Sri Lanka's credit rating was cut to five levels below investment grade by Standard & Poor's (S&P) B from B+ due to mounting public debt and political and security concerns, according to a Bloomberg report, which the Central Bank (CB) responded to by challenging S&P's reasoning.
Senior economist from the University of Colombo Dr. Sirimal Abeyratne said he believes the downgrading is justified for countries which have very vulnerable economic and political positions. However, he said this will create difficulties for the government to borrow and will also increase the cost of borrowing.
Secretary General of the Bankers Association, Upali De Silva said it is arguable if the ratings downgrade is reasonable. "The CB says it is not justified because S&P focused on one or two specific issues. However, S&P would have looked at most of the factors," he said. "Our biggest problem is how externally, people will look at the country for credit and so on. The cost of borrowing will increase." Internally, he said there will not be any fallout from the downgrade. Commenting on the state of the banks in Sri Lanka, Mr. De Silva said there is a liquidity problem and that the CB has reduced the reserve ratios. "More than liquidity, there is reluctance on banks and borrowers to go into credit and this is creating an indirect credit crunch but if banks find a good borrower, they will lend." He added that growth has really come down in 2008. "Credit growth has slowed and it will continue at least for the first half of next year."
The CB challenged several of the reasons behind S&P's downgrade, saying it has overlooked many favourable developments in the Sri Lankan economy. A CB press release stated that Sri Lankan authorities view S&P's decision as being arrived at without proper assessment of current developments and future trends. In contrast to claims by S&P, the CB stated that the elimination of fuel subsidies has improved the macroeconomic stability of the country further as it has prevented the transfer of huge funds through the government budget by way of fuel subsidies. It is also a fact that the overall budget deficit of the country has declined gradually in the recent past from 10.8% of GDP in 2001 to around 7% in 2008 has not been given the due recognition by S&P.
The CB also said S&P has simply neglected the improvements the country has achieved in the recent past while commenting on Sri Lanka's debt position. According to the CB, the true picture is that the debt burden has eased significantly over the years, which is reflected in the sharp decline in the outstanding debt to GDP ratio from 105.6% in 2002 to 75% by end of 2008 as has been projected by S&P.
Further, in contrast to the S&P's claim, the CB said there is no evidence that migrant worker remittances will decline in the near future. In fact, past experience shows that remittance flows are counter cyclical as Sri Lankan expatriates tend to make more remittances during the periods of slower economic growth. In addition, the S&P's presumption that the preferential access to EU markets will be lost is also incorrect as Sri Lanka has just received the confirmation of the GSP+ facility for the next 3 years. Garment industry officials say this is pending the ongoing probe.
The CB added that S&P has deliberately neglected the recent improvements in the country's macroeconomic fundamentals. This is even more significant when it is observed that S&P pointedly does not refer to the much concerned economic variable, inflation. The CB says inflation has come down to 16.3% in November 2008 from 28.2% in June 2008 due to favourable developments on both demand and supply factors.
The CB did state that there has been a decline in foreign exchange reserves in October and November 2008 due to the supply of foreign exchange to the market, mainly to meet higher oil bill payments and to allow the outflows of treasury bonds and bills. The CB purchased US$622 million out of foreign inflows, including foreign investments in treasury bonds and bills during the first eight months, to face events of this nature. On that basis, the CB said more than 60% of speculative capital in terms of treasury bonds and bills has already flown out of the country. Therefore, the high risk of further loss of reserves is very unlikely.
In addition, the CB stated a large amount of short-term credit by way of petroleum bills has already been settled and therefore, the pressure on external reserves as well as the exchange rate will be much lower than that prevailed during the last two months. The CB intervention in the foreign exchange market has also declined since November 2008 and as of now, the CB has even greater flexibility in the exchange rate management. “It is quite disappointing that S&P has apparently not realized that the decline in foreign exchange reserves is a global phenomenon under the present international financial crisis. Hence, it is grossly unfair to single out Sri Lanka only on a global situation and downgrade the rating position mainly based on that,” the CB said. |
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