Monday Nov 25, 2024
Monday Nov 25, 2024
Friday, 16 August 2013 00:02 - - {{hitsCtrl.values.hits}}
Setting the stage for the roundtable to kick off, Fitch Ratings Lanka Country Head/Managing Director Maninda Wickramasinghe narrated the Fitch story to the audience. Having achieved a great deal over the past 12 years, Wickramasinghe said the agency will continue to operate in the country and that it is here to stay.
The chief revealed that the agency has so far rated Rs. 600 billion worth of debt in the country, of which Rs. 4 billion has been rated for sovereign. “The significance of these events was the embracing of technology. Our aim is to transfer technology and the knowhow which will enable Sri Lanka to compete in the global market,” he said.
The event which featured Central Bank of Sri Lanka Governor Ajith Nivard Cabraal as Chief Guest explored the banking sector and the sovereign elements of the country in detail.
Transformation and future prospects for Sri Lanka
“No matter what anybody says about the vulnerability of the country, the crux of the matter is that transformation is taking place at the time you are living and this is an important factor to understand,” stated Central Bank Governor Cabraal during his keynote.
Noting that in almost in every macro fundamental, one will see reasonable change, he said that growth has been taking place in an extraordinary phase. The Governor made this statement referring to the fast paced growth witnessed over the past three years and the achievement in maintaining a single digit inflation rate for the longest period – 54 months, whereas the previous was 23 months between 1999-2001.
Referring to a recent budget consultation session, where, according to him, not a single person requested for wage increases, Cabraal said this shows that Sri Lanka has moved on to a low inflation regime and that it is important to understand this in the context, the overall tendency of the working population.
He highlighted that the financial system’s stability was maintained as it surpassed Rs. 5 trillion and foreign reserve accumulation has been prudent where it is not too excessive or too low. “The foreign reserves were high but we use them to buttress the growth momentum. Today, we have seen it at a reasonable level and we took some measures needed for Sri Lanka to move forward with confidence,” said Cabraal.
“The overall philosophy adopted helped us to deal with vulnerabilities with ease so that such do not take place. We have also been able to overcome the BOP deficit that we had in 2011 and we now are in positive territory, which we will continue to be in,” he added.
Commending the Government for extending a helping hand to address the fiscal deficit situation, Cabraal pointed out that having seen inflation moderated and lower interest rates, the Government was one of the beneficiaries of the policy that they themselves maintained.
Observing the debt to GDP contraction, Cabraal said that in 2014, there will be a sharp decline in interest which will help bring down the budget deficit down to 5.2%. “Today, we are well on our path on what we want to achieve, which is reaching US$ 4,000 GDP per capita by 2016. According to top officials of the World Bank, we are one of the few countries where the manifesto of the President puts forward the projected GDP. It’s a risk that many leaders wouldn’t take. This puts pressure on economic managers to ensure that those roles are also realised and today, there is a deep commitment by the entire Government, which the Central Bank supports, as it is the right way for the country to go forward,” he said.
Cabraal elaborated that while the overall projected growth will ensure that the targeted per capita is reached, the middle income trap must be avoided during the journey. “There are many features which will take us to our new income goal comfortably and these are our focus. During next month’s strategic planning session, we will address this issue in a fundamental manner to see what steps should be considered when taking the economy beyond the US$ 4,000 mark seamlessly.”
He opined this can happen by ensuring that the five hub concept is given momentum together with tourism, which will be the cornerstone of economic development. “It’s a working plan, a living dynamic plan that is getting realised on a constant basis. When some of these are over, there will be new projects that will come in to ensure that there is a pipeline. This is the future we are talking about,” added Cabraal.
He elaborated that sectors which were not seen as key will emerge and that services too will be an important factor. “Earlier, we were involved in trade. The export of tea, rubber and coconut, and the importing of certain items was all we were interested at the time. Today, it is not so. That is why sometimes I see people talking only about the trade deficit.
“Yes, there is a trade deficit but are we to only worry about that? We have to ensure that the economy should become widely spread, and through that strategy, we are now adding new services to the economy. The hubs and tourism mean that Sri Lanka will no longer be only a trading centre but a centre to do business in so many other areas as well,” he explained.
He further stated that FDI levels will change and as a result, the BOP will also undergo major changes within the next two to three years. He noted that while this will take the country by surprise, the changes are occurring in a low unemployment regime which in turn is another challenge.
“When unemployment rates are cut down, labourers will have to be more productive and this productivity will have to be proved. This is another aspect that we will be looking at more closely to see that the transitions from certain sectors will boom while making sure that there are constant improvements in the productivity levels as well,” emphasised Cabraal.
No improvement in Sri Lanka’s credit rating
The Governor also observed that the country’s credit ratings haven’t been improving although commendable growth rates were achieved. For this, he said, rating agencies should take into consideration a number of other factors when ranking countries.
