-priority public investment and recurrent expenditure, to mitigate part of the revenue loss from the tax announcement. However, the agency nevertheless expects the deficit to widen by about 1.5% of GDP relative to our previous forecasts.

Fitch has revised its budget deficit projection to 6.5% of GDP for 2020 and 6.2% for 2021, which are higher than the authorities’ estimates, from 5.0% previously in both years.

Following the tax cuts, Fitch projects that gross general government debt, currently at about 85% of GDP, will be on an upward trajectory over the medium-term in the absence of off-setting measures.

Fitch believes the authorities still aim to reduce the deficit to below 4.0% of GDP over the medium-term in line with their previous consolidation plans. However, the announced tax measures create uncertainty about the feasibility of these plans.

The outlook for the completion of the seventh and final review under the Extended Fund Facility arrangement with the IMF now seems uncertain and discussions of a new programme after the parliamentary elections expected in April 2020 could be complicated by the tax cuts.

Fitch acknowledges that the tax cut announcement has come during the early period of the new administration and that further policy announcements will follow, which could mitigate some fiscal issues. However, we believe the initial evidence of a roll-back of the revenue-driven fiscal consolidation path is negative for the sovereign’s creditworthiness.

The ‘B’ IDR also reflects the following key rating drivers:

Fitch expects growth to pick up to 3.5% in 2020 and 3.7% in 2021, from 2.8% in 2019. These forecasts reflect our expectation of a boost to growth in the short-term from the tax cuts, higher agricultural output and an ongoing recovery in tourism following last April’s terrorist bombings. Remittances are also likely to remain supportive of domestic demand.

Sri Lanka’s external balance sheet is weak, with external debt obligations totalling approximately USD19.0 billion coming due between 2020-2023, compared with foreign-exchange reserves of around USD7.5 billion as of end-November 2019. We expect the current account deficit to widen to about 3.0% of GDP in 2020 and 2021, from an estimated 2.2% in 2019, as domestic demand strengthens.

Large interest payments as a share of revenue, at about 46.0% (current peer median 10.2%), a low revenue ratio and a very high public debt/revenue ratio of 643% continue to highlight the weak structure of Sri Lanka’s public finances. In addition, foreign-currency debt is nearly half of total government debt and leaves public finances vulnerable to renewed currency depreciation.

Sri Lanka’s basic human-development indicators, including education standards, are high compared with the ‘B’ median, as it ranks in the 60th percentile of the UN’s Human Development Index compared with the 35th percentile of the current ‘B’ median. Furthermore, the country’s per capita income of USD4,023 (Fitch estimate as of end-2019) is somewhat higher than the current ‘B’ median of USD3,311.

SOVEREIGN RATING MODEL (SRM) AND QUALITATIVE OVERLAY (QO)

Fitch’s proprietary SRM assigns Sri Lanka a score equivalent to a rating of ‘B+’ on the Long-Term Foreign-Currency IDR scale.

Fitch’s sovereign rating committee adjusted the output from the SRM to arrive at the final Long-Term Foreign-Currency IDR by applying its QO, relative to rated peers, as follows:

– External Finances: -1 notch to reflect high sovereign external refinancing needs against relatively low foreign-currency reserves that leave the external position vulnerable to any adverse shifts in investor sentiment.

Fitch’s SRM is the agency’s proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a Long-Term Foreign-Currency IDR.

Fitch’s QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.

RATING SENSITIVITIES

The main factors that individually, or collectively, could trigger a downgrade are:

– Failure to place the gross general government debt/GDP ratio on a downward path due to wider budget deficits or the crystallisation on the sovereign balance sheet of contingent liabilities that are linked to state-owned entities or government-guaranteed debt.

– Increase in external sovereign funding stresses that threaten the government’s ability to meet upcoming debt maturities, particularly in the event of a loss of confidence by international investors.

– A further deterioration in policy coherence and credibility, leading to lower GDP growth and/or macroeconomic instability.

The main factors that, individually or collectively, could lead to a revision of the Outlook to Stable:

– Stronger public finances, underpinned by a credible medium-term fiscal strategy that places gross general government debt/GDP on a downward path, accompanied by higher government revenue.

– Improvement in external finances, supported by lower net external debt or a reduction in refinancing risk; for example, from a lengthening of debt maturities or increased foreign-exchange reserves.

– Improved macroeconomic policy coherence and credibility, evidenced by more predictable policy-making and a track record of meeting previously announced economic and financial targets.

KEY ASSUMPTIONS

– Global economic outcomes are consistent with Fitch’s latest Global Economic Outlook report.

ESG CONSIDERATIONS

– Sri Lanka has an ESG relevance score of ‘5’ for political stability and rights, as World Bank governance indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.

– Sri Lanka has an ESG relevance score of ‘5’ for rule of law, institutional and regulatory quality and control of corruption, as World Bank governance indicators have the highest weight in Fitch’s SRM and are therefore highly relevant to the rating and a key rating driver with a high weight.

