S&P revises Sri Lanka outlook to positive, ratings affirmed

Standard & Poor’s Ratings Services yesterday revised its outlook on the long-term foreign currency sovereign credit rating on Sri Lanka to positive from stable.

At the same time, Standard & Poor’s affirmed its ‘B+/B’ foreign currency and ‘BB-/B’ local currency sovereign credit ratings on Sri Lanka.  The outlook on the long-term local currency rating is stable. The transfer and convertibility (T&C) assessment is unchanged at ‘B+’.

“We revised our outlook on the foreign currency rating to reflect the improving external liquidity, progress in addressing structural fiscal weaknesses, the Government’s effort to keep inflation near that of trading partners,” said Standard & Poor’s credit analyst Takahira Ogawa.

The ratings are constrained by the sovereign’s fundamental fiscal weaknesses, high public debt and interest burden, and its political institutions that in some cases lack transparency. On the other hand, four months reserves coverage of current account payments, a return to single-digit inflation, and improved growth prospects are supporting factors for the ratings.



“We expect investment to edge upward to 28% of GDP, boosting per capita growth to about 6.5% per year. If the business environment improves to boost net foreign direct investments above 2% of GDP, stronger growth may be possible,” Ogawa said.

The ratings incorporate our expectation of gradual improvement in public finances, via tax reform and better management of Government-owned companies, Ogawa added.

Improving external liquidity is another positive rating factor. Investor confidence rose with the end of the war and the one-year extension of IMF’s Standby Loan Programme.

Standard & Poor’s believes the prevailing combination of increased political stability and a healthier global economy will enable the Sri Lankan administration to implement its planned fiscal and microeconomic reforms. These reforms are likely to improve the country’s competitiveness and fiscal and debt profiles gradually.

“The one-notch differential between our long-term local currency and foreign currency ratings reflects the monetary flexibility provided by Sri Lanka’s floating exchange rate and modestly developed local debt markets.

“Standard & Poor’s T&C assessment reflects our opinion that the likelihood of the sovereign restricting access to foreign exchange needed by Sri Lankan-based non-sovereign issuers for debt service is similar to the likelihood of the sovereign defaulting on its foreign currency obligations.

“In our opinion, the Government tends to be interventionist and may, in a severe downside scenario, use restrictions on access to foreign exchange needed for debt servicing as a policy tool,” Ogawa noted.

The positive outlook on the foreign currency rating reflects the improving external liquidity, inflation staying close to that of trading partners, and the government’s progress in addressing structural fiscal weaknesses.

Balanced progress in addressing the external and domestic weaknesses may result in the equalisation of the local and foreign currency ratings, while disproportionate fiscal progress, without any monetary slippage, could result in our maintaining the one-notch distinction in an upgrade.

Balanced progress would likely stem from significant fiscal or structural economic reforms that reduce faster than expected the vulnerabilities from high debt and interest burdens, and the country’s still-narrow economic profile.

“Conversely, the ratings are likely to stabilise, or we may lower them, if there is a substantial deviation from the IMF programme, or if Sri Lanka’s growth and revenue prospects begin to ebb.”