SL cautioned of rate and currency shocks as they ready for next eurobond

As Sri Lanka readies for its next sovereign debt issuance and the first in 2018, Moody’s Investors Service (Moody’s) has sent warning signals amid further rate hike expectations in developed economies, as the country relies heavily on foreign debt and a sizeable section of the debt consisting of foreign currency.

Last week Sri Lanka’s Central Bank called for the lead managers for its US $ 2.0 billion sovereign bond, which is planned during the next couple of months as a part of its liability management exercise to extend maturities and rollover some foreign currency denominated debt.      

But it is widely expected that the next hike in short-term rates by the Federal Reserve in the US under the incoming Fed Chairman Jerome Powell would happen as soon as in March followed by at least another three rate hikes penciled for the year. 

Central Banks in Europe and Japan are also expected to ease their stimulus and start raising their benchmark rates later this year as for the first time since the global financial crisis in 2007/08 as the world is seeing a synchronized growth in all three major economies. 

Issuing a sovereign outlook on Asia Pacific economies, Moody’s—one of big three global rating agencies—issued a warning message to Sri Lanka and other Asia Pacific frontier markets—Pakistan, Mongolia and Maldives—ahead of the gradual monetary policy tightening by major Central Banks. 
“Looking at public finances, the impact of an interest rate shock would be most acutely felt by sovereigns that already have high gross borrowing needs (in part linked to relatively short debt maturities), especially if they rely significantly on market borrowing, and/or if a sizeable portion of their debt relies on foreign-currency funding”, Moody’s said in their report. 

The government’s foreign currency-denominated debt was about 43 percent of total general government debt in 2016 and about 34 percent of GDP.

According to Moody’s data, there are as much as US $ 14 billion foreign debt service payments coming up for due during 2019-2022 and US $ 2.4 billion worth of foreign debt is to be settled in 2018. 

The announced US $ 2.0 billion sovereign debt issuance is therefore barely sufficient to rollover the debt due this year. 

“In the event of an interest rate shock, several of these sovereigns, particularly those with already weak debt affordability metrix, would be affected”, Moody’s noted.

According to the Moody’s Asia-Pacific interest rate vulnerability heat map, in the areas of gross borrowing requirement and External Vulnerability Indicator (EVI) Sri Lanka has an elevated vulnerability. 

Moody’s perceives Sri Lanka with a diminished flexibility considering its 79.6 percent general government debt as a percentage of GDP. 

However, for some sovereigns, like India and Malaysia, the vast majority of the government’s and economy’s debt is financed domestically through stable sources, thereby mitigating risks from flagging foreign demand.

Meanwhile, out of the 24 Asia Pacific sovereigns Moody’s rates, Sri Lanka is the only country, which has a ‘Negative’ rating outlook in 2017. Moody’s has a B1 speculative grade rating on Sri Lanka with a ‘Negative’ rating outlook considering the country’s significant borrowing requirements and heavy reliance on external and foreign-currency funding expose the sovereign to material liquidity and external financing risk, which weighs on the sovereign’s credit profile. 

In 2017, however there were more positive rating actions than negative rating actions, a reversal from 2016.