Singapore, November 20, 2018 -- Moody's Investors Service ("Moody's") has today downgraded the Government
of Sri Lanka's foreign currency issuer and senior unsecured ratings to
B2 from B1 and changed the outlook to stable from negative.
The decision to downgrade the rating to B2 is driven by Moody's
view that ongoing tightening in external and domestic financing conditions
and low reserve adequacy, exacerbated most recently by a political
crisis which seems likely to have a lasting impact on policy even if ostensibly
resolved quickly, have heightened refinancing risks beyond levels
anticipated when the rating agency affirmed the rating at B1 with a negative
outlook in July. Moody's projections include a slower pace
of fiscal consolidation than assumed in July to reflect disruption to
fiscal policy implementation in a period of political turmoil.
The stable outlook denotes balanced credit risks at the B2 rating level.
Moody's expectation is that, despite the current political
crisis, any future government will remain broadly focused on implementing
important fiscal, monetary and economic reforms that would strengthen
the credit profile over the medium term. However, Moody's
assessment is that the government's debt refinancing will remain
highly vulnerable to sudden shifts in investor sentiment in a period of
further tightening in financing conditions and political and policy uncertainty,
with limited buffers to face such risk.
Concurrently, Moody's lowered the local-currency bond
and deposit ceilings to Ba2 from Ba1. The foreign-currency
bond ceiling was lowered to Ba3 from Ba2 and the foreign currency deposit
ceiling was lowered to B3 from B2.
RATINGS RATIONALE
RATIONALE FOR THE RATING DOWNGRADE TO B2
POLITICAL CRISIS EXACERBATES REFINANCING RISK AS FINANCING CONDITIONS
TIGHTEN, RESERVE ADEQUACY IS LOW
Sri Lanka's low foreign exchange reserve coverage of large external
debt repayments over the next five years exacerbates its reliance on external
bilateral and commercial lenders' willingness to refinance maturing debt.
The risks related to that structural external vulnerability are rising
in an environment of tightening financing conditions globally and,
most recently, heightened domestic political tensions which threaten
to undermine international investors' confidence and the flow of
foreign capital, from private markets and international bilateral
lenders, into Sri Lankan financial assets.
The political situation has also resulted in delay to the disbursements
planned under the IMF programme. A prolonged pause in the IMF programme,
associated to uncertainty about the direction of policy, would likely
undermine investors' confidence, exacerbating the tightening
in financing conditions.
Tightening external financial conditions and domestic political instability
are resulting in capital outflows and placing increasing pressure on the
exchange rate and foreign exchange reserves. The Sri Lankan rupee
has depreciated about 13% over the past 12 months to 176.7
per US dollar as of November 16, 2018, of which around 9%
occurred in the last three months. In addition, spreads on
Sri Lankan bonds over US Treasuries have widened sharply in recent weeks
to more than 550 basis points. Combined, these factors are
raising the value and cost of external debt.
If prolonged, tightening global financial conditions and domestic
political instability could hinder the government's access to global
capital markets, curb foreign direct investment inflows to the country
and reduce funding from international lenders. Such conditions
would undermine the sovereign's ability to meet its large external
repayment obligations. The government will need to make principal
payments on external debt that could be as high as $4 billion per
year between 2019 and 2023, in addition to financing part of the
budget deficit externally. International sovereign bonds account
for a sizeable portion of maturing government debt over this period.
Moody's projects foreign exchange reserves (excluding gold and SDRs)
to remain in a range of $6.5 to $7 billion in the
coming years, lower than it forecast in July. As a result,
Moody's estimates that Sri Lanka's External Vulnerability
Indicator (EVI), the ratio of external debt payments due over the
next year to foreign exchange reserves, will be about 180%
in 2019 and 2020, higher than previously expected and much higher
than the median level for B-rated sovereigns.
Parliamentary approval of the Active Liability Management Act in October
allows the government to raise up to an additional LKR310 billion (approximately
$1.7 billion, or 2% of GDP) over and above
the government's annual borrowing requirements for the purposes
of debt management. This gives the government some flexibility
to smooth the timing of its debt refinancing operations and avoid a concentration
of debt maturities in the future. However, the benefits will
be limited in the next few years given the high level and frequency of
debt maturing.
