Fitch Lanka Managing Director/CEO Maninda Wickramasinghe and Fitch Asia Pacific Sovereigns Associate Director Sagarika Chandra
Pic by Pradeep Pathirana

By Chandeepa Wettasinghe
While remaining positive about Sri Lanka’s growth prospects, Fitch Ratings yesterday said continued progress in fiscal policy and increased foreign direct investment (FDI) would be crucial for Sri Lanka to move up the ratings ladder.
“…if we see continued progress on the fiscal front, which is supported by a clear strategy on improving government revenues to gross domestic product (GDP), that would be positive for the rating. 
Also, on the external front, moving away from debt to FDI funding would also be a positive rating driver,” Fitch Asia Pacific Sovereigns Associate Director Sagarika Chandra told the reporters in Colombo.
She said a full year of a higher value-added tax (VAT) rate, increasing efforts to collect more revenue and being under an International Monetary Fund (IMF) programme, would help further fiscal consolidation efforts. “We think that they could probably reach a deficit target of 4.4 or 4.6 percent of GDP for 2017,” she said.

In 2016, the non-tax revenue increases and expenditure cuts contributed to the budget deficit falling to the targeted 5.4 percent of GDP from 7.6 percent of GDP in 2015.
Fitch earlier this year revised Sri Lanka’s outlook from B+ Negative to B+ Stable. Chandra said if there are clear changes, another ratings revision may take place this year, although usually, ratings are revised once a year.
She noted despite policy inconsistency continued to remain a key concern—which caused FDIs into Sri Lanka to remain around one percent of GDP in the recent years—some progress is now being observed within the coalition government with respect to passing policies which they announce. “I think while there are delays, you can always argue, but the way they have come together on critical reforms—passing VAT and getting the budget in parliament, those are important things. That hadn’t happened in the past,” she said. Chandra suggested that to start off with, Sri Lanka should aim to attract around US $ 2-3 billion in FDIs and that the government has to work on improving policy consistency to achieve this.
“I think that’s one area that we have encountered. Policy inconsistency appears to be a factor that’s holding back higher investment. So, I think with the fund (IMF) coming in and the government sort of consistently moving in one direction, I think that would be positive for sure,” she said.
Chandra added that although a comprehensive study hasn’t been done on which sectors Sri Lanka should attract FDIs into, tourism is a visible area, while any other industries, which could make use of Sri Lanka’s highly educated population, would also be attractive.
Despite the positive sentiments, Chandra noted that the key threat is from the external sector, along with low reserves having to match up against high debt repayments. 

People’s Bank to get Rs.5bn capital boost

The Cabinet of Ministers has given the approval to increase the capital base of the state-run People’s Bank by injecting Rs.5 billion. People’s Bank is the second largest bank in the country with an asset base of Rs.1.4 trillion.

The injection of capital is targeted at assisting the bank to comply with the Basel III requirements.
The proposal to increase the capital base of the bank was made by Public Enterprise Development Minister Kabir Hashim. People’s Bank has 737 service centres and handles about 18 million accounts.

Basel III increases capital pressure for Lankan banks: Fitch

The Sri Lankan banks are likely to come under increased capital pressure from the Basel III-related requirements that take full effect at the start of 2019, the international rating agency, Fitch Ratings, yesterday said. 
“We expect most banks will have to raise capital to meet the higher requirements, particularly if they are pursuing rapid growth,” Fitch noted. 
According to Fitch, the sector’s capital needs could be exacerbated by the deteriorating asset quality following the aggressive lending in 2015/2016 to more vulnerable segments, such as retail and small and medium enterprises (SMEs), the effects of the recent floods and weak internal capital generation. 

“Our negative outlook on the Sri Lankan banking sector reflects these pressures, although the banks have coped with the deterioration in the operating environment and the loan book growth could keep the non-performing loan ratios around the current levels.”
Meanwhile, Fitch pointed out that capitalisation is thin at the state banks due to the substantial dividend payouts. In 2016, the three largest state banks—National Savings Bank, Bank of Ceylon and People’s Bank—paid 76 percent of their profits as dividends. 
“Their capital levels are vulnerable to dividend demands from the state and continued high payouts in the absence of capital infusions could leave them struggling to meet the regulatory capital requirements.”
The rating agency also highlighted that the rapid loan growth by the private banks exceeding their rate of internal capital generation has weakened the capital ratios.  “The sector’s average Tier I capital ratio declined to 11.4 percent at end-2016 from 13.0 percent at end-2015, following the high loan growth of 21.1 percent and 17.5 percent in 2015 and 2016, respectively, despite several contractionary monetary policy measures.” 
Sri Lanka’s Central Bank increased the policy rates in March 2017 in its latest attempt to curtail credit growth. 
Some large private listed banks have already announced capital-raising plans to support balance-sheet expansion in the next two years but it may be challenging for the sector as a whole to raise large amounts, given the market conditions. The Central Bank issued the new local capital requirements related to the global Basel III regulatory framework in late 2016. 
The Sri Lankan banks will have to maintain the common equity Tier I (CET1) of at least 7.0 percent of risk-weighted assets (RWAs), Tier I capital of at least 8.5 percent and total capital (CET1, additional Tier I and Tier II capital) of at least 12.5 percent by the start of 2019, compared with 10 percent under the current regime.  The domestic systemically important banks (D-SIBs) will have to hold an additional buffer of 1.5 percent of RWAs. The Central Bank has said that the banks with more than Rs.500 billion of assets will be designated as D-SIBs and six banks meet this criterion.
Pre-2017, the Tier II capital instruments will be eligible to be included as Tier II capital under the new rules, subject to a 20 percent discount each year. At end-2016, the approved Tier II capital amounted to Rs.132 billion among the Fitch-rated banks. The Sri Lankan banks may start issuing the Basel III-compliant debt instruments once the clarification on the tax treatment of interest from the listed debt securities is obtained, Fitch noted. The government proposed removing this tax relief in its November 2016 budget but a final decision has not been made.
The Central Bank’s new rules introduce a 20 percent risk weighting for foreign currency lending to the government and a risk-weighting based on loan/values (LTVs) for gold-backed lending (20 percent for LTVs of 70-100 percent; 100 percent for LTVs over 100 percent), which will put further pressure on banks’ capital positions.  Until now, these assets have benefited from zero risk weightings.