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Tuesday January 31st, 2023

Sri Lanka’s NDB downgraded to ‘A(lka)’ amid soft-peg collapse

ECONOMYNEXT – Sri Lanka’s National Development Bank has been downgraded to ‘A(lka)’ from ‘A+(lka)’ amid rising economic stress from the worst currency crisis in the history of the island’s central bank, triggering a sovereign default in its wake.

“The downgrade reflects our view that NDB’s credit profile has weakened relative to that of similarly rated peers,” the rating agency said.

“This is due to the pace of the deterioration in its capital buffers and the limited profitability headroom to absorb credit cost shocks in light of the rising risks to the bank’s operating environment.”

Sri Lanka defaulted on its foreign debt in April 2012 after running out of reserves.

“The sovereign’s default on its foreign-currency obligations has exerted significant pressure on NDB’s foreign-currency liquidity position, given its large holding of foreign-currency government securities, at 6.5% of assets at end-2021,” Fitch said.

“Access to foreign-currency funding has been severely dampened due to the sovereign’s debilitated credit profile, which has caused the bank to rely on limited flows of remittances and export proceeds.

Sri Lanka prints money to keep interest rates down and trigger a currency crises and soft-pegging leading to depreciation and sharply higher rates as corrective pressure is applied. Under flexible inflation targeting the frequency of currency crises had increased.

In the current crises corrective market rates have topped 25 percent raising concerns over bad loans and also market to market losses.

“We expect worsening economic stress to destabilise corporate and household balance sheets further, leading to a marked increase in impaired (Stage 3) loans from the 8.3% estimated in 1Q22 in the near-to-medium term,” Fitch said.

“Still, recently announced concessions for affected borrowers may limit the growth in impaired loans, which we believe could mask true credit quality. The bank’s exposure to the government’s foreign-currency instruments also adds to its asset-quality woes.”

The full statement is reproduced below:

Sri Lanka’s NDB Bank downgraded to ‘A(lka)’ amid currency crisis

Fitch Ratings – Colombo – 28 Jul 2022: Fitch Ratings has downgraded Sri Lanka-based National Development Bank PLC’s (NDB) National Long-Term Rating to ‘A(lka)’ from ‘A+(lka)’. Fitch has also downgraded NDB’s subordinated debt ratings to ‘BBB+(lka)’ from ‘A-(lka)’. The ratings remain on Rating Watch Negative (RWN).

A full list of the rating actions is detailed below.

KEY RATING DRIVERS

Capital Buffers Deteriorating: The downgrade reflects our view that NDB’s credit profile has weakened relative to that of similarly rated peers. This is due to the pace of the deterioration in its capital buffers and the limited profitability headroom to absorb credit cost shocks in light of the rising risks to the bank’s operating environment.

RWN Maintained: The RWN on NDB’s National Long-Term Rating reflects the potential for the bank’s creditworthiness relative to other entities on the Sri Lankan national rating scale to deteriorate amid the heightened stress on the bank’s funding and liquidity and its material exposure to the sovereign via investment in foreign-currency instruments that raises the risks to its overall credit profile. We believe the acceleration in inflation, depreciation of the local currency and other factors can distort the bank’s underlying financial performance in the current operating environment.

Constrained Foreign-Currency Liquidity: The sovereign’s default on its foreign-currency obligations has exerted significant pressure on NDB’s foreign-currency liquidity position, given its large holding of foreign-currency government securities, at 6.5% of assets at end-2021. Access to foreign-currency funding has been severely dampened due to the sovereign’s debilitated credit profile, which has caused the bank to rely on limited flows of remittances and export proceeds.

Highly Vulnerable Capitalisation: We believe that risks to NDB’s capital have increased significantly since our last rating review, despite a capital infusion of LKR9.5 billion in 2Q21. This stems from the possibility that increased provisioning on both loan and non-loan exposures could far outweigh pre-impairment profitability, potentially eroding its equity and capital buffers.

The bank’s above-average share of unprovided impaired loans and the potential for a haircut on its foreign-currency government securities that is higher than the amount already factored into its metrics exacerbate the risk on its thin capital buffers. Recently announced regulatory forbearance measures could help the bank to remain compliant with minimum capital ratios on a reported basis.

