Fitch provides negative rating on Sri Lanka

Fitch Ratings has downgraded its rating on Sri Lanka to a negative outlook saying the security situation is causing a lot of uncertainty in the country.

"A further deterioration in the security situation to the point where it adversely affects Sri Lanka's credit fundamentals would lead to a downgrade of the sovereign ratings," said Paul Rawkins, Senior Director in Fitch's sovereign team. "Conversely, the outlook could revert to stable given clear signs of fiscal consolidation, a reduction in inflation and, in Fitch's judgement, a material diminution in the risk to sovereign creditworthiness from the conflict".

Fitch said it had affirmed Sri Lanka's foreign and local currency Issuer Default Ratings ("IDRs") of 'BB-' (BB minus) with a Negative Outlook. The Country Ceiling is affirmed at 'BB-' (BB minus) and the Short-term foreign currency rating at 'B'.

The outlook on Sri Lanka's sovereign rating was revised to negative in April 2006 in response to concerns that the deterioration in the security situation threatened to adversely affect economic performance and sovereign creditworthiness.

"The affirmation of Sri Lanka's 'BB-' (BB minus) ratings acknowledges that the feared adverse impact on the economy and sovereign creditworthiness has yet to materialize," says Rawkins in a press release, "but Fitch still judges that the domestic security situation continues to pose risks to economic stability and growth and hence the Negative Outlook remains warranted".

Fitch said the economy is expanding at its fastest rate for more than two decades, underpinned by rising domestic and foreign investment, as well as record inflows of remittances in recent years that exceeded US$2 billion in 2006 (approx. 7% of GDP). The foreign exchange reserves of the Central Bank of Sri Lanka have also increased, to US$ 2.5 billion, providing more than four months import cover and compared to US$ 550 million of public foreign debt repayments due in 2007.

Gross and net external debt relative to GDP and current account receipts modestly declined despite the current account deficit widening to almost 5% of GDP, in part due to the higher cost of oil imports. In addition, donor and other capital inflows continue to be robust.

The elimination of fuel subsidies helped the government to outperform its fiscal targets in 2006, although the deficit remained high at 8.4% of GDP (excluding grants). Public debt declined slightly in 2006 but, even taking account of the low cost of much of the debt owed to foreign creditors, it remains high by the standards of rating peers at 93% of GDP and interest payments on the debt absorb almost 30% of government revenues.

Inflation has risen sharply, partly but not wholly as a result of higher fuel and administered prices. Running at close to 17%, its' highest level for almost 10 years, it is prompting a tightening of monetary policy. Ensuring that inflation is brought back towards single digit levels is essential in Fitch's opinion for sustaining strong economic growth and reducing the government's debt servicing costs, Fitch said.

It said the government's target of reducing public debt to 76% of GDP by 2010 is potentially at risk if the security situation were to adversely affect economic growth and delay planned reductions in the budget deficit from last year's level of 8.4% of GDP. Consequently, Sri Lanka's sovereign ratings remain under downward pressure given the uncertain outlook for the security situation.