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External positions have strengthened for most rated frontier sovereigns in Asia over 1H21, reducing downside risks to ratings, says Fitch Ratings.
Nonetheless, Fitch believes external liquidity strains will continue to present challenges for 2022 and beyond for many of these sovereigns, with medium-term pressures being particularly marked in Sri Lanka and Laos (both CCC).
In the last six months, official reserves have risen in most of Asia-Pacific’s frontier economies – defined in this context as Bangladesh (BB-/Stable), Laos, the Maldives (CCC), Mongolia (B/Stable), Pakistan (B/Stable) and Sri Lanka. Sri Lanka is the sole exception, with reserves falling to $ 4 billion by end-May 2021, from $ 5.7 billion at end-2020.
Where reserves have risen, the increase should provide a cushion against potential difficulties in accessing external finance and associated external liquidity stress, and reduce the likelihood of negative rating action, all else being equal.
Bilateral and multilateral financing has helped to support external positions. Pakistan has benefited from the disbursement of IMF resources under its Extended Fund Facility with the completion of the “combined second through fifth reviews” last March, and more recently from Saudi Arabia’s agreement in June to an oil assistance package for Pakistan that the FT reported could be worth up to $ 1.5 billion. In May, media reports indicate Sri Lanka agreed a $ 250 million currency swap with Bangladesh, which if finalised would build on existing loan and swap agreements it has with China.
All six of these frontier markets should benefit from the expected new allocation of special drawing rights (SDR) by the IMF. Most notably, it could bolster Sri Lanka’s reserves by $ 780 million and by $ 2.8 billion in Pakistan.
“We expect the IMF’s Board of Governors to approve the allocation in August,” Fitch said.
It said the Maldives, Mongolia and Pakistan have raised funds in the international market through bond issuance, easing near-term liquidity pressures. Mongolia issued a $ 600 million bond in September 2020, and has proposed further issuance which Bloomberg reports will be similar in size. In March and April 2021, the Maldives raised a total of $ 300 million in sukuk issuance, while Pakistan raised $ 2.5 billion in bonds in March.
In some countries, restrictions and effects associated with Covid-19 have continued to dampen demand for imported goods and services, even as exports have recovered from the initial pandemic shock, bolstering external positions. In Mongolia, for example, goods exports rose by 65.7% yoy in 1M-5M21, supported by strong Chinese demand and high commodity prices, while imports increased by only 30.6%.
However, service export earnings remain affected by the pandemic’s impact in burgeoning tourism-oriented economies like Sri Lanka. Even in the Maldives – one of few countries globally to see a surge in tourism this year – tourist arrivals and bed nights are still only around 60% and 80%, respectively, of their 2019 levels.
Meanwhile, in Bangladesh and Pakistan, the goods trade deficit widened sharply in 1Q21, driven partly by the higher cost of oil imports. In Pakistan the Government’s adherence to a market-determined exchange-rate regime will continue to serve as a shock-absorber, and should help keep the current-account deficit contained. Pandemic-related trade distortions are likely to ebb in the coming months with the rollout of vaccine programs globally, but this process could be lengthy in countries where vaccination moves slowly.
Remittances have been another source of support to external positions since the start of the pandemic, and remain surprisingly strong, with inflows in May 2021 up by 44.3% yoy in Bangladesh and 33.5% in Pakistan, for example.
