Fitch affirms Sri Lanka sovereign rating

  • Rating reflects external debt burden, low forex

  • Highlights $ 29 b debt obligation till 2026

  • Projects forex reserves to drop to $ 3.9 b end-2022

  • 3.8% growth rate anticipated in 2021 down from earlier 4.9%

On Monday (14), Fitch Ratings affirmed Sri Lanka’s Long-term Foreign-Currency Issuer Default Rating (IDR) at “CCC”, reflecting a challenging foreign currency sovereign external debt repayment burden over the medium term, low foreign exchange reserves, and high and rising government debt that gives rise to sustainability risks.

Fitch noted that external liquidity pressures have eased somewhat in recent months following bilateral loan disbursements, and their expectation of a forthcoming International Monetary Fund (IMF) special drawing rights (SDR) allocation. Nevertheless, Sri Lanka’s medium-term debt service challenges are substantial and pose risks to the sovereign’s debt repayment capacity, in Fitch’s view. A total of about $ 29 billion in foreign currency debt obligations are due between now and 2026, against foreign exchange reserves of $ 4.5 billion as of end-April 2021.

It stated that authorities have recently secured project financing through various multilateral and bilateral channels, including Asian Development Bank (AAA/Stable), Asian Infrastructure Investment Bank (AAA/Stable), China Development Bank (A+/Stable), and Export-Import Bank of Korea (AA-/Stable), as well as swap facilities under the South Asian Association for Regional Co-operation (SAARC) currency framework and People’s Bank of China, equivalent to $ 400 million and $ 1.5 billion, respectively.

“The planned IMF SDR allocation would also add $ 780 million to reserves. These resources should enable Sri Lanka to meet its remaining debt maturities through the rest of this year, including a $ 1 billion international sovereign bond maturing in July. However, the authorities have yet to specify their plans for meeting the country’s foreign currency debt-servicing needs for 2022 and the medium term. They have consistently indicated that they do not plan to seek programme financing from the IMF,” Fitch noted.

The rating agency projects foreign exchange reserves to remain at about $ 4.5 billion by end-2021 before declining to $ 3.9 billion by end-2022. Under our baseline, the current account deficit is likely to widen to 2.8% in 2021 and narrow to 2.1% of GDP in 2022. Our forecasts assume remittances will remain resilient in 2021-2022 and tourism is likely to recover only from 2022.

Sri Lanka’s economy contracted by 3.6% in 2020 as a result of the Covid-19 pandemic. We project growth of 3.8% in 2021, down from an earlier forecast of 4.9%, in light of a recent surge in Covid-19 cases. Fitch expects the economy to grow by 3.9% in 2022.

“There remains a high degree of uncertainty associated with our forecasts in light of the evolution of new Covid-19 cases in the country. The authorities plan to inoculate 60% of the population by end-2021, but this target could be hampered by vaccine supply shortages.

“Travel and tourism, an important driver of the economy, have been hit hard and the outlook for recovery remains uncertain, particularly given the recent surge in virus cases. The direct contribution of tourism to pre-pandemic GDP was about 4%, but the indirect contribution was much higher. Tourist arrivals in the first five months of 2021 were 97% lower than the same period last year,” Fitch added.

The general government deficit widened to 11.1% of GDP in 2020, from 9.6% in 2019, as the economic contraction led to a sharp fall in fiscal revenue. The rating agency expects the deficit to remain elevated in 2021 and 2022 at 11.1% and 10.4%, respectively. Their deficit projections are wider than those presented by the Government under its growth-oriented strategy of 9.4% and 7.5%, respectively. Under their forecasts, the revenue-to-GDP ratio in 2021 would rise to 10.9% in 2021 and 11.1% in 2022, compared with the authorities’ projections of 11.9% and 13.0%, respectively.

The Government’s fiscal consolidation strategy is based on a planned acceleration in GDP growth, underpinned by tax cuts, as opposed to direct revenue-raising or expenditure measures, albeit supported by planned improvements in tax administration. The interest-to-revenue ratio remains high, at around 71% as of 2020, well above the “CCC” median of 13%. The Government expects to achieve primary surpluses from 2023, supported by annual GDP growth of 6%, which appear optimistic in Fitch’s view as they anticipate growth that is closer to 4%, still above the pace in the immediate pre-pandemic period.

General government debt reached 101% of GDP by end-2020, broadly in line with Fitch’s forecast at our last review in November. Our baseline forecasts suggest this ratio will rise further to 108% by 2022. Fitch does not think the Government will meet its 2025 targets of reducing government debt to 70% of GDP and narrowing the fiscal deficit to 4% of GDP.