Fitch affirms Sri Lanka rating at 'B+'

Fitch Ratings on Wednesday affirmed Sri Lanka's LongTerm Foreign- Cur rency Issuer Default Rating (IDR) at 'B+' with a ‘Stable Outlook’.

In Fitch's view, policies aimed at fiscal consolidation and maintenance of a disciplined monetary stance under the framework of the 3- year IMF- supported programme have improved Sri Lanka's policy coherence and credibility, the rating agency said in a media release.

Although GDP growth of an estimated 3.9 per cent in 2017 fell short of forecasts due to weather- related supply disruptions, “we” expect growth to recover and stabilise at around 5 per cent in 2018 and 2019, Fitch said.

The shift towards greater exchange-rate flexibility since 2H15 has strengthened the external position, and the planned shift towards flexible inflation targeting should further enhance monetary policy credibility. Credit growth has declined to a more sustainable level of around 15 per cent in 2017 from a high of 20 per cent in 2016.

Fiscal performance has improved following the approval and implementation of tax reforms. Fitch said it expects Sri Lanka's ratio of general government revenue to GDP to improve to 15.5 per cent in 2018 and 16.2 per cent by 2019, from a low of 11.6 per cent in 2014, reflecting the passage of revenue- enhancing measures under the IMF programme. These include an increase in the VAT rate to 15 per cent in 2016 from 11 per cent, and implementation of a new Inland Revenue Act from April 2018 that aims to simplify tax laws, reduce exemptions and improve the efficiency of the tax system.

“We think the increase in general government revenues will support a further narrowing of the budget deficit to 4.8 per cent of GDP in 2018 and 4 per cent in 2019 from an estimated 5.2 per cent in 2017. While these revenue reforms should be positive for a more credible fiscal framework over time, ineffective implementation and/ or weaker-than-expected GDP growth remain downside risks to our fiscal projections,” it said.

Sri Lanka's interest pay- ments as a share of revenues remain exceptionally high at an estimated 38 per cent at end- 2017, far above the medians of 9.4 per cent for ' B' and 9.6 per cent for 'BB' rated sovereigns. The expected pick-up in general government revenues should lead to lower ratios over time, but this ratio is expected to remain above the ' B' and ' BB' medians for the foreseeable future.

Sri Lanka's external balance sheet remains a weakness for the rating, with high net external debt, weak sovereign net foreign assets and a low international liquidity ratio compared with rating peers. Foreign- exchange reserves rose to around US$ 8 billion at end-2017, representing 3.3 months of current external payments ( CXP), from $6 billion (2.7 months) at end-2016, but reserves remain below the rating category median of 3.9 months. The improvement in reserves reflects the allowance of greater exchange-rate flexibility, as well as a combination of forex purchases from the market, inflows from the Hambantota Port lease and new external borrowings.

Sri Lanka's external debt service outlook remains challenging over 2019- 2022. The sovereign's external debt service payments over this period are around $ 15 billion against current reserve levels of about $ 7.7 billion. The authorities expect to pass a liability management bill in 2018, which would allow them to smooth debt payments by potentially extending maturities over this period. However, the scale of external refinancing over the next few years creates a potential vulnerability for the sovereign, particularly against a backdrop of expected monetary tightening in developed marke t s. However, Sri Lanka's track record of accessing international capital marke t s remains a mitigating factor.

Sri Lanka's external debt service outlook remains challenging over 2019-2022.