Going forward, the government may pursue a range of financing options,
including international US dollar bond issuance, yuan and yen-denominated
bond issuances, and loans from China (A1 stable), the Middle
East or other bilateral and multilateral lenders. These options
may somewhat mitigate but are unlikely to materially reduce refinancing
risks, as ongoing tightening in financing conditions raise uncertainty
around the timing and availability of funding sources.
The government aims to increase its funding from the domestic market,
as domestic Treasury bond maturities are lower in coming years.
But although funding from the domestic market can reduce exchange rate
risk, given that local currency interest rates are much higher than
the average cost of total external government debt (including concessional
debt), a switch to domestic financing would involve a rise in the
overall cost of debt from already elevated levels.
VOLATILE DOMESTIC POLITICAL CONDITIONS UNDERMINE INSTITUTIONAL STRENGTH
A steady and credible implementation of planned fiscal and economic reforms
would improve Sri Lanka's ability to sustain investor confidence
through the upcoming period of large debt maturities. However,
the likelihood of the government pursing its reform agenda on the previously
planned schedule has fallen following recent political events that have
interrupted the reform momentum. Moody's does not expect
the current political crisis to be fully resolved rapidly, and the
crisis is in any event likely to leave its mark on the pace and content
of the reform programme. Even if past episodes of political disruption
have not changed the broad direction of reforms in Sri Lanka, delays
in the pace of reform will at a minimum limit the government's ability
to respond to changing market conditions.
SLOWER FISCAL CONSOLIDATION TO KEEP GOVERNMENT DEBT HIGHER FOR LONGER
Sri Lanka's large government debt burden and weak debt affordability
-- along with sizeable external and foreign currency borrowing needs,
lower capital inflows and higher financing costs -- weigh on Sri
Lanka's already very low fiscal strength and broader credit profile.
In the face of continued political strife and disruption to fiscal and
economic policymaking, fiscal consolidation efforts are likely to
resume only slowly. Moody's expects fiscal deficits to gradually
narrow below 5% of GDP in the coming years and the government's
debt burden to continue to decline. However, government debt
will remain above 75% of GDP in 2020, from about 77%
of GDP in 2017, higher than Moody's previously expected and
higher than many B-rated sovereigns. Even that progress
will rely heavily on the successful implementation of durable revenue
reforms and expenditure restraint, the risks associated with which
have risen in recent weeks.
As a result, Moody's expects government gross borrowing requirements,
incorporating projections on fiscal deficits and maturing government debt
repayments, to reach about 19% of GDP in 2018. Although
Moody's expects them to fall to around 15% by 2020,
that remains a high level -- and higher than at the time of July's
affirmation -- particularly given the low coverage of reserves and
consequently the high and rising EVI.
In the meantime, interest payments will continue to absorb about
40% of government revenue, much higher than most B-rated
sovereigns because of Sri Lanka's high debt burden and significant
borrowing requirements, as well as its low, albeit gradually
rising, revenue base.
RATIONALE FOR THE STABLE OUTLOOK
The stable outlook denotes balanced risks at the B2 rating level.
Against the backdrop of ongoing political turmoil, there may be
changes or delays to policies that could result in a slower pace of fiscal
consolidation in the short term. However, Moody's expects
the broad direction of policy will remain focused on gradually narrowing
fiscal deficits and lowering government debt, independent of political
shocks. The government had planned further reforms to broaden and
deepen its revenue base and pursue binding fiscal rules, including
implementing a medium-term debt strategy and establishing a debt
management agency. Although these measures are reflected in Moody's
fiscal projections, their effectiveness in raising revenue and maintaining
a prudent fiscal stance could be higher than currently assumed.
Over the medium term, planned changes to Sri Lanka's Monetary
Law Act should help the central bank anchor inflation expectations and
ensure monetary policy independence from fiscal developments. A
shift toward market-oriented policy frameworks -- including
inflation-targeting and floating exchange rate policies --
could increase the effectiveness of Sri Lanka's monetary policy
by helping to stabilise the cost of debt at lower levels than in the past
and bolster fiscal flexibility.
Moreover, planned efforts to develop and promote exports and foreign
direct investment, including through the streamlining of tax laws
and foreign investment applications and the ongoing removal of para-tariffs,
could bolster GDP growth and foreign exchange reserves to a greater extent
than Moody's currently projects, helping restore foreign reserve
adequacy.
