New York, December 12, 2017 — Moody’s Investors Service (“Moody’s”) has today affirmed the Government of Sri Lanka’s foreign currency issuer and senior unsecured ratings at B1 and maintained the negative outlook.
The decision to affirm the B1 rating balances Sri Lanka’s moderate institutional strength and an economy which exhibits strong, if somewhat volatile, growth and reasonable levels of wealth; against a high debt burden, narrow revenue base, large government borrowing requirements and elevated external vulnerability risk.
In June 2016, Moody’s assigned a negative outlook based on expectations of further weakening in fiscal metrics and a potential shortfall in the effectiveness of fiscal reforms. However, this expectation of fiscal weakening has not materialized, and the government has advanced important tax policy and administration reforms that have contributed to gradual fiscal improvements.
The decision to maintain the negative outlook reflects Moody’s view that persistently high government liquidity and external vulnerability risks continue to pressure Sri Lanka’s credit profile, and specifically that measures to build reserves and smooth the profile of external payments may be insufficient to stem imminent government liquidity and balance of payments pressures starting in 2019, when large international debt repayments come due and Sri Lanka’s three-year International Monetary Fund (IMF) Extended Fund Facility (EFF) program concludes.
Moody’s has also assigned a Ba1 ceiling for local currency bonds and deposits, a Ba2 ceiling for foreign-currency bonds and a B2 ceiling for foreign currency deposits.
RATINGS RATIONALE
RATIONALE FOR AFFIRMING SRI LANKA’S B1 RATING
Sri Lanka’s B1 rating is supported by moderate institutional strength, a relatively strong assessment compared to similarly rated peers, and an economy which exhibits strong, if somewhat volatile, growth and reasonable levels of wealth. Relatively strong — vis a vis similarly rated issuers — social indicators for education and health support Sri Lanka’s human capital base and overall growth potential.
Sri Lanka’s institutions, illustrated by Worldwide Governance Indicators, are generally stronger than those of B-rated peers. Ongoing progress with implementation of reforms under an IMF program will strengthen the country’s institutions if they result in lasting improvements beyond the lifetime of the program. This is balanced by our assessment that the complexity and ambition of planned fiscal, economic and monetary reforms will continue to test policy effectiveness, given Sri Lanka’s sometimes divided coalition government.
Meanwhile, at $81.3 billion, Sri Lanka’s 2016 nominal GDP was over four times the median for B1- and B2-rated sovereigns. This comparatively large economy provides important diversification and shock absorption capacity, which supports Sri Lanka’s credit profile at the B1 level. Robust real GDP growth also drives our assessment of Sri Lanka’s economic strength. We expect real GDP growth to average about 4.9% per year in 2017-21.
Set against those strengths, growth will likely remain somewhat volatile, in particular due to its vulnerability to droughts and flooding. The magnitude and dispersion of seasonal monsoon rainfall influences agricultural sector growth and rural household consumption.
Moreover, Sri Lanka’s general government debt is high and its debt affordability very low. The government’s narrow revenue base weighs on fiscal performance: the tax revenue-to-GDP ratio was only 12.4% in 2016, and the general government revenue-to-GDP ratio only 14.3%. The government estimates that revenue-to-GDP will rise to 14.6% in 2017.
Persistent sizeable budget deficits, combined with slower nominal GDP growth, have resulted in general government debt rising to 79% of GDP in 2016 — up ten percentage points in four years — a high level for an economy of Sri Lanka’s size and income levels. Meanwhile, interest payments were 36% of general government revenues in 2016, one of the highest interest burdens of all sovereigns rated by Moody’s.
Fiscal consolidation is a key focus of Sri Lanka’s IMF program. The government aims to reduce the general government fiscal deficit to 3.5% of GDP by 2020 from 7.6% in 2015. Following a rise in the Value-Added Tax rate in 2016, the government plans to implement a revised Inland Revenue Act (IRA) in April 2018 which will introduce a more efficient, modern and broad-based tax framework.
We expect the 2017 deficit to narrow to 5.2% of GDP, in line with the government’s projections, and consider their 2018 deficit target of 4.8% of GDP to be achievable, provided reforms continue at their current pace. Nevertheless, fiscal metrics will remain very weak. We expect the debt burden to decline only very gradually to about 74% of GDP by 2021.
