Rating agency S&P downgraded the Sri Lankan sovereign rating to CCC+ from B- with a stable outlook. They cited that with the implementation of expansionary budget measures in Sri Lanka, the fiscal position would materially deteriorate over the next few years along with insufficient existing funding support which could lead to financing risks. The rating agency also said that if external buffers decline substantially more than currently forecasted, the rating could be downgraded further. The stable outlook reflects that Sri Lanka is relatively balanced over the next 12 months. Listed below are some details on the rationale for the downgrade:
- Frequent uncertain political infighting and developments have affected predictability of policy and weighed on business confidence. While the current administration’s clear victory in August’s election is likely to ease uncertainty, further ‘consolidation of power in the executive’ may increase institutional risks. This could affect the stability of the legislature/judiciary system and make policy unpredictable
- Fiscal deficit is likely to be stretched due to medium-term budget measures – keeping the wide-ranging tax cuts, a lower VAT rate, plans to provide various tax exemptions and significantly ramp up infrastructure spending. Fiscal deficit is likely to be at 10.2% of GDP in 2021
- Interest payments are estimated to reach 60% of government revenues in 2020, slightly lower than previously expected but one of the highest ratios among the sovereigns S&P rates
- Weaker external profile due to a high share of dollar-denominated debt exposes the government to shifts in risk sentiments besides increased uncertainty over access to official creditors. S&P expects that funding from multilateral/bilateral partners may not be enough to cover external financing needs over the next 12 months. This would lead the nation to draw on its reserves as it has had to do repeatedly
- As of end-October 2020, forex reserves stood at $5.9bn, down from $7.6bn in January. This might be enough to cover maturities over the next 12 months, but it would bring reserves down to a dangerously low level impairing debt servicing ability
Sri Lanka recently got a double notch downgrade by Fitch. With S&P’s rating downgrade to CCC+, all the three major rating agencies have brought the sovereign to the ‘CCC’ equivalent bracket with Moody’s and Fitch rating Sri Lanka at Caa1 and CCC respectively. Sri Lanka’s dollar bonds were largely stable and it remains to be seen how they react – 7.55% 2030s around 58.1 and 6.25% 2021s around 89.
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