According to Cabraal, credit rating agencies have taken a “myopic” view on this regard due to imperfections and problems noticed in other countries. “They have to appreciate movements, trends and tendencies that take place in a country. Rating agencies should see if there is political stability, if there is a vision that is being clearly articulated. Taken into account should also be risks that are considered worthy. They need to take note if risks are taken in a rational manner or in confidence. These are highly important factors,” he asserted.
Acknowledging that although agencies have their own ways of doing things, Cabraal stressed that the mentioned factors should be considered in the rating grid as they are not only taking a decision for the country but for investors as well.
“Agencies say Sri Lanka has had an extraordinary transformation but when they go back, they find some reason to say that the country should remain where it is in terms of its ratings. I think this is a disservice to the investors,” he said. Cabraal pointed out that in the current context, investors might not want to come to Sri Lanka due to the delay by agencies in upgrading the country’s ratings. “We want people to come now and understand what the nation is all about. If they come 10 years later, they will lose out and those close to the country will gain,” he added.
Stating that investors who have come to Sri Lanka have been impressed with what they have witnessed, Cabraal added that the recent situation where a rating agency reduced the country’s outlook did have an impact on the financial market as the very next day, bonds were noted to have tightened.
He stressed that although the country came through a difficult period, Sri Lanka has not yet moved to a trajectory of high economic growth which people can enjoy. He pointed out that in order to achieve high economic status, continuous performance, maintenance of macroeconomic stability and continuous infrastructure development should be ensured so that sustained investor confidence could be gained.
Are operating environment related risks negative for bank ratings in South Asia?
Calling banks the creatures of the economy, Fitch Ratings Senior Director Financial Institution Head of Bank Group, South Asia Ambreesh Srivastava stated that most banking systems in Asian countries have proved to be far more resilient to the global economic downturn.
Having projected a GDP growth of 5-6% in 2013 and 2014, Srivastava stated that for banks in developing countries, this means the economic environment will still stay broadly supported although it may lead to moderation in the key banking indicators from historical highs.
Regarding the performance of South Asian banks, he observed that compared to previous forecasts in actual performance, the last few years have consistently turned out to be much better as the region showed it could be more flexible than expected.
“Together with several structural changes in the countries and their banking systems over the years, we believe that most South Asian banking systems, except Vietnam, have good defensive qualities and reasonable capacities to cope with the trend posed by global economies and rising leverage. Therefore, we have a stable outlook for most Asian banks,” said Srivastava.
The return on assets (ROA) on South Asian banks has been noted to be on an upward trend in the last few years due to fair conditions in the region. Despite some moderation in economic goals, particularly in export orientated countries, the ROA rating has been broadly stable for most Asian banking systems.
Pointing out that Sri Lankan banks too have recorded an impressive rise in the ROA during the post war period compared to previous years, Srivastava asserted that such increases would appear somewhat less spectacular when adjusted for factors such as provision wide tax and lower taxes which weigh in at a pre-provision level.
Taking into account the multiple credit growth and GDP growth which is said to be 3.4 in the Asian region, this multiple is noted to be well above the historical trend. “One may argue that the credit bubble maybe building up in some countries, which of course may also have limitations on bank asset quality a few years down the line. Such signs have already been captured by Fitch’s Macro Prudential Indicator (MPI).”
Srivastava added that this attempts to identify certain stresses in the banking system due to specific circumstances such as rapid credit growth and trend appreciation. “Using these indicators, we divided the countries into MPI categories where 1 represents the lowest risk of stress and 3 represents the highest,” he explained.
While Sri Lanka was in MPI category 1 from March 2007 to June 2011, the country was put under the MPI 3 category from December 2011 and is expected to remain there until 2014 according to forecasts by Fitch Ratings.
Having observed that this status has not been well received, Srivastava said: “Let me make it clear here that just because a country makes it to a higher MPI category, it doesn’t mean the end of the world. However, it is something we will take into account which will lead to potential concerns in banking sector down the road.”
He elaborated that when looking at the MPI trend for Asia Pacific countries, it is worthwhile to note that these trends are important pointers of potential problems in banking systems and are therefore important for consideration for the deliberations of the rating committees, particularly for the banking systems falling in MPI categories 2 and 3.
Stating that national regulators have learnt from the Asian financial crisis, Srivastava said that a few MPI measures have been noted in some countries in the Southeast Asia region primarily due to excessive optimism. “Those measures are not only relevant for advanced economies but also for countries such as Malaysia and the Philippines where several prudential regulations have been introduced in the past few years to control excesses in underwriting standards,” he said.
Moving on to asset quality, Srivastava pointed out that like most Asian countries, Sri Lanka has remained broadly stable over the past five to six years in terms of its NPL ratio. Going forward, Fitch expects NPL ratios to increase modestly across all Asian banking systems in 2013 and 2014. “In the first half of this year, the NPL of Sri Lanka has inched out a little bit. I guess these move in cycles and our view is that this deterioration appears to be quite manageable for most South Asian counties, including Sri Lanka,” he expressed.
