Sri Lanka's resilience masks medium-term credit risks: Fitch

Sri Lanka is the only twin-deficit country in Asia having a growth unaffected by currency volatility, according to Fitch Ratings (Fitch).

Fitch cites this relative currency stability to a less open onshore capital account that provides insulation from volatile global capital flows, as well as the country’s increasing ability to tap offshore global bond inflows.

The Sri Lankan Rupee appreciated to a three months high of 130.55/60 to the dollar having appreciated 3.42 percent since August 28 when it hit a record low of Rs. 135.20. Meanwhile the Central Bank (CB) Governor Ajith Nivard Cabraal has said the Rupee is currently under appreciation pressure.

However Fitch cautioned of the strategy repercussions as it is adding to the stock of gross and net external liabilities and carries medium-term credit risks.

While appreciating the efforts by the authorities to tame the inflation to around 6.0 to 7.0 percent from a near double digit level in late 2012, Fitch said it does not project the growth to be in excess of 6.0 percent this year, rising only to 6.6 percent in 2014.

This is despite the CB’s somewhat ambitious growth target of 7.5 percent and 8.0 percent for 2013 and 2014 respectively.

Fitch however said this benign growthinflation story is not enough to improve country’s overall sovereign credit profile which is currently at BB-, (with a Stable outlook) three notches below the investment grade due to two reasons.

The first reason is the low progress made in narrowing the current account deficit in the Balance of Payments and the second being country’s failure in attracting much Foreign Direct Investments (FDIs) even after the end of the conflict.

Fitch expects Sri Lanka's current account deficit to remain at 5.6 percent, a 1 percentage point improvement from a year ago. However the government targets to reduce the deficit to 4.7 percent of GDP this year.

Sri Lanka's current account deficit is larger than all the other Fitch-rated Asian emerging markets, except Mongolia (B+) and is also larger than the ‘BB' median current account deficit of 2.7 percent of GDP.

“Moreover, we see a rising external debt service burden limiting further improvement in the current account position in the year ahead,” Fitch opined.

The net FDIs to Sri Lanka since 2009 has averaged only 1.2 percent of GDP which is low in comparison to most of the regional peers, and thus has fueled the reliance on debtcreating capital. (DK)