Sri Lanka finances to improve; political uncertainty weighs: Fitch

ECONOMYNEXT – Sri Lanka recent fiscal reforms and automatic pricing of fuel will improve state finances and debt, but political uncertainty has heightened following recent regional polls, Fitch, a rating agency said.

"Sri Lanka’s rating balances an improving policy framework, which supports macroeconomic stability and rising government revenues, against a challenging external debt servicing outlook and high government debt," Fitch Ratings said Monday in its Asia Pacific Sovereign Credit Overview for the third quarter of 2018.

Fitch forecasts Sri Lanka will grow 3.8 percent in 2018 and 4.5 percent in 2019. Government debt at 77.6 percent of GDP is expected to fall to 75.9 percent in 2019.

"Progress has been made on critical fiscal reforms, including approval of an automatic fuel price mechanism effective May 2018.

"The authorities have also taken steps to introduce an automatic electricity pricing mechanism and establish a committee to develop a detailed restructuring plan for Sri Lankan Airlines," Fitch said.

Deteriorating policy coherence and credibility could lead to a loss of investor confidence, or a derailment of the IMF-supported programme that leads to external funding stress, the ratings agency has warned.

"Political uncertainty increased following the ruling coalition's heavy losses during the local elections in February, followed by a vote of no-confidence against the prime minister in April and temporary suspension of parliament in May," Fitch said.

"The risk of political uncertainty disrupting policy continuity, however, is mitigated by the election schedule, in which presidential elections are not due until end-2019, with parliamentary elections to follow."

Fitch Ratings statement on Sri Lanka is as follows:

High Refinancing Risks; Improving Framework: Sri Lanka’s rating balances an improving policy framework, which supports macroeconomic stability and rising government revenues, against a challenging external debt servicing outlook and high government debt. The rating is supported by higher per-capita income levels and stronger governance standards than the ‘B’ category median.

-Key Developments-

IMF Programme Progress; High Debt: The IMF completed its fourth review under a three-year extended fund facility in place since June 2016. Progress has been made on critical fiscal reforms, including approval of an automatic fuel price mechanism effective May 2018. The authorities have also taken steps to introduce an automatic electricity pricing mechanism and establish a committee to develop a detailed restructuring plan for Sri Lankan Airlines.

Nevertheless, Sri Lanka’s government debt remains high at around 77% of GDP, far above the ‘B’ median of 66.6%.

High Near-Term External Refinancing Risks: The sovereign’s projected debt service payments are significant, at USD15 billion in 2019-2022, from a bunching of sovereign bond redemptions, while its foreign-exchange reserves stood at only USD9.3 billion at end-June. The scale of external refinancing over the next few years creates a potential vulnerability for the sovereign particularly as US interest rates are on the rise.

Political uncertainty has increased: Political uncertainty increased following the ruling coalition's heavy losses during the local elections in February, followed by a vote of no-confidence against the prime minister in April and temporary suspension of parliament in May. The risk of political uncertainty disrupting policy continuity, however, is mitigated by the election schedule, in which presidential elections are not due until end-2019, with parliamentary elections to follow.

-Positive Sensitivities-

Further improvement in external finances supported by higher non-debt-creating inflows or a reduction in external sovereign refinancing risks from improved liability management.
Continued improvement in public finances underpinned by a credible medium-term fiscal strategy.

-Negative Sensitivities-

Reversal of fiscal improvements that leads to a failure to stabilise government debt ratios.

Deterioration in policy coherence and credibility, leading to loss of investor confidence, or a derailment of the IMF-supported programme that leads to external funding stress.