More than 40 % of Sri Lanka’s debt is in foreign currency, Moody’s says
View(s):More than 40 per cent of Sri Lanka’s government debt is denominated in foreign currency exposing the government to a larger repayment burden in the event of a depreciation in the local currency, as happened in late 2015, a new report says. Moody’s Investors Service, in its just-released report entitled “Sovereigns — Asia Pacific: High Public, Private Sector Leverage Poses Credit Risks Across the Region,” said that reliance on bilateral and multilateral lenders reduces but doesn’t eliminate vulnerability to international market volatility, as financing strains posed by falls in capital inflows in recent months have shown.
Sri Lanka is negotiating a financial assistance programme with the IMF, which should partly cover the country’s external financing needs over the next three years. The government also plans to raise currently very low revenues, and has announced some increases in tax rates. “However, slower growth and uncertainty about the efficiency of efforts to improve tax collection imply that government debt is unlikely to fall in the near future,” Moody’s said in the report released on Tuesday. It said Sri Lanka has a very high debt burden compared to its rating peers. General government debt stood at around 76 per cent of GDP in 2015, up from 71.6 per cent five years earlier, and well above the 48.6 per cent median for B-rated sovereigns.
Interest payments consume nearly a third of government revenues – much higher than rating peers. Dealing with Asia, the report said that the increase in leverage across Asia Pacific over the last five years could weigh on sovereign credit quality. The sovereign risks could materialize either directly, where the debt increase has been concentrated in the public sector, or indirectly, where the rise in private sector leverage has been rapid. The report said that in addition to the pace of increase in and level of debt, several other factors determine risks to sovereign credit profiles. It notes that macroeconomic trends, asset buffers, income profiles and policy responses can all mitigate or exacerbate the credit impact that high leverage can have.
Moody’s report identifies the sovereigns that face risks from an accumulation of debt, and the source, whether via government, state-owned enterprise, corporate, household or bank balance sheets. “Government debt levels are elevated and pose a sovereign credit constraint for India (Baa3 positive), Japan (A1 stable), Malaysia (A3 stable), Pakistan (B3 stable) and Sri Lanka (B1 stable). But government leverage is also climbing rapidly in several other countries, curbing room to ease fiscal policy in future,” the report said. Elsewhere, government borrowing is at moderate levels, but reliance on foreign currency and external debt is a vulnerability. State-owned enterprise (SOE) liabilities are large in China (Aa3 negative), and smaller but still material in Korea (Aa2 stable), Malaysia, Sri Lanka and Vietnam (B1 stable).
While only a fraction of total SOE liabilities may crystallize, sovereigns’ balance sheets would be affected as a result, it said. Private corporate debt has risen significantly in Hong Kong (Aa1 negative) and Singapore (Aaa stable), reflecting their status as international financial centers. While total corporate debt is modest relative to GDP in Indonesia (Baa3 stable), Moody’s says a previous build-up in private sector external debt exposes companies in the country to currency fluctuations. Moody’s points out that banking sector risks in Asia Pacific are mainly related to corporate credit profiles. In Vietnam and Mongolia, banks are working through legacy problem assets. In China, rising corporate leverage threatens to weaken bank asset quality, and in Bangladesh (Ba3 stable) and India, impaired loans at state owned banks expose the governments to risk.
As for households, Moody’s says that leverage is high relative to GDP in Australia (Aaa stable), Hong Kong, Korea, Malaysia, New Zealand (Aaa stable), Singapore and Thailand (Baa1 stable). In most cases, household financial assets are also substantial, alleviating credit risks to banks. But financial volatility can cause asset values to fall, just as household leverage constraints start to bite. Moreover, curbed consumption typically exacerbates the impact of negative economic shocks when household leverage is elevated. In such scenarios, affected sovereigns would face a much weaker growth environment.