Any severe and prolonged market volatility resulting from Brexit could affect heighten balance of payment pressures for Sri Lanka (B1 negative), the global rating agency, Moody’s said in a report released yesterday.

The Moody’s Investors Service says that the United Kingdom’s vote to leave the European Union will not have a significant credit impact on Asia Pacific sovereigns, but dependence on external finance poses a vulnerability for some countries.

Moody’s conclusions are contained in its just-released report on the impact of Brexit on the Asia Pacific region, entitled “Sovereigns -Brexit and Asia Pacific: Limited Direct Credit Impact; Some Sovereigns Exposed to Market Volatility.”

According to the report, over the coming months, announcements related to Brexit could trigger financial market volatility and if global financial volatility results in tighter external financing conditions, it would hurt growth in countries where fiscal and monetary policy space is already constrained.

The elevated Government debt of Sri Lanka, which has significant debt repayments due in 2016, would constrain fiscal policy room to offset the impact of weaker external flows on GDP growth.

“Sri Lanka is also dependent on portfolio inflows to refinance its external debt,” the report said.

Funding from the International Monetary Fund (IMF) under an Extended Fund Facility (EFF) and other international lenders, combined with FDI inflows, will relieve pressure on foreign exchange reserves, according to the Moody’s report.

“However, they will not fully cover Sri Lanka’s external financing requirements in the next few years.”

In Sri Lanka, Government debt increased to 76.0% of GDP in 2015, significantly higher than similarly rated sovereigns, according to Moody’s.

“Under the IMF’s EFF, the Government aims to reduce the budget deficit significantly, in particular through higher revenue collection. Tighter financing conditions that hamper GDP growth would make the fiscal consolidation goals more challenging,” Moody’s said.

“Weakening fiscal metrics, which could lead to renewed balance of payment pressure, were one of the drivers of our change in the outlook on Sri Lanka’s B1 rating to negative from stable in June 2016,” it said.

Moody’s assigns (P)B1 rating to Sri Lanka’s global bond offering

Moody’s Investors Service has assigned a provisional rating of (P)B1 to the Government of Sri Lanka’s announced US-dollar denominated bond offering. The Government of Sri Lanka’s issuer rating is B1, with a negative outlook.

Moody’s expects to remove the provisional status of the rating upon the closing of the proposed issuance and a review of its final terms.

Sri Lanka’s B1 rating is supported by the economy’s robust growth potential and higher income levels than similarly rated sovereigns. With the effective implementation of some of the fiscal policy measures and other structural reforms planned under the International Monetary Fund’s (IMF) Extended Fund Facility (EFF), the Government would be able to tap a significant potential revenue base. However, there are material risks that the IMF program does not deliver the outcomes that are currently expected. This could lead to a deterioration in Sri Lanka’s credit metrics to levels no longer comparable to B1- rated sovereigns.

In June 2016, Moody’s affirmed Sri Lanka’s B1 ratings and changed the outlook to negative from stable. The action was prompted by: 1) Our expectation of a further weakening in some of Sri Lanka’s fiscal metrics in an environment of subdued GDP growth which could lead to renewed balance of payments pressure. 2) The possibility that the effectiveness of the fiscal reforms envisaged by the Government may be lower than we currently expect, which could further weaken fiscal and economic performance.

The negative outlook signals that an upgrade is unlikely. Evidence of effective reform implementation leading to significant and lasting improvements in tax collection would be positive. Such an improvement, coupled with reforms of macroeconomic policy that lead to more stable external financing conditions, would support a return of the rating outlook to stable.

Conversely, signs that the fiscal consolidation measures are ineffective or that the authorities’ commitment towards fiscal consolidation is wavering would point to a higher debt burden for longer and put negative pressure on the rating. In particular, if such developments were accompanied by a marked fall in foreign exchange reserves and lack of market access, a downgrade to the rating would be possible.