CB rubbishes Fitch statement on election outcome

The Central Bank yesterday rubbished a statement issued by Fitch Ratings on the outcome of Sri Lanka’s presidential election, saying that the contents of it were “purely based on loose assumptions” and “very much at variance with the actual market developments and expectations.”

Fitch Ratings issuing a statement just two days after Gotabaya Rajapaksa was sworn in as the seventh Executive President of Sri Lanka said Sri Lanka’s presidential election significantly increases policy uncertainty and could rollback the country’s economic reforms process.    

The rating agency said policy environment in Sri Lanka (B/Stable) had improved following the resolution of the 2018 political crisis, supporting the resumption of fiscal and economic reforms and of Sri Lanka’s International Monetary Fund (IMF) programme. 

However, Fitch warned that political tensions could resurface ahead of elections to parliament, which is expected early next year.

“The new president’s constitutional reform plans could resurrect controversial proposals to enhance the executive’s powers,” Fitch cautioned.

However, strongly objecting Fitch’s standpoint, the Central Bank said the market response to the outcome of the presidential election, the assumption of duties of President Rajapaksa and the ongoing key appointments were positive.

The Central Bank said the domestic foreign exchange market, as well as debt and equity markets have responded positively to the election outcome. 

In fact, the Sri Lankan rupee has appreciated by more than one rupee against the US dollar during the four days since the conclusion of the election. During this period, there has also been a sharp decline in the forward premium, reinforcing expectations of a further appreciation of the rupee. 

In the government securities market, primary market yields declined sharply at the auction for Treasury bills held on November 20, 2019 while the secondary market yields have also declined notably across the yield curve. 

Meanwhile, international sovereign bond (ISB) yields have behaved orderly since the start of the business week. Foreign investors have continued to invest notable amounts of funds in the Sri Lankan rupee denominated Government securities. 

Further, the All Share Price Index of the Colombo Stock Exchange has increased significantly over the past few days. 

“Ignoring these positive market trends is a material omission in the statement issued by Fitch Ratings,” the Central Bank emphasized. 

Fitch Ratings in its statement said Sri Lanka is running the risk of a more expansionary fiscal stance after the parliamentary elections due to ambitious growth targets mentioned in the manifesto of President Rajapaksa. 

Rajapaksa’s economic manifesto targets an average growth of 6.5 percent or higher, compared with 3.2 percent in 2018 and Fitch forecasts 2.8 percent in 2019, by promoting commodity and apparel exports, construction and tourism. 

Also, his manifesto targets a budget deficit below 4 percent of GDP and inflation below 5 percent.

“Although detailed economic plans are yet to be announced, we think achieving ambitious growth targets could entail stimulus measures that erode fiscal headroom, which is limited by high public debt (about 83 percent of GDP). 

“This could undermine policy credibility, investor confidence, and potentially complicate relations with the IMF,”  Fitch said.

The rating agency also noted that President Rajapaksa’s commitments on social spending and public-sector wages and pensions could jeopardize deficit reduction unless government revenue, which is low at just over 13 percent of GDP increases. 

His manifesto includes plans to replace the Inland Revenue Act, a lynchpin of fiscal reforms under the IMF programme, to unify VAT (currently 15 percent) and the Nation-Building Tax (2 percent) with a single VAT rate of 8 percent and cap personal income tax rates at 15 percent. 

“If these lead to revenue losses, they could put Sri Lanka’s medium-term fiscal consolidation plan at risk,” Fitch said.

While claiming the 4 percent fiscal deficit target set is challenging, Fitch forecast the deficit to stabilize at about 5 percent of GDP in 2020-2021 as GDP growth recovers from Easter
Sunday bombings.

Also, Fitch Ratings cautioned that a row-back on reforms could have implications for Sri Lanka’s IMF programme which has been extended till June 2020.

The sixth review was completed in September, and coupled with US$ 4.4 billion worth sovereign bond issuance this year, has eased near-term
external pressures. 

But Sri Lanka’s external debt repayments are substantial at US$ 19 billion in 2020-2023 against reserves of US$ 7.8 billion.

The Central Bank in response said as the new government is still being formed, it is premature for any analyst to express a view on the precise policy path of the new government and its potential outcome.

President Rajapaksa yesterday appointed former President and his brother Mahinda Rajapaksa as Prime Minister following the resignation of Ranil Wickremesinghe. A new Cabinet is likely to be announced before the end of this week.