Fitch affirms Sri Lanka at 'B'; Outlook Stable

Fitch Ratings has affirmed Sri Lanka's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' with a Stable Outlook.

Sri Lanka's 'B' rating balances high government debt and contingent liabilities, a challenging external financing profile and subdued economic growth against higher human development standards and per capita income levels compared with peer medians, the rating agency said on Monday.

The policy environment has improved after the resolution of last year's political standoff. The 2019 budget was passed and the IMF programme resumed and was extended by one year to June 2020, it said in a media statement.

The IMF staff announced recently an agreement on the sixth review of the extended fund facility (EFF). The currency appreciated by about 3 per cent against the US dollar by end-1H19 after weakening by nearly 19 per cent by end-2018. However, Sri Lanka is entering an election cycle, with presidential elections in November this year followed by parliamentary elections in 2020, and the risk of policy slippage and political tensions resurfacing closer to the elections remains high, in Fitch's view.

Fitch forecasts a budget deficit of 5.4 per cent of GDP in 2019, above the authorities' target of 4.4 per cent, as weak growth partly reflecting the drop in tourists has adversely affected revenue collection.

Fitch has revised its growth forecast for 2019 to 2.8 per cent from 3.6 per cent at the time of the previous review in December 2018 because of the negative impact of the April 2019 bombings on tourism, which accounts for about 5 per cent of GDP. 

Monetary policy continues to focus on maintaining macroeconomic stability and inflation has remained subdued so far in 2019, partly a result of the slowdown in growth and lower food and commodity prices. The benign outlook for inflation combined with slowing growth led the Central Bank of Sri Lanka to cut policy rates twice this year by a cumulative 100bp.

Fitch said taxes imposed on a wide range of automobiles led to a contraction in vehicle imports, while gold and rice imports also fell. “We expect the current account deficit to narrow further to about 2.8 per cent of GDP by end-2021 but there are risks to our forecast from a possible shift towards more expansionary fiscal and monetary policies or weaker-than-expected export performance,” it said, pointing out that high government debt and large interest payments remain a key credit weakness. 

Fitch maintains a negative outlook on Sri Lanka's banking sector as it anticipates continued pressure on banks' financial profiles due to pressure from a challenging operating environment.

The trend of rising non-performing loans (NPLs) continued into 2019, with the sector-wide NPL ratio rising to 4.8 per cent by end-June 2019. Credit risks are likely to linger reflected in an increase in restructured loans across banks.