Political crisis may lead to reduced investor interest, increased capital outflows: Moody’s

Sri Lanka is warned of reduced investor interest and increased capital outflows, leading to more pressure on rupee and raising financing costs amid the current fractious political environment.

“A higher likelihood that the country’s fiscal and current account deficits will widen again could reduce investor appetite for Sri Lankan debt and spur capital outflows, weigh on the currency and raise financing costs, international rating agency, Moody’s Investor Services stated yesterday. 

Moody’s expressed concerns over uncertainty in continuation of fiscal consolidation programme with the change of Prime Minister and Cabinet, which would adversely impact the health of State-owned enterprises, and as a result the country’s fiscal position.

An aide to new Prime Minister Rajapaksa, MP Dullas Alahapperuma yesterday said that IMF-backed fuel pricing formula is likely to be scrapped from next month, subject to the Cabinet approval.  “In particular, fiscal consolidation beyond the conclusion of the International Monetary Fund programme in mid-2019 and especially ahead of elections due in 2020 is at risk of delays. Some planned measures, such as electricity price reform, which is already politically contentious, will be even more difficult to implement. If it falls through, this will hurt the financial health of some State-owned enterprises and, as a result, the country’s fiscal position,” Moody’s stated. 

The rating agency projected that Sri Lanka’s debt will remain above 70 percent of GDP by 2020 and that interest payments will continue to absorb about 40 percent of revenue in the next couple of years – along with sizeable external and foreign currency borrowing needs, lower capital inflows and higher financing costs would hurt Sri Lanka’s fiscal strength and credit profile.

Sri Lanka’s foreign exchange reserves fell to US $6.4 billion in September 2018, covering about 3.4 months of imports, down from their peak of US $9.0 billion in April 2018.

Moody’s highlighted that Sri Lanka faces greater refinancing risks in an environment of rising political tensions and tightening financing conditions globally, as Sri Lanka has smaller buffers to manage repayments. 

According to Moody’s External Vulnerability Indicator, the ratio of external debt due over the next year to foreign exchange reserves is projected to stand at 160 percent at the end of 2019. 

Moreover, Moody’s stated that simmering civil unrest – as reflected in recent protests linked to underlying religious and social tensions – poses a threat to economic stability, as GDP growth was already low at 3.7 percent in the second quarter of 2018, compared to an average of 5.6 percent in the ten years to 2017. 

Moody’s  noted that Sri Lanka’s top trading partners including the US (Aaa stable) and European Union (Aaa stable) have voiced concern over the prevailing political crisis, calling on the government to follow the constitutional process for leadership changes.

“As the basis for the dismissal, the President cited Article 42, which states that the President appoints as Prime Minister the Member of Parliament who, in the President’s opinion, has the confidence of parliament. According to Articles 46 and 48, the Prime Minister’s office can end in case of death, resignation, if he or she is no longer a Member of Parliament, or if the government loses the confidence of parliament,” Moody’s stated.