– Sri Lanka has an ESG relevance score of ‘4’ for human rights and political freedom, as World Bank governance indicators have the highest weight in Fitch’s SRM and are relevant to the rating and a rating driver.

– Sri Lanka has an ESG relevance score of ‘4’ for creditors’ rights, as willingness to service and repay debt is relevant to the rating and a rating driver, as for all sovereigns.

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Fitch confirms ‘A(lka)’ domestic rating of Sampath Bank Plc

ECONOMYNEXT – Fitch Ratings said it was confirming a national long-term A(lka) rating on Sri Lanka’s Sampath Bank Plc with a stable outlook, amid an improvement in operating environment, indicated by headline macroeconomic indicators.

The bank had stage 3 loans of nearly 17 percent at end-1Q24 (2023: 16.6 percent).

Fitch expected this ratio to decrease in the near- to medium-term alongside focused recoveries.

“We expect Sampath’s impaired (stage 3) loans ratio to decline gradually in the medium term, due to its recovery efforts, improvements in repayment capacity of borrowers from the stabilisation in economic conditions, and moderate loan book growth.”

The bank also had defaulted sovereign bonds. “Defaulted foreign-currency sovereign bonds, which accounted for 1.9% of assets, had impairments amounting to 52% of its holdings as of end-1Q24.”

The full statement is reproduced below:

Fitch Affirms Sampath Bank at ‘A(lka)’; Outlook Stable

Fitch Ratings – Colombo – 22 Jul 2024: Fitch Ratings has affirmed Sri Lanka-based Sampath Bank PLC’s (Sampath) National Long-Term Rating at ‘A(lka)’. The Outlook is Stable. Fitch also affirmed Sampath’s outstanding Sri Lankan rupee-denominated subordinated debt at ‘BBB+(lka)’.

KEY RATING DRIVERS

Intrinsic Profile Drives Rating: Sampath’s National Long-Term Rating reflects its own financial strength, which is highly influenced by its exposure to the sovereign’s weak credit profile (Long-Term Foreign-Currency Issuer Default Rating (IDR): RD; LongTerm Local-Currency IDR: CCC-) and the ongoing sovereign debt restructuring, which had been putting pressure on Sampath’s credit profile. The rating also reflects Sampath’s modest domestic franchise as Sri Lanka’s fifth-largest commercial bank.

Stabilising OE: Sri Lankan banks’ operating environment (OE) continues to show signs of stabilisation, as evident in sustained improvements in reported headline macroeconomic indicators, supporting the recovery in banks’ operational flexibility.

Further improvement to the bank’s OE remains contingent on successful execution of the sovereign’s external debt-restructuring exercise alongside the restoration of the sovereign’s creditworthiness, given the strong link between sovereign financial health and banks’ operating conditions.

Economic Stabilisation Aids Business Profile: We believe the gradual improvement in economic conditions should support Sampath’s ability to generate and defend business volumes, despite the vulnerabilities from the weak sovereign and economy. We expect a moderate resumption in lending alongside the gradual economic recovery, similar to peers. This should result in a higher loan book share of assets (net loans to assets of 48.0% at end-1Q24) in the medium term.

Sovereign Risk Remains: Sampath’s risk profile assessment continues to reflect its exposures to the weak sovereign and economic environment. Defaulted foreign-currency sovereign bonds, which accounted for 1.9% of assets, had impairments amounting to 52% of its holdings as of end-1Q24. In addition, local-currency-denominated treasury securities contributed to 34% of its assets at end-2023, of which 59% were treasury bonds and the remainder in treasury bills, which makes the bank susceptible to the sovereign’s repayment ability and liquidity status.

Impaired Loans Decline Gradually: We expect Sampath’s impaired (stage 3) loans ratio to decline gradually in the medium term, due to its recovery efforts, improvements in repayment capacity of borrowers from the stabilisation in economic conditions, and moderate loan book growth. Prolonged economic challenges that continued for most of 2023 led to a further impaired-loans accretion, which together with loan book contraction resulted in the bank’s impaired-loans ratio rising to 16.6% by end-2023 (end-2022: 11.6%), above the industry’s 12.8%.

Declining Risks to Profitability: We believe downside risk to profitability from the restructuring of sovereign bonds has diminished, and any incremental impairment, if necessary, will be manageable, given the existing provisions on the holdings. We expect Sampath’s operating profit/risk weighted assets ratio (1Q24: 4.8%, 4-year average 3.2%) to moderate over the medium term on account of the decline in interest rates. This will be partially offset by lower credit costs, alongside the increase in risk density from the growth in the share of loans.

