Moody’s downgrades Sri Lanka; outlook changed to Stable
Rating agency troubled mostly by possible weakening of institutions and governance
Says refinancing risks and stretched budget deficit exacerbated by pandemic
Projects Sri Lanka’s annual external debt repayments at US $ 4bn between 2020 and 2025
Estimates fiscal deficit to be 8-9% of GDP; debtto-gdp to rise to around 100%
Moody’s Investors Service yesterday downgraded Sri Lanka’s long-term foreign currency issuer and senior unsecured ratings to Caa1, from B2 and changed the outlook to stable, after more than five months since the rating agency put the country’s sovereign rating under review for downgrade on April 17.
Moody’s, one of the big three global rating agencies, cited heightened refinancing risks and stretched fiscal deficit among others for the downgrade, as the pandemic tightened the country’s external position while it necessitated the government to stretch its budget to provide assistance to businesses and the people affected by the pandemic.
The two-notch downgrade, which was unusual, also came at a time when the Sri Lankan economy was making notable strides in many areas, including agriculture, manufacturing, services, exports, employment and wages.
However, Moody’s appeared to have been troubled by the fiscal and external pressures, which render a limited scope for reforms to address long-standing credit vulnerabilities, “denoting weakening institutions and governance”, triggering the rating action.
“Governance considerations are an important driver of today’s decision to downgrade the rating,” Moody’s said.
Sri Lanka has approximately US $ 4.0 billion in external debt repayments between 2020 and 2025, Moody’s estimates.
Sri Lanka raised US $ 1.2 billion from the China Development Bank in March and it finalised a US $ 400 million swap facility with the Reserve Bank of India, as it seeks to diversify its funding to non-market sources while it plans to return to external capital markets by late this year or early next year, as the global market unease caused by the pandemic dissipates.
“Nevertheless, delays in securing additional funding from multilateral and bilateral creditors, in addition to the IMF’S Rapid Financing Facility, mean that the financing sources for upcoming repayments in the next few years are not secured and risk coming at high costs,” Moody’s cautioned.
“Sri Lanka continues to face very tight external financing conditions and a significant decline in revenue from a sharp and prolonged economic slowdown. This shock occurs at a time when Sri Lanka’s credit profile is highly vulnerable, given low reserve coverage of large forthcoming external debt payments and very weak debt affordability,” the rating agency added.
On the fiscal front, Moody’s is of the opinion that the significant social and policy hurdles will inhibit the mediumterm fiscal consolidation and projects the fiscal deficit to be in the range of 8 to 9 percent of GDP during 2020 and 2021.
“Sri Lanka’s already narrow revenue base will be slow to recover amid weaker economic growth and expenditure pressure from public sector wage hikes and higher debt servicing costs will continue to limit flexibility, likely beyond the most acute phase of the economic and financial shock,” Moody’s opined.
Due to the requirement of higher borrowings to fund the stretched fiscal deficit, combined with the slower nominal GDP and a weaker rupee, Moody’s projections showed
Sri Lanka’s debt-to-gdp to rise to around 100 percent. The rating agency also said the current shock would also challenge the country’s monetary policy effectiveness. But the data has shown that the current Monetary Policy has been the most effective in its entire history.
Making sense of what its ‘stable’ outlook means, Moody’s said it reflects the rating agency’s assessment of balanced credit risks at the Caa1 rating level.