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Sri Lanka’s credit, current account deficit to be watched: Fitch

COLOMBO (EconomyNext) – Sri Lanka’s credit growth, any widening of the external current deficit that would be worsened by expansionary activities of the state would be watched, a Fitch Ratings official said.

Sri Lanka is now rated ‘BB-‘, three levels below ‘BBB-‘ investment grade with a stable outlook, by Fitch, helped by strong growth, a gradual reduction in the budget deficit and an unblemished debt servicing record, Sagarica Chandra, head of Asia Pacific Sovereigns at Fitch.

The rating agency would be on the lookout for "any signs of overheating, which would be reflected in an expansion of private sector credit or a widening of the (external) current account deficit, that would be driven by a pro-cyclical fiscal or monetary stance," she told a business forum in Colombo.

An improvement in foreign direct investment or exports which would lead to a build-up of foreign reserves would help the rating, she said.

Analysts say exports and FDI create their own import demand and reserves would grow only to the extent that overall credit is curbed allowing a part of the inflows to remain within the country.

While a surplus in the capital account, in the form of net foreign borrowings would expand the current account deficit as the proceeds are spent, a crisis happens only if the Central Bank prints money either to finance the budget deficit or sterilize foreign exchange sales to delay a rate hike.

Following a balance of payments crisis in 2012, which was fixed by a delayed rate hike and currency float, Sri Lanka’s credit growth slowed and state energy enterprises repaid debt allowing Sri Lanka’s foreign reserves to grow until August 2014.

Since August private credit has started to recover helped by ultra-low interest rates not seen since the 1970s.

A revised budget on January 29, has pushed up state spending via an unprecedented public sector salary hike, while the finances of energy SOEs have also become less strong following a price cut.

However monetary policy was tightened last week by lifting a restriction on the floor liquidity window of the central bank, which may result in an overnight rate increase of around 75 to 100 basis points.

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Gilt yields deeper along the yield curve has also moved up.

Meanwhile Chandra said up to the end of 2014, there has been steady fiscal consolidation.

Analysts have pointed out that improvements in the budget deficit has come from a reduction in current spending, which is the best possible type of correction that could happen, rather than through a tax revenue increase, which leaves less money for high growth private activities.

Sri Lanka’s short term debt, another metric watched by Fitch was almost 100 percent of foreign reserves, Chandra said.

After credit turned in August 2014, coupled with IMF repayments (which are monetary policy neutral) and the repayment of debt in early 2014 reserves have come down by about 2 billion US dollars.

Sri Lanka’s deb to gross domestic product ratio was high at around 75 percent, and general government revenues were low, Chandra said.

She said strong foreign remittances which helped growth as well as a "solid" repayment record helped the credit. Human development was also high.

Sri Lanka’s governance indicator were weak compared to other BB rated countries, with the country scoring low on ‘political stability’ and ‘voice and accountability.’

"However at this point we acknowledge that there had been a smooth and orderly transfer of power at the recent elections, which does indicate a basic level of stability in the political system.

"There is potential for change given that there is a new government now."

She said however there was no clarity on any reforms.

"The outlook for reforms is not very clear, and implementation of policy is still uncertain."