Downside Risks to Capital Manageable: We believe downside risk to capital from the bank’s exposure to defaulted sovereign bonds (1.9% as of end-1Q24) is manageable, as per the announced restructuring terms – given the bank’s provisions on these instruments amounting to 52% on the exposure at end-1Q24. The regulatory common equity tier 1 (CET1) capital ratio declined marginally to 15.6% by end-1Q24 (excluding 1Q24 profit) from 16.7% at end-2023, following a cash dividend payment, but remains one of the highest among Fitch-rated large Sri Lankan banks.

Funding and Liquidity Risks Remain: We believe Sampath ‘s funding and liquidity stress has eased on both the foreign- and local-currency fronts relative to the crisis period.

This was due to favourable external sector flows and the bank’s focus on liquidity preservation, as reflected in its high liquidity coverage ratio. We believe these developments have reduced the risk of bank failure. However, its funding and liquidity profile – particularly in foreign currency – remains susceptible to sudden changes in creditor sentiment driven by adverse changes to the sovereign’s credit profile, similar to peers.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

The bank’s National Rating is sensitive to a change in its creditworthiness relative to other Sri Lankan issuers.

A deterioration in Sampath’s key credit metrics beyond our base-case expectations relative to peers would also lead to increased pressure on the rating, which is driven by its intrinsic financial strength.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Positive rating action on the sovereign may lead to an upgrade. A sustained improvement in key credit metrics beyond our base-case expectations relative to peers, could also lead to an upgrade.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS SUBORDINATED DEBT

Sampath’s Sri Lankan rupee-denominated outstanding subordinated debt is rated two notches below the National Long-Term Rating anchor. This reflects Fitch’s baseline notching for loss severity for this type of debt, and our expectations of poor recoveries.

There is no additional notching for non-performance risks, as the notes do not incorporate going-concern loss-absorption features.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

The subordinated debt ratings will move in tandem with the bank’s National Long-Term Rating.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Additional information is available on www.fitchratings.com (Colombo/Jul24/2024)

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Sri Lanka presidential candidate cash deposits not updated in 43 years: MP

MP Dullas Alahapperuma

ECONOMYNEXT — The cash deposits Sri Lanka’s presidential candidates are required to pay have not been revised in 43 years, opposition MP Dullas Alahapperuma said, calling for a significant increase in order to save money and to prevent proxy candidates.

Alahapperuma told parliament on Wednesday July 24 that, as per the Presidential Elections Act No. 15 of 1981, a candidate nominated by a recognised political party has to deposit only 50,000 rupees while an independent candidate, or a candidate nominated by any other party or by an elector, must pay only 75,000 rupees.

The MP said the cabinet of former president Gotabaya Rajapaksa had approved an amendment to the act to increase these amounts.

“The election commission proposed that this be increased to 2.5 million rupees for political parties and 3 million for independent candidates. This was a pertinent proposal. There were 35 candidates who contested the last election,” he said.

The Act notes that “Where the number of votes polled by any candidate does not exceed one-eighth of the total number of votes polled at the election, the deposit made in respect of such candidate shall be declared forfeit and shall be transferred by the Commissioner from the deposit account to the Consolidated Fund, and in every other case the deposit shall be returned to the person who made the deposit, as soon as may be after the result of the election is declared.”

At the 2019 presidential election, said Alahapperuma, the deposits made by all candidates besides the top two contenders were transferred to the Consolidated fund.

“The number of candidates might be 80 or 85 this election. Many candidates have no basis for contesting, and it costs a vast sum of money to print ballots and other expenses, not to mention the time consumed for counting votes. This is not just to prevent proxy parties from contesting but also to save a lot of national wealth,” he said.

Leader of the House Susil Premajayantha responding to Alahapperuma said, however, that it would not be possible to pass the proposed amendment in time for the 2024 presidential election.

“The election commission made this proposal some time ago. But we know that to gazette a bill, we need to first draft the bill, the cabinet has to decide on it, send it back to the Legal Draftsman, and receive clearance from the Attorney General. So there is no time to bring this amendment for the upcoming presidential election. You can propose it at the next one,” he said. (Colombo/Jul24/2024)

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Sri Lanka deaf driver license project to be expanded islandwide

ECONOMYNEXT – A pilot project that allowed hearing-impaired persons to obtain light-vehicle driving licenses has been successful and will be rolled out island-wide, Sri Lanka’s Motor Traffic Department said.

The project was implemented in the Gampaha District initially where 50 licenses were provided to drivers who qualified.

The project was expanded to the Kurunegala District, where 150 drivers obtained licences. The drivers were given a probation period.

“Actually, this was a very successful project. It has been almost a year and we haven’t received a single complaint yet,” Motor Traffic Department Commissioner – Driving Licence Wasantha Ariyarathna told reporters on Wednesday.

“We plan to roll it out to all 25 districts islandwide.”

The issuance of driver’s licenses to hearing impaired persons will be done on a bi-annual renewal basis.
(Colombo/Jul24/2024)

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