Sri Lanka’s economy seen growing by 1.5% in 2020 - Moody's

Sri Lanka's economy is expected to grow just 1.5 per cent in 2020, with risks skewed to the downside. Weaker foreign exchange inflows from exports, tourism activity and overseas remittances will further weaken Sri Lanka's already fragile external position, despite some relief from a lower imports bill, Moody's Investors Service (Moody's) said on Friday.
In a media statement, the rating agency on Friday placed the Government of Sri Lanka's long-term foreign currency issuer and senior unsecured B2 ratings under review for downgrade. 
The decision to place Sri Lanka's ratings on review for downgrade is prompted by Moody's assessment that the acute tightening in global financing conditions, fall in export revenue, and sharp slowdown in GDP growth as a result of the global coronavirus outbreak exacerbate Sri Lanka's existing government liquidity and external vulnerability risks, raising risks of heightened financing stress and macroeconomic instability, the agency said in a media release. 
Moreover, the economic and financial shock will further dim medium-term prospects for reforms that would meaningfully strengthen Sri Lanka's fiscal and external position. 
Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. 
For Sri Lanka, the current shock transmits mainly through capital outflows, a marked local currency depreciation, wider risk premia and a sharp drop in GDP growth that raise the sovereign's debt burden, liquidity pressures and cost of external debt servicing. This shock occurs at a time when Sri Lanka's credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt payments and very weak debt affordability. 
“At the same time, Sri Lanka's relatively robust institutions and governance strength compared to similarly rated peers and a sizeable banking sector may support the government's access to funding at manageable costs,” Moody’s said. 
Like other emerging and frontier market sovereigns, Sri Lanka faces a severe tightening in financing conditions and fall in revenue, including export revenue, from a sharp economic slowdown. 
Compared to most other sovereigns, this shock occurs at a time when Sri Lanka's credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt payments, and very weak debt affordability. 
Prior to the coronavirus outbreak, the government's fiscal position had already begun to weaken, amplifying long-standing debt affordability, liquidity and external credit weaknesses. Tightening external financial conditions have resulted from large capital outflows and increased pressure on the exchange rate. 
The Sri Lankan rupee has depreciated approximately 6 per cent against the US dollar since the beginning of March, while spreads on Sri Lankan international sovereign bonds over US Treasuries have widened sharply in recent weeks to around 1600 basis points, indicating significantly impaired market access. 
These conditions are raising Sri Lanka's cost of servicing external debt, weigh on foreign exchange reserves and jeopardize macroeconomic stability. Meanwhile, the ongoing global shock will significantly curtail demand for Sri Lanka's textile and garment exports in major markets including the US and Europe, in addition to a domestic lockdown curbing domestic demand, which will only be partially buffered by income support from policy measures. 
The government's external debt service payments amount to approximately $4 billion between 2020 and 2025, in addition to financing part of the wider budget deficit externally. International sovereign bonds account for a sizeable portion of maturing government debt over this period, including upcoming payments of $1 billion each in October 2020 and July 2021. 
In the current market conditions, refinancing these maturities on international markets would come at considerable costs. Moody's expects that Sri Lanka will reorient some of its external funding to international and bilateral creditors. 
The government may also rely more on domestic financing but refinancing external debt domestically would dent reserves further, potentially putting more pressure on the exchange rate. Moreover, domestic debt generally comes at higher costs and shorter maturities than external debt. 
Combined with slower nominal GDP growth and a weaker exchange rate, the government's debt burden will rise to close to 100 per cent of GDP. Debt affordability, already one of the weakest amongst the sovereigns that Moody's rates, will worsen further with interest payments comprising more than 50 per cent of government revenue in 2020-21.
Moody’s said the current shock will also challenge monetary policy effectiveness. The Central Bank has undertaken substantial liquidity injections over the past month to ease domestic credit conditions. Nonetheless, given Sri Lanka's worsening external position, risks are skewed towards more pronounced pressure on the rupee. Further currency depreciation may result in higher inflation, given the pass-through to prices for Sri Lanka's import-reliant economy. 
Even after the parliamentary elections which have been postponed from April 25 to an undetermined date, policy scope for reforms that would address hurdles to economic competitiveness, very weak public finances and a strengthened monetary regime is likely to be very limited for some time 
Social considerations are material to Sri Lanka's credit profile. As Sri Lanka's population continues to grow, the government will face ongoing fiscal pressures to deliver high-quality social services and infrastructure. Governance considerations are material to Sri Lanka's credit profile and are captured in our assessment of institutions and governance strength. These considerations primarily relate to the slow pace of reform implementation, as well as political risks, which impair the effectiveness of fiscal and economic policymaking. 
“Moody's would likely downgrade Sri Lanka's rating should it become increasingly likely that financing of the government's debt will come at significant financial costs and/or weaken reserves adequacy further. Should the probability increase that Sri Lanka's government debt will continue to rise markedly beyond Moody's baseline projections, with a related further deterioration in debt affordability, this would also likely result in a downgrade of the rating. A significant probability of missed or delayed payments of contractually obligated interest or principal owed to private sector creditors, potentially as part of a broad initiative, would also likely be negative for the rating,” the statement said.