Fitch confirms Sri Lanka’s “CCC” rating
- Reiterates the burden of repaying external sovereign debt in foreign currencies
- Economy predicts 3.8% growth in 2021, down from previous forecast of 4.9% in light of recent surge in virus cases
- The budget deficit is expected to remain high in 2021 at 11.1% like last year
Fitch Ratings announced yesterday that it has confirmed the long-term default rating of Sri Lanka’s foreign currency issuers (IDRs) to “CCC”.
He said Sri Lanka’s “CCC” rating reflects a medium-term sovereign external debt repayment burden in foreign currencies, low foreign exchange reserves, and high and growing public debt that poses risks to sustainability.
Fitch said external liquidity pressures have eased somewhat in recent months following bilateral loan disbursements and the wait for an upcoming IMF Special Drawing Rights (SDR) allocation. Nonetheless, Sri Lanka’s medium-term debt servicing challenges are significant and pose risks to sovereign debt repayment capacity, according to Fitch.
A total of around $ 29 billion in foreign currency debt obligations is due by 2026, compared to foreign exchange reserves of $ 4.5 billion at the end of April 2021.
He said the authorities had recently secured project financing through various multilateral and bilateral channels, including Asian Development Bank (AAA / Stable), Asian Infrastructure Investment Bank (AAA / Stable), the Development Bank of China (A + / Stable) and The Export-Import. Bank of Korea (AA- / Stable), as well as swap facilities under the monetary framework of the South Asian Association for Regional Cooperation (SAARC) and the People’s Bank of China, respectively equivalent to $ 400 million and 1 , $ 5 billion. The IMF’s planned allocation of SDRs would also add $ 780 million to reserves.
Fitch said the resources should allow Sri Lanka to meet its remaining debt maturities through the end of the year, including a $ 1 billion international sovereign bond maturing in July. However, the authorities have not yet clarified their plans to meet the country’s foreign exchange debt service needs for 2022 and the medium term. They have consistently indicated that they do not consider seeking program financing from the IMF.
“We expect foreign exchange reserves to remain at around $ 4.5 billion by the end of 2021 before falling back to $ 3.9 billion by the end of 2022. In our baseline scenario, the deficit current account is expected to expand to 2.8% in 2021 and decline to 2.1% of GDP in 2022. Our forecast assumes that remittances will remain resilient in 2021-2022 and that tourism is only likely to recover. ‘from 2022,’ Fitch mentioned.
He said Sri Lanka’s economy contracted 3.6% in 2020 due to the COVID-19 pandemic and forecast 3.8% growth in 2021, down from previous forecasts by 4.9%, in light of a recent increase in virus cases. Fitch expects the economy to grow 3.9% in 2022.
“There remains a high degree of uncertainty associated with our predictions in light of the evolution of new cases of COVID-19 in the country,” Fitch added. Authorities plan to vaccinate 60% of the population by the end of 2021, but that goal could be hampered by vaccine shortages.
Travel and tourism, a major driver of the economy, have been hit hard and the outlook for recovery remains uncertain, especially given the recent increase in cases of the virus. Tourism’s direct contribution to GDP before the pandemic was around 4%, but the indirect contribution was much higher. Tourist arrivals in the first five months of 2021 were 97% lower than in the same period last year.
The general government deficit widened to 11.1% of GDP in 2020 from 9.6% in 2019, as the economic contraction led to a sharp decline in budget revenues. Fitch expects the deficit to remain high in 2021 and 2022 at 11.1% and 10.4%, respectively.
“Our deficit projections are broader than those presented by the government as part of its growth strategy of 9.4% and 7.5%, respectively. We forecast the revenue-to-GDP ratio in 2021 to increase to 10.9% in 2021 and 11.1% in 2022, compared to the authorities’ projections of 11.9% and 13.0%, respectively, ”said Fitch. .
He said the government’s fiscal consolidation strategy is based on an expected acceleration in GDP growth, underpinned by tax cuts, as opposed to direct measures to increase revenue or spending, although sustained. through planned improvements in tax administration. The interest-to-income ratio remains high, at around 71% in 2020, well above the “CCC” median of 13%.
The government expects to generate primary surpluses from 2023, supported by annual GDP growth of 6%, which we believe is optimistic as we anticipate growth closer to 4%, still above the pace of the period. immediate pre-pandemic.
General government debt reached 101% of GDP at the end of 2020, which is broadly in line with our forecasts during our last review in November. Fitch’s baseline forecast suggests that this ratio will rise further to 108% by 2022. Fitch does not believe the government will meet its 2025 targets of reducing public debt to 70% of GDP and reducing the budget deficit to 4% of GDP.
Sri Lanka’s basic human development indicators, including education standards, are high relative to peers in the rating category. The United Nations Human Development Index places Sri Lanka in the 62nd percentile, well above the 27th percentile for the median “CCC”. The country’s per capita income of about $ 3,822 is also above the median “CCC” of $ 2,662.
The banking sector is vulnerable to the weakness of Sri Lankan sovereign debt due to the large direct exposure of banks to sovereign debt and their operations focused on the domestic market. The operating environment for banks remains difficult and the quality of assets remains a major risk. Asset quality measures reported at the end of 2020 – bad loans for Fitch-rated banks increased to 9.7% at the end of 2020 from 9.5% at the end of 2019 – likely underestimate the extent of credit depreciation due to forbearance measures.
ESG – Governance: Sri Lanka has an ESG relevance score of “5” for political stability and rights as well as for the rule of law, institutional and regulatory quality and control of corruption, as is the case. case for all sovereigns. These scores reflect the high weight of the World Bank’s governance indicators in our exclusive sovereign rating model.
Sri Lanka has an average ranking of the World Bank’s governance indicators in the 46th percentile, reflecting a recent record of peaceful political transitions, moderate level of rights to participate in the political process, moderate institutional capacity, established rule of law and a moderate level of corruption.
Factors that could, individually or collectively, lead to negative rating action / downgrade: Increased signs of a likely default event, e.g. severe external strains on liquidity, potentially reflected in continued erosion of foreign exchange reserves and a reduced capacity of the government to access external financing.
Factors which could, individually or collectively, lead to a positive rating action / reclassification: External finances – Improvement of external finances, supported by higher non-debt inflows or a reduction in external sovereign refinancing risks resulting from a profile of improved passive; Public finances – Stronger public finances, reflected by a sustained decline in the public debt-to-GDP ratio to approach the “B” median, and supported by a credible medium-term fiscal consolidation strategy; Structural – Improved policy coherence and credibility, leading to more sustainable public and external finances and reduced risk of debt distress.