Moody’s Ratings: Political change unlikely to derail reform trajectory

While new President Anura Kumara Dissanayake's election constitutes a major shift in Sri Lanka's political landscape, it is believed the broad appetite for reforms will remain intact, Moody’s Ratings said in a report on Wednesday.

“We do not expect significant disruption to the country's reform agenda or macroeconomic policies, which include the ongoing debt restructuring and structural adjustments under its programme with the International Monetary Fund (IMF),” it said.

However, some policies are likely to be reprioritised amid challenges in maintaining fiscal consolidation that could keep credit risks elevated for some time. Fiscal consolidation would contribute to a durable strengthening of Sri Lanka's credit profile.

Since its default in 2022, fiscal authorities have implemented a number of reforms to restore fiscal sustainability, such as raising the value-added tax and corporate income tax rates and lowering the personal income tax free allowance. These reforms increased revenue to slightly more than 11 per cent of GDP in 2023 from 8.3 per cent in 2021. In turn, the government's fiscal deficit narrowed to 8.3 per cent of GDP in 2023 from 11.7 per cent in 2021.

“However, we expect the government's debt affordability to remain weak, with interest payments likely averaging 40 per cent-50 per cent of revenue over the next two to three years, and still among the weakest across sovereigns we rate, albeit an improvement from more than 70 per cent in 2021,” Moody’s said.

Moody’s said it doesn’t expect any significant shifts in Sri Lanka's reform trajectory or policies, although some reprioritisation is likely. C

In terms of policy priorities, Dissanayake has spoken about the need to tackle corruption, alleviate conditions for the poor and reduce austerity affecting social welfare, while pursuing economic and fiscal reforms. The new president has not opposed Sri Lanka's debt restructuring deals and has said any changes to policy and reform measures will be in consultation with the IMF.

However he has opposed the privatisation of state-owned enterprises in important sectors. As any negotiation of potentially revised targets or changes in specific measures will take time, there could be delays in disbursements or finalisation of external debt restructuring with private-sector creditors.

With the decision to hold Parliamentary elections in November, Moody’s said it expects some period of political uncertainty until a new parliament is formed. Besides fiscal reforms, Sri Lanka has also made considerable progress in rebuilding its external position. Official foreign-exchange reserves rose to around $6 billion as of the end of August – sufficient to cover around 3.5-4 months of imports – from well below $2 billion for most of 2022.