Singapore, July 19, 2021 -- Moody's Investors Service ("Moody's") has today
placed the Government of Sri Lanka's Caa1 foreign currency long-term
issuer and senior unsecured debt ratings under review for downgrade.
The decision to place the ratings under review for downgrade is driven
by Moody's assessment that Sri Lanka's increasingly fragile
external liquidity position raises the risk of default. This assessment
reflects governance weaknesses in the ability of the country's institutions
to take measures that decisively mitigate significant and urgent risks
to the balance of payments.
Although the government has secured some financing, mainly from
bilateral sources, its financing options remain narrow with borrowing
costs in international markets still prohibitive. Absent large
and sustained capital inflows through a credible external financing strategy,
Moody's expects Sri Lanka's foreign exchange reserves to continue
declining from already low levels, further eroding its ability to
meet sizeable and recurring external debt servicing needs, and increasing
balance of payment risks. Extremely weak debt affordability --
with interest payments absorbing a very large share of the government's
very narrow revenue base -- compounds the debt repayment challenge.
The rating review will focus on assessing whether the sovereign is able
to use a period of time provided by its current foreign exchange reserves
and bilateral arrangements to implement measures that widen and increase
its financing sources for the medium term, and thereby avoid default
for the foreseeable future.
Sri Lanka's foreign currency country ceiling has been lowered to Caa1
from B3, while the local currency country ceiling remains unchanged
at B1. The three-notch gap between the local currency ceiling
and the sovereign rating balances relatively predictable institutions
and government actions against the low and declining foreign exchange
reserves adequacy that raises macroeconomic risks as well as the challenging
domestic political environment that weighs on policymaking. The
three-notch gap between the foreign currency ceiling and local
currency ceiling takes into consideration the high level of external indebtedness
and the risk of transfer and convertibility restrictions being imposed
given low foreign exchange reserves adequacy, with some capital
flow management measures already imposed. These ceilings typically
act as a cap on the ratings that can be assigned to the obligations of
other entities domiciled in the country.
RATINGS RATIONALE / FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE
OF THE RATINGS
RATIONALE FOR INITIATING THE REVIEW FOR DOWNGRADE
Sri Lanka's low and declining foreign exchange reserves adequacy,
limited and narrowing set of external financing options for the government,
and the extremely large share of government revenue taken up by interest
payments raises the risk of debt default. The increasing fragility
of the situation and continued worsening of credit metrics without decisive
actions are indications that institutional credibility and effectiveness
have weakened compared with Moody's prior assessment. In
contrast to the urgency of the situation -- and notwithstanding the
government's stated commitment to repay its debt -- Moody's
expects a credible and durable financing strategy to only materialise
over a number of years.
Meanwhile, Moody's expects the coverage by foreign exchange
reserves of external repayments to continue falling from already low levels.
As of the end of June, Sri Lanka's foreign exchange reserves
(which in Moody's definition exclude gold and Special Drawing Rights)
amounted to just around $3.6 billion, down 30%
since the start of the year and insufficient to cover the government's
annual external debt repayments alone of around $4-5 billion
over the next 4-5 years. Taking into account plausible projections
for the balance of payments, the country's foreign exchange
reserves will fall further over the next 2-3 years, unless
Sri Lanka manages to markedly raise capital inflows.
Moody's baseline scenario assumes that the government and the Central
Bank of Sri Lanka (CBSL) will continue to secure some foreign exchange
resources and financing support through a combination of project-related
multilateral loans, official sector bilateral assistance including
central bank swaps, commercial bank loans, and the divestment
of some state-owned assets -- albeit at a relatively slow
pace. Measures introduced by CBSL, such as the required sale
of a share of all inbound remittances and export proceeds to the central
bank, will also generate additional reserves, while capital
flow management measures restricting imports and outbound remittances
and investment will help retain some foreign exchange resources in the
country. These measures can only shore up reserves temporarily
and marginally; they also come at a cost to the economy.
