Moody’s downgrades Sri Lanka’s ratings as political crisis continues

Moody’s Investors Service (“Moody’s”) has today downgraded the Government of Sri Lanka’s foreign currency issuer and senior unsecured ratings to B2 from B1 and changed the outlook to stable from negative.

The decision to downgrade the rating to B2 is driven by Moody’s view that ongoing tightening in external and domestic financing conditions and low reserve adequacy, exacerbated most recently by a political crisis which seems likely to have a lasting impact on policy even if ostensibly resolved quickly, have heightened refinancing risks beyond levels anticipated when the rating agency affirmed the rating at B1 with a negative outlook in July.

Moody’s projections include a slower pace of fiscal consolidation than assumed in July to reflect disruption to fiscal policy implementation in a period of political turmoil.

The stable outlook denotes balanced credit risks at the B2 rating level. Moody’s expectation is that, despite the current political crisis, any future Government will remain broadly focused on implementing important fiscal, monetary and economic reforms that would strengthen the credit profile over the medium term.

However, Moody’s assessment is that the Government’s debt refinancing will remain highly vulnerable to sudden shifts in investor sentiment in a period of further tightening in financing conditions and political and policy uncertainty, with limited buffers to face such risk.

Concurrently, Moody’s lowered the local-currency bond and deposit ceilings to Ba2 from Ba1. The foreign currency bond ceiling was lowered to Ba3 from Ba2 and the foreign currency deposit ceiling was lowered to B3 from B2.

Sri Lanka’s low foreign exchange reserve coverage of large external debt repayments over the next five years exacerbates its reliance on external bilateral and commercial lenders’ willingness to refinance maturing debt.

The risks related to that structural external vulnerability are rising in an environment of tightening financing conditions globally and, most recently, heightened domestic political tensions which threaten to undermine international investors’ confidence and the flow of foreign capital, from private markets and international bilateral lenders, into Sri Lankan financial assets.

The political situation has also resulted in delay to the disbursements planned under the IMF programme.

A prolonged pause in the IMF programme, associated to uncertainty about the direction of policy, would likely undermine investors’ confidence, exacerbating the tightening in financing conditions.

Tightening external financial conditions and domestic political instability are resulting in capital outflows and placing increasing pressure on the exchange rate and foreign exchange reserves. The Sri Lankan rupee has depreciated about 13% over the past 12 months to 176.7 per US dollar as of November 16, 2018, of which around 9% occurred in the last three months.

In addition, spreads on Sri Lankan bonds over US Treasuries have widened sharply in recent weeks to more than 550 basis points. Combined, these factors are raising the value and cost of external debt.

If prolonged, tightening global financial conditions and domestic political instability could hinder the Government’s access to global capital markets, curb foreign direct investment inflows to the country and reduce funding from international lenders. Such conditions would undermine the sovereign’s ability to meet its large external repayment obligations.

The Government will need to make principal payments on external debt that could be as high as $4 billion per year between 2019 and 2023, in addition to financing part of the budget deficit externally. (Colombo Gazette)