Heightened Asset-Quality Pressure: We expect worsening economic stress to destabilise corporate and household balance sheets further, leading to a marked increase in impaired (Stage 3) loans from the 8.3% estimated in 1Q22 in the near-to-medium term.
Still, recently announced concessions for affected borrowers may limit the growth in impaired loans, which we believe could mask true credit quality. The bank’s exposure to the government’s foreign-currency instruments also adds to its asset-quality woes.

Deteriorating Profitability: Fitch expects pressure on NDB’s earnings and profitability to intensify in the near-to-medium term as economic conditions continue to deteriorate rapidly. Earnings pressure is already evident in the substantial increase in impairment charges (86% of 1Q22 pre-impairment profit) on its loan and non-loan exposures, which led the bank’s core profitability metric – operating profit/risk weighted assets – to decline to 0.7% by end-1Q22 (end-2021: 2.3%).

Weakening Operating Environment: Our assessment of Sri Lankan banks’ operating environment reflects the pressure on the banks’ already stressed credit profile following the sovereign’s default on its foreign-currency obligations. It also captures the rapid deterioration in the broader economy, including increased interest rates, high inflation and acute currency depreciation, which has limited NDB’s operational flexibility.

Instability Weighs on Business Profile: We believe NDB’s business profile, like that of most domestic peers, is highly vulnerable to the intensifying risks in the domestic market as the profile is highly concentrated on the weak and unstable Sri Lankan economy. This could potentially limit the bank’s ability to generate and defend business volume while controlling risks.

High Risk Profile: NDB’s elevated risk profile, similar to local peers, stems from its predominantly domestic exposure with weak credit quality, including project financing, which is reflected in the ‘ccc’/negative operating environment score. This is exacerbated by NDB’s sizeable exposure to the foreign-currency instruments issued by the government, making the bank vulnerable to the sovereign’s repayment capacity and liquidity position.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

The RWN reflects rising risks to the bank’s rating from funding stresses, which could lead to a multiple-notch downgrade. We expect to resolve the RWN once the impact on the bank’s credit profiles becomes more apparent, which may take more than six months. Developments that could lead to a multiple-notch downgrade include:

– funding stress that impedes the bank’s repayment ability

– significant banking-sector intervention by authorities that constrains the bank’s ability to service its obligations

– a temporary negotiated waiver or standstill agreement following a payment default on a large obligation

– Fitch’s belief the bank has entered into a grace or cure period following non-payment of a large financial obligation.
A downgrade of the sovereign’s Long-Term Local-Currency Issuer Default Rating (CCC) could also lead to a downgrade of the bank’s rating.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

There is limited scope for upward rating action given the RWN.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

SUBORDINATED DEBT

NDB’s Basel II- and Basel III-compliant Sri Lankan rupee 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 expectation of poor recoveries. There is no additional notching for non-performance risks, as the notes do not incorporate going-concern loss-absorption features.

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Sri Lanka shares down for 2nd day as tax hike, delay in Chinese debt assurance weigh

ECONOMYNEXT – Sri Lanka’s shares edged down on Tuesday as worries over delay in financial assurances from China which is mandatory for a $2.9 billion dollar IMF loan and rise in protests against tax hike kept investors in check, analysts said.

The main All Share Price Index (ASPI) edged down by 0.28 percent or 24.62 points to 8,865.05. It fell for the second session after hitting more than three-month high.

“The market is looking for more macro cues because of faster Chinese debt assurance was expected. The market is also hit by fall in corporate earnings due to high taxes,” an analyst said.

China has given an initial response on debt re-structuring to Sri Lanka though analysts familiar with the process say it is not a ‘hard assurance’ sufficient for the IMF program to go through.

The International Monetary Fund is working with China on extending maturities of Chinese loans to defaulted countries like Sri Lanka, as there is resistance to hair-cuts, Managing Director Kristalina Georgieva told reporters on January 14.
The earnings for first quarter are expected to be negative for many corporates with higher taxes and rising costs. However, investors had not expected earnings to be low in the December quarter because of year end pick ups on heavy counters, the analyst said.
Earnings in the second quarter of 2023 are expected to be more positive with the anticipation of IMF loan and possible reduction in the market interest rates as the tax revenue has started to generate funds.