RATIONALE FOR MAINTAINING THE NEGATIVE OUTLOOK
The negative outlook reflects Moody’s view that Sri Lanka’s credit profile is increasingly undermined by the government’s and country’s elevated exposure to refinancing risk.
Very high refinancing needs for the government, driven in part by the relatively short maturity of government debt, will pose an increasing risk in a period of rising global interest rates. According to the IMF, Sri Lanka’s gross government borrowing requirement (GBR) is around 19% of GDP in 2017. We expect the GBR to remain broadly stable, well above the 10.3% of GDP median level for B1 and B2-rated sovereigns, heightening exposure to a sharp rise in interest rates.
In addition, the economy’s significant foreign borrowing requirements combined with a fragile external payments position pose material external vulnerability risk. Despite a recent increase in foreign currency reserves, reserve adequacy remains low. As of October 2017, Sri Lanka’s foreign currency reserves (excluding gold and SDRs) stood at about $6.5 billion and covered around 4.0 months of imports, up from 2.5 months in April 2017, but still only marginally above the IMF’s recommended three-month minimum adequacy level. The Central Bank of Sri Lanka (CBSL) estimates that reserves will rise to $6.6 billion by the end of 2017. While we expect foreign currency reserves to rise to about $7.5 billion in 2018 following the completion of the Hambantota port sale, we do not expect reserves to rise materially thereafter.
Absent a significant increase in reserves, external vulnerability risk will rise still further in 2019-2022, when several large international debt repayments are due and Sri Lanka’s IMF program will have ended. As a result, Moody’s expects Sri Lanka’s external vulnerability indicator (EVI), which measures the ratio of external debt payments due over the next year to foreign-exchange reserves, to rise from around 150% in 2016 to close to 180% by the end of that period. While the government is taking steps toward addressing these risks, including through the development of a revised external liability management strategy underpinned by a new Liability Management Act, it is far from certain that such measures will be sufficient to stave off rising balance of payments pressures.
WHAT COULD MOVE THE RATING UP
The negative outlook signals that an upgrade is unlikely. A significant improvement in the external position, driven by a substantial increase in foreign-exchange reserves and reduction of external financing pressures, resulting in a material decline of external vulnerability metrics, would support a return of the rating outlook to stable. In addition, greater clarity around how the government will manage large external debt repayments in 2019-2022 through an effective, predictable and transparent liability management strategy supported by parliamentary approval of the planned Liability Management Act would support the sovereign credit profile.
Evidence of effective reform implementation leading to significant and lasting improvements in tax collection, including through successful implementation of the new Inland Revenue Act, would provide further support to the sovereign credit profile.
WHAT COULD MOVE THE RATING DOWN
Moody’s would downgrade the rating were it to conclude that the government’s refinancing capacity will not improve and that exposure to interest rate and confidence shocks will remain high. Similarly, failure to implement a strategy to manage repayment of large external liabilities in 2019-2022, either through an effective liability management exercise or through faster accumulation of foreign-exchange reserves, would put further negative pressure on Sri Lanka’s credit profile. A marked fall in foreign-exchange reserves or signs of loss of investor confidence though capital outflows or less affordable market access would place more immediate pressure on the rating. In addition, signs that achieving further fiscal consolidation will be difficult, that reforms are ineffective or that the authorities commitment towards fiscal consolidation is wavering, would all point to a higher debt burden for longer and put negative pressure on the rating. Given the imminence of the rise in the sovereign’s refinancing needs and its already high exposure to shocks, Moody’s may review the rating again in 2018.
GDP per capita (PPP basis, US$): 12,285 (2016 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 4.4% (2016 Actual) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 4.5% (2016 Actual)
Gen. Gov. Financial Balance/GDP: -5.4% (2016 Actual) (also known as Fiscal Balance)
Current Account Balance/GDP: -2.4% (2016 Actual) (also known as External Balance)
External debt/GDP: 57.3% (2016 Actual)
Level of economic development: Moderate level of economic resilience
Default history: No default events (on bonds or loans) have been recorded since 1983.
On 7 December 2017, a rating committee was called to discuss the rating of the Sri Lanka, Government of. The main points raised during the discussion were: The issuer’s economic fundamentals, including its economic strength, have not materially changed. The issuer’s institutional strength/ framework have not materially changed. The issuer’s fiscal or financial strength, including its debt profile, has not materially changed. The issuer’s susceptibility to event risks has not materially changed.
The principal methodology used in these ratings was Sovereign Bond Ratings published in December 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.
For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.
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