• Last Update 2024-07-18 22:51:00

Relief package supports SL’s economic recovery but compounds state fiscal challenge - Moody’s

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While the size of the Sri Lankan Government’s recent relief package is moderate and will be fully funded via reallocations from the budget, it reduces the scope for fiscal and debt consolidation at a time when fiscal flexibility is already severely limited by the large share of interest payments in government revenue, says rating agency Moody’s Investors Service.

It was commenting on the January 3 fiscal relief package worth Rs.229 billion to support the economy and alleviate the impact of higher consumer prices on low-income households. Moody’s has downgraded Sri Lanka’s rating to Caa2 stable which is “judged to be of poor standing and are subject to very high credit risk”.

“Funding the package with reallocations from the budget in part reflects this limited fiscal space, which constrains the government's ability to use fiscal policy to mitigate the impact of economic shocks. Furthermore, the risk of fiscal slippage has increased with the emergence of the Omicron variant of the coronavirus. Some countries have tightened activity and travel restrictions, and any reintroduction of measures domestically or a delay in the recovery of Sri Lanka’s tourism sector would intensify fiscal and external pressures,” Moody’s said in a statement on Monday.

Key features of the relief package include cash handouts of Rs.1,000 to citizens receiving income support, agricultural subsidies, the removal of certain taxes on food and medicine and an increase in public-sector salaries (Rs.5,000 a month from January). Such measures would support domestic demand and the economic recovery as surging prices – particularly for food – stemming from global supply chain-related disruptions and some import restrictions over 2020-21 reduce the purchasing power of households.

“We expect inflation-adjusted real GDP growth to pick up to around 5% in 2022 from around 4-5% in 2021, in part because of a lower base and because domestic economic activity has largely normalised, with international borders open to vaccinated tourists since October 2021,” the statement said.

However, risks remain as the new omicron variant of the coronavirus could delay such a recovery, and several countries have reversed their easing of travel restrictions. Should such risks materialise, the recovery in government revenue would likely be delayed beyond our assumptions, with fiscal and debt metrics remaining very weak for longer.

Moody’s said it forecasts that the fiscal deficit will narrow only slightly to around 9-10% of GDP in 2022 from around 11% in 2021, mainly reflecting ‘our’ expectation for lower revenue growth than the budget envisages. “Wide deficits will keep the government's debt burden at higher levels for some time; we estimate that the debt burden will rise to around 108% of GDP by the end of 2022 from around 101% at the end of 2020 and 87% at the end of 2019, before stabilising at the elevated 2022 level thereafter, mainly reflecting the recovery in nominal GDP growth,” it said.

 

Moody’s said a delay in the recovery of tourism receipts would weigh on Sri Lanka's precarious external liquidity position. As of November 2021, the country had $1 billion in foreign-exchange reserves (which in our definition excludes gold and Special Drawing Rights), covering less than one month of imports. “While the Central Bank indicated that reserves had risen as of  the end of December with the disbursement of a $1.5 billion swap agreement with the People’s Bank of China, reserves adequacy remains very weak, with reserves at around $2-3 billion compared with $5-6 billion of foreign-currency obligations due annually through at least 2025,” the statement said.

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