Moody’s affirms Sri Lanka’s B1 rating, maintains negative outlook

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 rating at B1 reflects Sri Lanka’s progress in implementing the planned reform program, which entails fiscal consolidation and a build-up foreign exchange reserves buffers, ahead of the end of the IMF Extended Fund Facility program in June 2019, along with its moderate per capita income levels, and stronger institutions relative to many similarly-rated sovereigns.

This is balanced against Moody’s expectation that the sovereign’s fiscal strength will remain very low and government liquidity and external vulnerability risk will remain rating constraints.

The decision to maintain the negative outlook reflects Sri Lanka’s ongoing high vulnerability to a potential tightening in external and domestic financing conditions, given relatively large borrowing needs, reliance on external funding and still low reserves adequacy.

That feature dominates Sri Lanka’s credit profile. The government could face significantly tighter refinancing conditions at some point during the next few years, which would quickly lead to much weaker debt affordability and a higher debt burden, especially if the currency
depreciated at the same time.

Concurrently, the local-currency bond and deposit ceilings remain unchanged at Ba1. The foreign-currency bond ceiling is unchanged at Ba2 and the foreign currency deposit ceiling at B2.

Under its IMF Extended Fund Facility Program, Sri Lanka continues to advance reforms that support fiscal consolidation and attempt to reduce external vulnerabilities. Progress in fiscal consolidation and in building up of reserves buffers strengthens the credit profile by providing greater assurance of Sri Lanka’s ability to refinance its domestic and external debt at affordable costs.

The government’s commitment to continuing to broaden and deepen its revenue base including through implementation of the Inland Revenue Act (IRA), which came into effect in April 2018, will bolster revenue generation. Moreover, legislative measures pursuant to changes in the Fiscal Management Responsibility Act aim to apply fiscal rules that ensure deficit and debt consolidation efforts endure beyond the conclusion of the IMF program.

In addition, the planned changes to the Monetary Law Act should strengthen the credibility and effectiveness of Sri Lanka’s monetary policy, helping the central bank anchor inflation expectations and prevent fiscal dominance. If effective, this would contribute to stabilising the cost of debt at lower levels and as a result enhance fiscal flexibility.

The Active Liability Management Act (ALMA) will provide the government with some flexibility to smooth the timing of its debt refinancing operations within a given year. Over time, effective use of the ALMA may allow the Sri Lankan government to smooth somewhat the consecutive large debt maturities over the period 2019-2023 and to prevent the recurrence of such a concentration in future. During the next few years, however, the
gains will be limited given the high frequency of debt repayments.

In addition, the government plans to further diversify external funding sources through the issuance of Chinese renminbi or Japanese yen denominated bonds, as well as loans from other bilateral or multilateral lenders.