Meanwhile, Sri Lanka's current account deficit is likely to
remain stable and relatively narrow compared to peers at around 1-2%
of GDP over the next few years, with the gradual recovery of the
tourism sector partly hampered by the ongoing wave of infections and border
restrictions. Foreign direct investment has the potential to pick
up with the development of the Colombo Port City and the government's
privatisation plans, although amounts are likely to increase only
gradually over time.
By contrast, Moody's does not assume that the government will
enter into programme-based financing facilities with multilateral
development partners at this stage, which significantly narrows
its external financing options. Furthermore, while the government
has historically relied on international market access to finance its
fiscal deficits and external repayment needs, borrowing costs remain
prohibitive with Sri Lanka's government bond spreads to US Treasuries
still very wide at more than 1600 basis points, compared to around
500 basis points before the onset of the coronavirus pandemic.
Sri Lanka's long-standing fiscal weaknesses complicate the
government's policy choices. Moody's expects Sri Lanka's
economy to grow by around 3.5% this year, taking into
account less stringent pandemic-containment measures compared to
last year. Economic growth is likely to accelerate further next
year on base effects and the reopening of borders, providing some
boost to government revenue. However, even with some revenue
increases, Moody's estimates that the government's fiscal
deficit will remain wide at around 9.5-10% of GDP
this year and average 8.5% over the next two years.
In turn, the government's debt burden will likely rise further
to around 110% of GDP over 2022-23, from around 100%
at the end of 2020 and around 87% in 2019.
Extremely weak debt affordability magnifies debt repayment risks.
Interest payments exceeded 70% of government revenue in 2020 and
will likely remain around 60-70% over the next few years
-- highest across sovereigns that Moody's rates by some distance
-- even as revenue rebounds from very low levels. Indeed,
government revenue is likely to remain around 10% of GDP over the
next few years, unless the government's efforts to enhance
tax administration and impose special taxes can sizeably and durably expand
its revenue base. While domestic resources have been sufficient
so far to finance the government's wider deficit in local currency,
limited fiscal resources impose difficult policy choices to rationalise
social spending and development expenditure, if interest payments
continue to be prioritised.
Given very weak credit metrics, there is material risk that falling
reserves precipitate a crisis of confidence, involving a negative
spiral of a rapidly depreciating exchange rate, rising inflation,
higher domestic interest rates, higher debt payments in local currency
terms, and a weaker domestic economy. In this scenario,
default risk would increase sharply. Conversely, the sovereign's
track record at securing some financing options, from foreign and
domestic investors, may keep such an adverse scenario at bay for
some time.
The rating review will focus on assessing whether the sovereign is able
to use a period of time provided by its current foreign exchange reserves
and bilateral arrangements to implement measures that widen and increase
its financing sources for the medium term, and thereby avoid default
for the foreseeable future.
ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS
Sri Lanka's ESG Credit Impact Score is highly negative (CIS-4),
reflecting its highly negative exposure to environmental and social risks.
Ongoing challenges to institutional and policy effectiveness constrain
the government's capacity to address ESG risks.
The exposure to environment risk is highly negative (E-4 issuer
profile score). Variations in the seasonal monsoon can have marked
effects on rural household incomes and real GDP growth: while the
agricultural sector comprises only around 8% of the total economy,
it employs almost 30% of Sri Lanka's total labour force.
Natural disasters including droughts, flash floods and tropical
cyclones that the country is exposed to also contribute to higher food
inflation and import demand. Moreover, ongoing development
projects to improve urban connectivity have increased the rate of deforestation,
although the country continues to engage development partners to preserve
its natural capital, such as its mangroves.
