Political uncertainty exacerbates SL’s external crisis: Moody’s

• Says resignations of key officials raise policy uncertainty, compounding external liquidity and fiscal difficulties
• Points out protracted political uncertainty also could prolong negotiations with IMF over potential policy or financing support
• Warns intensifying social unrest and sporadic curfews could strain tourism industry
• Says Russia’s military conflict with Ukraine is exacerbating SL’s external difficulties via higher energy and food import bill

Moody’s Investors Service yesterday warned that prolonged political uncertainty and the resignation of key officials could hinder Sri Lanka’s ability to obtain external financing to repay its sizeable foreign debt, thereby exacerbating the risk of a debt default for the country. 

“Protracted political uncertainty is likely to hinder progress in obtaining external financing from key development partners or attracting foreign direct investment or both, because of Sri Lanka’s reliance on capital inflows to repay its sizeable foreign-currency obligations,” the rating agency said. 

“An extended period of political uncertainty could also delay ongoing discussions to secure external financing from development partners, deter foreign direct investment and prolong negotiations with the IMF over potential policy or financing support,” it added.  

The rating agency also said the difficult political environment could also weigh on policymaking and the economy’s recovery from the pandemic, compounding challenges to fiscal consolidation and government efforts to shore up reserves to service its external debt obligations.

On April 3-4, all of Sri Lanka’s (Caa2 stable) Cabinet, with the exception of President Gotabaya Rajapaksa and Prime Minister Mahinda Rajapaksa, tendered their resignations, along with the Governor of the Central Bank. 
The resignations were partly a response to rising public dissatisfaction and social tensions over high inflation, shortages of essential items and lengthy power cuts, increasing political and policy uncertainty at a time when Sri Lanka is experiencing a severe external liquidity and fiscal crisis and a deteriorating macroeconomic environment.  

The government declared a state of emergency and imposed a two-day countrywide curfew on April 2-3 after protesters demanding the president’s resignation stormed his home.

As of now, Sri Lanka operates without a Finance Minister and a Treasury Secretary and the Sri Lankan authorities recently signalled their willingness to engage the International Monetary Fund (IMF) for a rescue package. 
Meanwhile, the rating agency also cautioned that intensifying social unrest and sporadic curfews are likely to further strain the tourism industry, delaying the recovery in tourism receipts that were a crucial part of the government’s plans to bolster foreign-currency inflows.  Sri Lanka’s foreign-exchange reserves were around US $ 2 billion as of the end of February 2022, well below the government’s annual external debt repayments of US $ 6 billion-US $ 7 billion through to at least 2025 and covering less than two months of imports. 

Inflation rose to double digits in November 2021 and reached 17.5 percent year-on-year in February 2022. The rating agency pointed out that higher inflation is likely to prompt further policy rate hikes, which will raise government borrowing costs and further weaken debt affordability. 

The Central Bank raised its main policy rate by 100 basis points to 10.5 percent in early March 2022 and its policy rate is now 200 basis points above a low of 8.5 percent in 2020-21, although it remains below the 15 percent rate that preceded aggressive rate cuts following the coronavirus outbreak.

Meanwhile, Moody’s said Russia’s military conflict with Ukraine is exacerbating Sri Lanka’s external difficulties, mainly via a higher energy and food import bill. Fuel imports accounted for 18 percent of total imports in 2021 and agricultural imports 8 percent.