Relief package could worsen SL’s budget challenges: Moody’s

• Says fiscal flexibility already severely limited by a large share of interest payments in government revenue
• Forecasts budget deficit of 9-10%, compared to govt.’s 8.8% estimate 
• Expects GDP growth to pick up to around 5% from a low base 
• Highlights weak foreign reserves position, particularly with US $ 5-6bn foreign currency obligations annually

The Rs.229 billion relief package announced by the government a week ago could reduce Sri Lanka’s scope for fiscal and debt consolidation, though it could support economic recovery, Moody’s Investors Service said in a brief statement yesterday.

“While the size of the package is moderate and will be fully funded via reallocations from the budget (6 percent of budget expenditure in 2022), it reduces the scope for fiscal and debt consolidation at a time when fiscal flexibility is already severely limited by the large share of interest payments in government revenue (60-70 percent),” Moody’s said. 

“Funding the package with reallocations from the budget in part reflects this limited fiscal space, which constrains the government’s ability to use fiscal policy to mitigate the impact of economic shocks. Furthermore, the risk of fiscal slippage has increased with the emergence of the omicron variant of the coronavirus,” it added.

Moody’s expects Sri Lanka’s GDP growth to pick up to around 5 percent this year, from around 4-5 percent in 2021, in part because of a lower base and because domestic economic activity has largely normalised.

The rating agency also expects the fiscal deficit to narrow only slightly to 9-10 percent of GDP in 2022, from around 11 percent in 2021, largely due to lower revenue growth than the budget 2022 envisages. 

Budget 2022 forecasts a fiscal deficit of 8.8 percent. “Wide deficits will keep the government’s debt burden at higher levels for some time;

 we estimate that the debt burden will rise to around 108 percent of GDP by the end of 2022, from around 101 percent at the end of 2020 and 87 percent at the end of 2019, before stabilising at the elevated 2022 level thereafter, mainly reflecting the recovery in nominal GDP growth,” Moody’s noted. Commenting on Sri Lanka’s foreign reserves position, Moody’s said it remains weak despite a US $ 1.5 billion equivalent yuan currency swap from China. “While the Central Bank indicated that reserves had risen as of the end of December with the disbursement of a US $ 1.5 billion swap agreement with the People’s Bank of China, reserves adequacy remains very weak, with reserves at around US $ 2-3 billion, compared with US $ 5-6 billion of foreign currency obligations due annually through at least 2025.”