Sri Lanka warned of further downgrades by Moody’s if reforms are halted

ECONOMYNEXT – Sri Lanka may face further downgrades if recent reforms to reduce budget deficit and improve investment flows were reversed or halted and foreign reserves fell faster, Moody’s Investors Service, a rating agency said after cutting the island’s speculative B2 rating to B1.

"Moody’s would consider downgrading the rating if external and domestic financing conditions were to deteriorate further than currently expected," the rating agency said.

"In particular, a larger drain on foreign exchange reserves would increase the risk of lower capital inflows and sharply raise refinancing costs.

"This would contribute to repayment stresses that would be more consistent with a B3 rating."

Sri Lanka has a soft-pegged exchange rate regime, which means the currency does not float, but interventions are made in the forex markets, which are they filled by printed money.

Sri Lanka has attempted to operate an inflation targeting framework without a floating exchange rate. Moody’s said a floating regime will help.

Sri Lanka is now in a political crisis after President Maithripala Sirisena appointed Mahinda Rajapaksa as Prime Minister, who has since been defeated twice in no-confidence motions in parliament.

Moody’s said it downgraded Sri Lanka because a political crisis seemed "likely to have a lasting impact on policy even if ostensibly resolved quickly, have heightened refinancing risks beyond levels anticipated when the rating agency affirmed the rating at B1 with a negative outlook in July."

Moody’s said a reversal or halt of current reforms could also trigger more downgrades, but a credible continuation of reforms could boost confidence.

Following the political crisis Sri Lanka has already suspended a fuel pricing formula and cut some trade taxes, but said the deficit will be in track.
"Moody’s would also consider downgrading the rating if the government were to reverse recent reforms or to halt implementation of future reforms to address fiscal and external vulnerabilities and bolster GDP growth potential," the rating agency said.
"That would lead to much wider fiscal deficits, larger gross borrowing requirements and higher government debt than Moody’s currently projects, weighing on already very low fiscal strength and further heightening liquidity risks.
"A steady and credible implementation of planned fiscal and economic reforms would improve Sri Lanka’s ability to sustain investor confidence through the upcoming period of large debt maturities," Moody’s said in a rating report.





"However, the likelihood of the government pursing its reform agenda on the previously planned schedule has fallen following recent political events that have interrupted the reform momentum.

"Moody’s does not expect the current political crisis to be fully resolved rapidly, and the crisis is in any event likely to leave its mark on the pace and content of the reform programme.

"Even if past episodes of political disruption have not changed the broad direction of reforms in Sri Lanka, delays in the pace of reform will at a minimum limit the government’s ability to respond to changing market conditions."

Moody’s budget deficits may reduce to 5 percent in the coming years, but debt may remain above 75 percent of gross domestic product, higher than Moody’s previously expected and higher than B-rated countries.

Even that progress will rely heavily on the successful implementation of durable revenue reforms and expenditure restraint, the risks associated with which have risen in recent weeks.

Sri Lanka wants to raise more loans from China, the Middle East and a yen – denominated loan in the short term to repay maturing debt, Central Bank Governor Indrajit Coomaraswamy had said. State banks were also expected to borrow abroad.

He said Sri Lanka had the ability to repay maturing billion dollar sovereign bond in January 2018.

"These options may somewhat mitigate but are unlikely to materially reduce refinancing risks, as ongoing tightening in financing conditions raise uncertainty around the timing and availability of funding sources," Moody’s said.

Sri Lanka has annual foreign debt repayments of about 4 billion US dollars. But if the central bank is steadily injecting rupees in the banking system, credit expands and it is not possible to collect reserves to repay debt. (Colombo/Nov21/2018)

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