This is balanced against Moody's assessment that Sri Lanka's
vulnerability to tightening in financing conditions will remain high and
will rise -- as reflected in the EVI -- over the period of large
debt maturities. A sharp rise in refinancing costs would further
erode debt affordability and weigh on already very low fiscal strength
and low reserve adequacy.
WHAT COULD CHANGE THE RATING UP
Moody's would consider upgrading the rating should it conclude that
Sri Lanka's vulnerability to refinancing risk, which anchors
the rating at B2, is likely to diminish. In particular,
a faster and more sustained buildup in non-debt creating foreign
exchange inflows, which could stem from policy measures which improve
investor confidence and enhance FDI inflows, would bolster reserve
adequacy over time and lower government liquidity risks and external vulnerability
risks.
The implementation of further reforms that significantly lower fiscal
deficits and government debt and enhance debt affordability could also
prompt Moody's to upgrade the rating.
WHAT COULD CHANGE THE RATING DOWN
Given repeated large debt maturities over 2019-2023 and Sri Lanka's
already high exposure to refinancing risk, Moody's would consider
downgrading the rating if external and domestic financing conditions were
to deteriorate further than currently expected. In particular,
a larger drain on foreign exchange reserves would increase the risk of
lower capital inflows and sharply raise refinancing costs. This
would contribute to repayment stresses that would be more consistent with
a B3 rating.
Moody's would also consider downgrading the rating if the government
were to reverse recent reforms or to halt implementation of future reforms
to address fiscal and external vulnerabilities and bolster GDP growth
potential. That would lead to much wider fiscal deficits,
larger gross borrowing requirements and higher government debt than Moody's
currently projects, weighing on already very low fiscal strength
and further heightening liquidity risks.
GDP per capita (PPP basis, US$): 12,863 (2017
Actual) (also known as Per Capita Income)
Real GDP growth (% change): 3.3% (2017 Actual)
(also known as GDP Growth)
Inflation Rate (National CPI, 2013=100, % change
Dec/Dec): 7.3% (2017 Actual)
Gen. Gov. Financial Balance/GDP: -5.5%
(2017 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -2.6% (2017 Actual)
(also known as External Balance)
External debt/GDP: 59.4% (2017 Actual)
Level of economic development: Moderate level of economic resilience
Default history: No default events (on bonds or loans) have been
recorded since 1983.
On 15 November 2018, a rating committee was called to discuss the
rating of Sri Lanka, Government of. The main points raised
during the discussion were: The issuer's economic fundamentals,
including its economic strength, have not materially changed.
The issuer's institutional strength/framework, have materially decreased.
The issuer's fiscal or financial strength, including its debt profile,
has not materially changed. The issuer has become increasingly
susceptible to event risks.
The principal methodology used in these ratings was Sovereign Bond Ratings
published in December 2016. Please see the Rating Methodologies
page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used
in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt,
this announcement provides certain regulatory disclosures in relation
to each rating of a subsequently issued bond or note of the same series
or category/class of debt or pursuant to a program for which the ratings
are derived exclusively from existing ratings in accordance with Moody's
rating practices. For ratings issued on a support provider,
this announcement provides certain regulatory disclosures in relation
to the credit rating action on the support provider and in relation to
each particular credit rating action for securities that derive their
credit ratings from the support provider's credit rating.
For provisional ratings, this announcement provides certain regulatory
disclosures in relation to the provisional rating assigned, and
in relation to a definitive rating that may be assigned subsequent to
the final issuance of the debt, in each case where the transaction
structure and terms have not changed prior to the assignment of the definitive
rating in a manner that would have affected the rating. For further
information please see the ratings tab on the issuer/entity page for the
respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit
support from the primary entity(ies) of this credit rating action,
and whose ratings may change as a result of this credit rating action,
the associated regulatory disclosures will be those of the guarantor entity.
Exceptions to this approach exist for the following disclosures,
if applicable to jurisdiction: Ancillary Services, Disclosure
to rated entity, Disclosure from rated entity.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
Please see www.moodys.com for any updates on changes to
the lead rating analyst and to the Moody's legal entity that has issued
the rating.
Please see the ratings tab on the issuer/entity page on www.moodys.com
for additional regulatory disclosures for each credit rating.
Matthew Circosta
Analyst
Sovereign Risk Group
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
Releasing Office:
Moody's Investors Service Singapore Pte. Ltd.
50 Raffles Place #23-06
Singapore Land Tower
Singapore 48623
Singapore
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077
