SL faces significant deterioration in debt affordability: Moody’s

• Second highest deterioration among non-investment grade sovereigns, only behind Angola
• Interest payments to GDP ratio forecast to increase by almost 10% this year
• Gross borrowing requirement likely to exceed 20% of GDP 
• Debt servicing obligations worth of US $ 4.3bn per year on average over 2021-2025 period

Sri Lanka is facing the second most significant deterioration in debt affordability among the non-investment grade sovereigns, amid the erosion in its revenue base and upcoming external debt maturities, according to Moody’s Investors Services. 

Issuing a report titled ‘Non-investment grade sovereigns - Global: Coronavirus shock triggers sharp economic downturn and intensifies fiscal and external liquidity challenges’, the credit rating agency forecast Sri Lanka’s interest payments to the GDP ratio to increase by almost 10 percent this year.

The projected sharp deterioration in debt affordability for Sri Lanka is the second highest among 76 non-investment grade sovereigns, only behind Angola. 

It noted the erosion in the revenue bases as the reason for the expected deterioration of the debt affordability.

According to the Treasury, Sri Lanka’s state revenue has declined by 20 percent year-on-year (YoY) to Rs.476.8 billion during first four months of the year, despite the Rs.24 billion Central Bank (CB) profit transfer.  

The fiscal deficit is projected to surpass 9 percent of GDP this year, according to analysts. However, the Treasury expects to contain the fiscal deficit at 8.5 percent of GDP 
this year.

“Fiscal deficits widen acutely in all regions. APAC and Emerging Europe unlikely to consolidate to pre-crisis levels before 2022,” the rating agency said. 

In April, Moody’s placed Sri Lanka’s B2 Stable sovereign crediting rating on review for downgrade while Fitch Rating moved to downgrade the rating to ‘B-’, from ‘B’, with a Negative Outlook, in the same month. 

Moody’s also expects Sri Lanka’s gross borrowing requirements (GBR) to exceed 20 percent of GDP this year, one of the highest among non-investment grade sovereigns, reflecting the country’s increasing external debt maturities. 

Sri Lanka has debt servicing obligations worth of US $ 4.3 billion per year on average, over the 2021-2025 period, according to Fitch Ratings.  

The country’s official foreign reserves fell by US $ 716 million to US $ 6.5 billion at end-March, while the external debt servicing is estimated at around US $ 3.8 billion from June to December, including a US $ 1 billion international sovereign bond (ISB) payment in October. 

“The crisis has led to sharp falls in foreign-currency receipts from exports, foreign direct investment and remittances at a time when sovereigns’ access to international capital markets is constrained. As a result, countries are drawing on their foreign-exchange reserves, diminishing the sovereigns’ ultimate ability to meet external debt-service payments,” Moody’s pointed out. 

However, the rating agency expects the non-investment grade sovereigns are likely to increase their reliance on concessional financing in the post-COVID-19 crisis era, which would likely to mitigate the borrowing pressures to some extent, for these economies.

Meanwhile, the World Bank (WB) recently reclassified Sri Lanka as a low-middle-income country, from an upper-middle-income country, which is likely to make the country eligible for certain concessional funding facilities. 

However, commenting on the Debt Service Suspension Initiative announced by the G-20 countries, Moody’s opined that the initiative is unlikely to have a significant impact on the medium-term debt trends that have materially worsened due to the COVID-19 pandemic. 

“The coronavirus shock and the authorities’ associated policy response have opened large fiscal and external imbalances that will take time to unwind. Low-income sovereigns entering the crisis with elevated debt burdens and/or exposure to foreign-currency risk are most at vulnerable,” it added.

Further, Moody’s predicted that non-investment grade sovereigns may compete for financing in the international capital market with refinancing hump approaching in the year. Although ISB yield spreads narrowed for non-investment grade sovereigns recently, the rating agency noted that it still remains above the pre-crisis levels for many sovereigns, including Sri Lanka. 
Sri Lanka is expected to go to international capital markets next year. 

In addition, the credit agency warned that fragile banking systems remain a key credit risk among some non-investment grade sovereigns, with high saturation of government securities and dollarisation levels intensify the risks. The report highlighted a sharp economic downturn following the coronavirus outbreak for non-investment grade sovereigns, with many not recovering to pre-crisis levels until 2022 or beyond.

“All non-investment grade emerging and frontier market sovereigns will experience slower growth on account of the global coronavirus shock, with 2020 growth forecasts revised down by 6.8 percentage points on average from the end of 2019,” Moody’s said.

The World Bank Group has forecast Sri Lanka’s GDP to contract by 3.2 percent this year and to remain flat at zero percent in 2021.

In terms of 2021 economic recovery prospects, Moody’s expects economic recoveries to vary widely, depending on the policy measures governments implement, including their nature, magnitude and timeliness, as well as on the structure of the economy.

On a cautionary note, the rating agency warned the non-investment grade sovereigns, if they contribute to greater nationalism and shifts away from global trade integration, they could impact from lingering global geopolitical tensions.