The exposure to social risk is highly negative (S-4 issuer profile
score). Balanced against Sri Lanka's relatively good access
to basic education, which has continued to improve throughout the
country in the post-civil war period, are weaknesses in the
provision of some basic services in more remote and rural areas,
such as water, sanitation and housing. As the country's
population continues to grow, the government will face greater constraints
in delivering high-quality social services and developing critical
infrastructure amid ongoing fiscal pressures.
The influence of governance is highly negative (G-4 issuer profile
score). While international surveys point to stronger governance
in Sri Lanka relative to rating peers, including in judicial independence
and control of corruption, institutional challenges remain,
particularly in the pace and effectiveness of reforms. Domestic
political developments also tend to weigh on fiscal and economic policymaking.
The ratings would likely be confirmed at their current level if the risk
of external debt default were to diminish materially and durably.
This could stem from the government demonstrating its capacity to use
short-term financing sources as a means to gain time to secure
a medium-term external financing strategy that maintained a manageable
cost of debt, and a faster and more sustained buildup in non-debt
creating foreign exchange inflows. Additionally, likely implementation
of fiscal consolidation measures, particularly greater revenue mobilisation,
that pointed to a material narrowing of fiscal deficits in the next few
years and contributed to lower annual borrowing needs, would also
support a confirmation of the rating.
The rating would likely be downgraded in a status quo scenario where the
financing of Sri Lanka's large external debt repayments remained
uncertain while foreign exchange reserves adequacy still looked likely
to continue deteriorating.
GDP per capita (PPP basis, US$): 13,215 (2020
Actual) (also known as Per Capita Income)
Real GDP growth (% change): -3.6% (2020
Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 4.6%
(2020 Actual)
Gen. Gov. Financial Balance/GDP: -11.1%
(2020 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -1.3% (2020 Actual)
(also known as External Balance)
External debt/GDP: 61.0% (2020 Actual)
Economic resiliency: ba2
Default history: No default events (on bonds or loans) have been
recorded since 1983.
On 14 July 2021, a rating committee was called to discuss the rating
of the 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
institutions and governance strength, have materially decreased.
The issuer's fiscal or financial strength, including its debt profile,
has not materially changed. The issuer's susceptibility to event
risks has not materially changed.
The principal methodology used in these ratings was Sovereign Ratings
Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631.
Alternatively, 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 further specification of Moody's key rating assumptions and
sensitivity analysis, see the sections Methodology Assumptions and
Sensitivity to Assumptions in the disclosure form. Moody's
Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.
For ratings issued on a program, series, category/class of
debt or security this announcement provides certain regulatory disclosures
in relation to each rating of a subsequently issued bond or note of the
same series, category/class of debt, security 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.
The ratings have been disclosed to the rated entity or its designated
agent(s) and issued with no amendment resulting from that disclosure.
These ratings are solicited. Please refer to Moody's Policy
for Designating and Assigning Unsolicited Credit Ratings available on
its website www.moodys.com.
Regulatory disclosures contained in this press release apply to the credit
rating and, if applicable, the related rating outlook or rating
review.
Moody's general principles for assessing environmental, social
and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.
At least one ESG consideration was material to the credit rating action(s)
announced and described above.
The Global Scale Credit Rating on this Credit Rating Announcement was
issued by one of Moody's affiliates outside the EU and is endorsed
by Moody's Deutschland GmbH, An der Welle 5, Frankfurt
am Main 60322, Germany, in accordance with Art.4 paragraph
3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies.
Further information on the EU endorsement status and on the Moody's
office that issued the credit rating is available on www.moodys.com.
The Global Scale Credit Rating on this Credit Rating Announcement was
issued by one of Moody's affiliates outside the UK and is endorsed
by Moody's Investors Service Limited, One Canada Square,
Canary Wharf, London E14 5FA under the law applicable to credit
rating agencies in the UK. Further information on the UK endorsement
status and on the Moody's office that issued the credit rating is
available on www.moodys.com.
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.
Christian Fang
Vice President - Senior 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: 44 20 7772 5456
Client Service: 44 20 7772 5454
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
