Credit rating agencies downgrade Sri Lanka on political crisis

• Both Fitch and S&P downgrade SL’s sovereign rating on political stalemate 
• But both rating agencies maintain ‘Stable’ outlook on the economy
• Moody’s downgraded Sri Lanka almost 2 weeks ago and revised outlook to ‘Stable’

The big three credit rating agencies had downgraded Sri Lanka’s rating as of yesterday owing to the current political crisis that triggered on October 26 with the sacking of the then Prime Minister Ranil Wickremesinghe by President Maithripala Sirisena. 

Both Fitch Ratings and Standard & Poor’s (S&P) yesterday downgraded Sri Lanka’s sovereign rating, flagging multiple risks stemming from the ongoing political stalemate having a spillover effect on the country’s external debt re-financing, fiscal consolidation and policy outlook, which has turned murkier.
Accordingly, both rating agencies lowered Sri Lanka’s sovereign rating to ‘B’ from ‘B+’ while maintaining a ‘Stable’ outlook on the economy. 

Moody’s Investor Services was the first to downgrade Sri Lanka’s rating almost two weeks ago on the political crisis. S&P maintained their ‘Stable’ outlook on the belief that the Sri Lankan economy would nevertheless meet its upcoming debt redemptions while continuing the economic recovery over the next 12 months, as effects from weather related disruptions dissipate. 

“The downgrade reflects heightened external refinancing risks, an uncertain policy outlook, and the risk of a slowdown in fiscal consolidation as a result of an ongoing political crisis following the President’s sudden replacement of the Prime Minister on 26 October 2018,” Fitch Ratings said. 

S&P echoed similar sentiments adding that the fractious policy making environment may persist even if the current political standoff ends. Both actions by President Sirisena—appointing former president Mahinda Rajapaksa as prime minister and the subsequent dissolution of Parliament—now been stayed by the courts.

 However, President Sirisena maintains his actions were constitutional and legal.

Sirisena said he sacked Wickremesinghe to put an end to Wickremesinghe’s actions, which are inimical to the country, going beyond the sphere of the economy. 
“Fitch believes the ongoing political upheaval, which has disrupted the normal functioning of parliament, exacerbates the country’s external financing risks, already challenged by the tightening of global monetary conditions amid a heavy external debt repayment schedule between 2019 and 2022. 

Investor confidence has been undermined, as evident from large outflows from the local bond market and a depreciating exchange rate”, the rating agency said. 
Fitch estimates Sri Lanka’s foreign currency debt repayments with principal and interest at a massive US $ 20.9 billion during 2019 and 2022, but the country has only US $ 7.54 billion in foreign reserves.

Sri Lankan rupee has weakened as much as 17 percent against the US dollar up to November end, which has contributed to further deterioration of the country’s debt profile as half the government debt is in foreign currency. 

Hence, Fitch forecasts Sri Lanka’s debt-to-GDP to reach over 80 percent of the Gross Domestic Product (GDP) from 77.2 percent. 

“The authorities plan to raise funds through a combination of bilateral and commercial borrowing and the exercise of foreign-currency swaps, but there are risks to this strategy that could arise from a prolonged period of political uncertainty accompanied by an adverse shift in investor sentiment”, Fitch added. 

The rating agency also expressed doubt if the government could benefit from the Active Liability Management Bill, which received parliament nod in October, which raises the borrowing limit and could help smoothen upcoming debt maturities should the political standoff continues. 

Meanwhile, Fitch further expects the budget deficit to reach closer to 5.0 percent of GDP for 2019 and 2020 from the previous forecast of 4.0 percent of GDP. 
“Fitch expects fiscal slippages, as the current political climate is likely to lead to delays in setting policy priorities and to disrupt progress on future reforms. The 2019 budget has already been pushed back, while the IMF programme has been put on hold.

We believe a speedy resolution of the political situation and a return to credible macroeconomic policies could eventually lower fiscal risks”, Fitch said.

CB says rating action based on uncorroborated facts

In response to the decision by Fitch and S&P to downgrade Sri Lanka, the Central Bank yesterday said the rating actions were based on uncorroborated facts on the country’s macroeconomic fundamentals. 

“In spite of the recent developments in the country’s political sphere, an array of measures has been taken by the CBSL and the government to minimize any potential impact from the recent political developments on the economy, especially with regard to external financing requirements and debt payment obligations, the Central Bank said.

“In meeting the Government’s external liabilities of International Sovereign Bond (ISB) maturities of US$ 1 billion in January 2019 and US$ 500 million in April 2019, the authorities have already built a buffer fund from proceeds of non-strategic asset divestment and recently contracted Syndicated loan, in addition to the space provided under the Active Liability Management (ALM) initiative not exceeding a limit of Rs. 310 billion,” the Central Bank added. 

The Central Bank also said plans to raise around US $ 750 to US $ 1 billion during the remainder of the year and in early 2019 through the issuance of Sri Lanka Development Bonds, sourced through enhanced credit lines for state banks from Middle East and East Asia is nearing completion.

Further, the enhancement of US $ 500 million to the syndicated loan arrangement by February 2019 is also in progress. 

In addition, the Central Bank said further support could be expected from the proceeds of about US $ 600 million expected as disbursements from bilateral and multilateral agencies during next year. 

“These proceeds together with the available funds would more than cover all the ISB payments due in 2019,” the Central Bank noted.

Meanwhile, with the aim of further strengthening the reserve adequacy, the Central Bank has initiated negotiations with central banks and regional funds such as SAARC Swap Framework to obtain foreign currency SWAP facilities. 

“These measures would not only further strengthen the country’s foreign reserve adequacy, they would also enable timely servicing of external obligations while providing the space for intervening cautiously in the foreign exchange market to prevent excessive volatility.

It is noteworthy that there has been a favourable adjustment in the exchange rate during recent days supported by rising foreign currency inflows which would be further enhanced in the upcoming holiday and New Year season. In addition, the fiscal and macro prudential measures that are already in place are expected to result in an improvement in the external trade balance as well, thus reducing pressure on external reserves and the exchange rate,” the Central Bank said.

Meanwhile, the Central Bank noted that domestic financing conditions have shown considerable improvement through spaces created and debt management strategies introduced recently. 

“This has reduced the roll-over requirement of Treasury bonds and SLDBs in 2019, 2020 and in the medium-term. Notably, the new acquisition of government securities by the banking sector has increased by only 1.5 percent in 2018 as against the trend increase of around 5 per cent in recent years.” The Central Bank also stressed that Sri Lanka’s banking and financial sector remains resilient to both domestic and external vulnerabilities. 

“Given these parameters, the CBSL is of the view that the recent rating actions by Fitch Ratings and S&P Global Ratings are unwarranted. 

Such an action only on the premise of heightened political uncertainty, with no evidence of slippages in macroeconomic policies or fundamentals, cannot be justified. The soundness of the underlying macroeconomic conditions was reinforced by the fact that staff-level agreement in principle was reached with the IMF (26 October 2018) on the fifth review of the Extended Fund Facility (EFF),” the Central 
Bank said.