However, the central bank said the IMF deal is likely in the first quarter or in the first month of the second quarter.

The most liquid index S&P SL20 dropped by 0.64 percent or 17.74 points to 2,764.51 points.

The central bank has said it could cut interest rates in future when the country sees fall in inflation, which has already started decelerating.

The market saw a turnover of 1.7 billion rupees, slightly lower than the month’s daily average of 1.8 billion rupees and while being significantly lower than 2022’s daily average turnover of 2.9 billion rupees.

The bourse saw a net foreign inflow (NFI) of 93 million rupees extending the net offshore buying to 413 million rupees so far this year.

Top losers were LOLC, Royal Ceramics Limited and Hayleys. (Colombo/Jan31/2023)

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Sri Lanka exports fall in December as global recession weighs

ECONOMYNEXT – Sri Lanka’s merchandise exports earnings fell 9.7 percent in December year-on-year as the island nation saw a drop in buying from its key export destinations which are facing a looming recession after the Russia-Ukraine war.

The earnings from the merchandise exports recorded $1.04 billion  in December 2022 compared to the same month in the previous year as per the data released by the Sri Lanka Customs.

“This was mainly due to the decrease in export earnings from Apparel & Textiles, Tea, Rubber based Products, and Coconut based Products, Food & Beverages, Spices & Essential Oils and Fisheries products,” the Export Development Board (EDB) said in a statement.

“The reason for this decline was due to the ongoing recession in major markets due to rising cost of production, energy etc. Imports declined sharply due to inflation and demand for goods and services are reduced.”

However, Sri Lanka saw a record export earning of $13.1 billion in 2022 due to increased demand in the key exports throughout the year

Earnings from all major product sectors except Electrical & Electronic components as well as Diamonds, Gems & Jewellery fell in December.

Exports of Apparel & Textiles decreased by 9.6 percent to $480.3 million in December 2022.  Export earnings from Tea fell by 3 percent to $107.3 million, Rubber and Rubber Finished products dropped 20.3 percent to $74.5 million,

However, export earnings from the Electrical & Electronics Components increased by 16.18 percent to $42.9 million in December 2022, while Diamond, Gems & Jewelry jumped 35.7 percent to $30.8 million. (Colombo/Jan31/2023)

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Sri Lanka records over 6,000 dengue cases in first three weeks of January

ECONOMYNEXT – Sri Lanka recorded over than 6,000 dengue cases in the first three weeks of January 2023 after a spell of heavy monsoon rain though a drop in cases is likely from February, officials said.

Health officials identified 6,204 dengue patients by January 22, up from 5,793 recorded in the corresponding period last year.

“A rise in cases can be observed in the November-January period with the heavy rain due to the northeast monsoon,” an official from the National Dengue Control Unit told EconomyNext.

Of all reported cases, 46.3 percent were from the Western Province, official reports showed.

Akuressa, Batticaloa, Eravur, Trincomalee, Madampe, Badulla, Eheliyagoda, Kegalle, Kalmunai North and Alayadivembu MOH areas were identified as high-risk areas for dengue during the third week of January by the health officials.

“We are expecting a decline in dengue cases soon. The Western province is always in the top position with the highest number of dengue cases. Apart from that, we are seeing a higher number of cases during this period in areas like Puttalam, Jaffna districts. A certain number of cases have also been recorded in the Kandy district,” the official said.

“Usually the cases peak in December, but they decline by February. This year, too, we are facing this scenario. There is an increase of dengue during the months of November, December and January”.

Due to the economic situation in the country, the Public Health Inspectors (PHIs) in an earlier report said, diesel and pesticides are not being provided by the ministry.

However, rejecting the allegation, the official from the NDCU said the government has provided enough funds for get the necessary pesticides but it is being used according to a scientific method to avoid building a resistance in the dengue mosquito.

“The recommendation is to do the fogging if there is a dengue outbreak or if there are few patients reported from the same locality.

“If you use this pesticide haphazardly, the mosquitos will develop resistance against it,” the official said, adding that there are adequate stocks of the chemical available. (Colombo/ Jan 31/2023)

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