Ongoing drought could derail SL’S fiscal consolidation, undermine growth: Moody’s

„SL facing worst drought in four decades „Moody’s expects real GDP to grow by 5% against govt.’s 6% „Forecasts 5.2% budget deficit against govt.’s 4.6% target „Moody’s assigned Sri Lanka a B1 rating with ‘Negative’ outlook

Sri Lanka is currently facing its worst drought in four decades and it could well derail the country’s ambitious agenda for fiscal consolidation and squeeze the growth by at least a percentage point in 2017, warns Moody’s Investor’s Service.

The prevailing drought has taken a toll on the paddy harvest and the farming community mainly in the northern and eastern regions of the country— Sri Lanka’s rice bowl.

The situation has aggravated so much that the government is providing relief to these families. The real risk, according to Moody’s, is that it increases the government spending at a time when Sri Lanka’s fiscal strength remains low.

Sri Lankan government has so far spent Rs.82 million in droughtrelated compensation and will further provide Rs.10, 000 each per acre of unusable, dried-out rice paddies and compensation for other crops for a period of four months.

“Therefore, Sri Lanka’s ambitious 2017 fiscal deficit target will be even more challenging to achieve, a credit negative,” the global rating agency stated in its Credit Outlook for Sri Lanka.

Moody’s has assigned Sri Lanka a B1 rating with a ‘Negative’ outlook.

The cautious approach by Moody’s calls into questions the rationale behind the recent revision of Sri Lanka’s rating outlook to ‘Stable’ from ‘Negative’ by Fitch in February mainly on account of the progress made in the fiscal front.

Some analysts opine that last month’s action by Fitch was bit too premature. Majority of Sri Lanka main macroeconomic indicators from inflation to interest rates to exchange to external sector outlook have worsened in recent times, mostly due to selfinflicted economic ills and partly to legacy issues.

The only exception was the somewhat improved fiscal conditions, thanks to the conditions forced on the authorities by the International Monetary Fund in return of a US $ 1.5 billion bailout package.

“Drought-related government spending will add to the challenge of containing public expenditures as specified under Sri Lanka’s current IMF Extended Fund Facility programme”, Moody’s said. While no official information is available yet on the extent of the damage to crops, if half the paddy acreage sown in 2015 proves unusable, that would amount to 1.5 million acres and Moody’s estimates the fiscal cost of such compensation to be as high as 0.1 percent to 0.2 percent of GDP, plus costs related to compensation for other crops.

Sri Lanka targets a 4.6 percent fiscal deficit for 2017 but Moody’s forecasts that the government would overshoot the target to record a deficit of 5.2 percent of GDP.

According to the Sri Lanka’s Ministry of Disaster Management and World Food Programme, only 35 percent of cultivable rice paddy land had been farmed as endnovember, the lowest level in the last 30 years. MORE ON P9

Meanwhile, Sri Lanka’s major reservoirs were at only 29 percent of capacity as end-december, and hydropower availability was only 30 percent of total installed capacity.

A high level IMF official is expected in town within a few weeks to press the government on certain delayed fiscal and structural reforms such as reforms to the stateowned enterprises, which were promised when the two parties entered into an agreement last year.

The pressure would mount not just from the expenditure side but also from the revenue side as the drought will weigh on the economic growth because of lower overall agricultural production.

“We expect the drought to weigh on economic activity in the first half of this year, with the summer monsoon rains providing some relief in the second half. Lower agricultural output will reduce exports, household income and consumption in affected areas, posing downside risks to GDP growth.

We currently expect real GDP to increase by 5.0 percent in 2017, which is materially lower than the government’s forecast of 6.0 percent,” Moody’s said.

Highlighting the external woes that could be prompted by the drought, Moody’s said the lower agricultural exports and higher imports to substitute for the loss in domestic production will weigh on Sri Lanka’s current account deficit and foreign-exchange reserve buffers, a key constraint to Sri Lanka’s credit quality.

The difficulties faced by the agricultural sector in Sri Lanka could spill over into multitude of socio-economic issues as the sector employs 28 percent of the labor force but account for just under 10 percent for the GDP. “Therefore, droughts can create economic and social costs for the sovereign”, Moody’s said.