Fitch voices concerns over political uncertainty; says could affect investor confidence

• Says policy implementation likely to become slower and more challenging
• Urges government to keep an economic team that prioritises reform and stability
• Says current ‘B+’ sovereign rating already factors in a degree of political risk

Ratings agency Fitch yesterday voiced concerns over the political uncertainty prevailing in Sri Lanka, saying that investor confidence may be affected unless political issues are swiftly resolved followed by the implementation of reforms and continued fiscal consolidation in order to maintain stability in the debt-ridden economy. “Recent political developments in Sri Lanka have created some uncertainty over the reform momentum and fiscal consolidation, and prolonged upheaval could undermine investor confidence ahead of large external debt maturities in 2019-22,” Fitch said in a media communiqué. 

It said that so far, the unrest has had limited economic impact and Sri Lanka’s current ‘B+’ sovereign rating has factored in a degree of political risk. 

“However, policy implementation looks likely to become slower and more challenging. Reform distractions and pressure for more populist policies might also rise as Sri Lanka enters an election cycle,” Fitch said.

The ratings agency noted that the Sri Lankan government’s commitment to the IMF reform programme so far has been strong.

Recently passed legislation such as the Active Liability Management Act and the new Inland Revenue Act, along with the Cabinet-approved amendments of the Monetary Law Act for flexible inflation targeting have helped the reform process and have been coupled with the Value Added Tax hike which has helped improve the fiscal position, Fitch said.

With the progress, Fitch had upgraded Sri Lanka’s outlook to ‘Stable’ from ‘Negative’ in 2017, and affirmed Sri Lanka’s outlook this year as well.
“This progress may still continue if recent political problems can be resolved and the government keeps in place an economic team that prioritises reform and stability,” the ratings agency said.

The unity government lost the local polls this February, indicating declining public support for the government, while the infighting among the two main parties in the unity government has contributed to political and policy uncertainty.

Prime Minister Ranil Wickremesinghe survived a vote of no confidence in early April, before parliament was effectively suspended until 8 May upon the resignation of coalition ministers. The coalition leadership is now discussing a Cabinet reshuffle.  

Fitch said that an early election is unlikely since such a move would require two-thirds majority in parliament, and this gives the current administration another 18 months to mitigate the risk of political instability disrupting policy continuity.

The first order of business for the government going forward would be to implement the fuel and electricity pricing formulas.

Fitch said that if the government continues to drag its feet in implementing the electricity and fuel pricing reforms continue (originally planned for implementation by end-2016), it would in turn delay the IMF’s next review for the balance of payments loan tranche, raising risks to the fiscal outlook.

The ratings agency added that large upcoming debt maturities and low reserve coverage make Sri Lanka vulnerable to shifts in global investor confidence, which could be affected by an extended period of political unrest or signs of waning commitment to the IMF programme. 

Sri Lanka’s gross external debt was equivalent to 59 percent of gross domestic product in 2017, and a quarter of this— around US $ 15 billion—is due to be repaid in 2019-22. The Active Liability Management Act may allow the authorities to smooth debt repayments, while foreign reserves were bolstered by a sovereign bond issuance of US$ 2.5 billion in April. 

However, reserves stood at just US $ 7.3 billion in March 2018 and Sri Lanka’s international liquidity ratio of 69 percent is well below the 147 percent median for sovereigns rated at ‘B’ or below, Fitch said. 

“A high proportion of public debt is denominated in foreign currency, which could weaken repayment ability should there be sustained rupee depreciation. The rupee has weakened by 2.4 percent against the US dollar so far in 2018,” Fitch said.