Touching slightly on the capital scenario, as far as Sri Lanka is concerned, the reposted regulatory Tier 1 capital ratio is noted to be good but would be considerably lower if adjusted for zero risk weighed assets such as Governmental exposures, which are zero weighted. “The point taken is that some of these are low risk but it does distort the capital.”
Opining that Sri Lanka’s foreign currency denominated exposure being zero risk weighted is a debatable issue, Srivastava added that Sri Lankan banks do not look well capitalised although it seems reasonable. “On an adjustment basis, Sri Lanka’s capital position is not as healthy as it would appear on the surface. The private banks here look much better on this measure compared to Government banks. In fact, some of it is also partly because of risk rates,” noted Srivastava.
Sri Lankan banking sector
Having assigned national ratings to 20 Sri Lankan banks, Fitch Ratings Vice President Financial Institutions Rukshana Thalgodapitiya explained that the national ratings provide a relative measure of creditworthiness for rated entities only within the country concerned.
While Fitch has also assigned some major Sri Lankan banks international ratings since 2012, the Issuer Default Ratings (IRDs) are meant to be internationally comparable across countries and industries.
Touching on how ratings are given to banks, Thalgodapitiya said that the methodology applied for national and international ratings are the same. When looking at the rating drivers, it was noted that in terms of support, IDRs and national ratings of large State banks factor the ability and tendency of the sovereign to support as long as their majority State ownership, role and systemic importance remain intact.
Stating that the differentiation made on the national ratings scale in the case of National Savings Bank (NSB) was due to the existence of preferential support to the institution. Thalgodapitiya shared that the national ratings of other State banks are also driven by State support although these ratings are further from the sovereign.
Moving on to the common rating sensitivities, Thalgodapitiya revealed that on the upward side are the stronger capital buffers and stronger franchise, whereas the downward drivers are capital impairment risk, diminishing loss absorption capacities, shifting risk profile and increasing risk appetite.
Focusing on the MPI for Sri Lanka, she pointed out that Fitch monitors developments in bank lending, house prices, equity prices and the Real Exchange Rate (RER) to identify potential systemic stress, often preceded by a combination of rapid bank lending growth, bubbles in asset markets and the RER.
Thalgodapitiya shared that according to Fitch, the country’s MPI score was revised to 3 (high risk) from 1 (low risk) in December 2011. The revision in the status was noted to be triggered by real private sector credit growth exceeding an average 15% a year for over two years, and real equity price growth of more than 17% a year.
Taking into account the risk scenario, Thalgodapitiya said: “Looking at some points that could elevate from the downside risk of Sri Lankan banks, it is particularly in relation to the rapid loan growth that banks experience this. This year, there was a steady slowdown in the private sector.”
As Fitch looks at the core sustainable operating profitability, noting a clear correlation between the credit costs and the ROA, Thalgodapitiya said it can be seen that the latter has been elevated to an extent to lower credit cost. “Historically, credit cost for the banking sector has been just above 1% and even before 2008 and 2009, which were difficult periods for the banking sector, profitability had also been supported through tax reductions,” she said.
Noting than the impairment provision is higher than regulatory provisions, she said that the rating agency observes that there are no constant basis assessment in the impairment of banks. For shares of pawning loans, it is understood that the loan book composition is sizeable. “Delinquencies in the pawning loan portfolio are noted to be rising and reported NPL ratios are higher for pawing loans while reported NPLs have historically been low,” she stated.
Considering the core capital adequacy ratio, which benefits from zero weight according to some exposures, Thalgodapitiya opined that it is clearly noted that the equity assets for large private banks are much higher than the equity assets of large State banks.
“The strengths of a franchise are seen as a determinant in securing a stable deposit base, particularly in terms of a sustainable share of CASA in the deposit mix,” Thalgodapitiya emphasised. Pointing out that credit growth has been muted for the first half of the 2013, she stressed the need for a shift in the balance sheet structure towards investments.
Sri Lanka’s sovereign credit outlook in a global context
Starting off by presenting the global economic macro and sovereign credit overview, Fitch Ratings Head of Sovereign Ratings Asia Pacific Andrew Colquhoun said that the first point to note should be the relatively weak recovery of the global economy from the 2009 recession which resulted in an overall loss in the global outlook.
Stating that the second point that should be considered is the uncertain nature of recovery, he said that when looking at the 2013-2014 growth forecast revision, it can be observed that for most countries, it is below zero. “What is interesting to note is that for advanced economies, the revisions are still downward, with the exception of Japan, and for developing countries, the downward trend is even bigger. However, Sri Lanka bucks the trend with a positive marginal revision in 2013,” highlighted Colquhoun.
Drawing attention to the potential tightening of the global wholesale market due to these revisions, he shared that there has been a loosening of policy and it is noted to have had an impact on the financial markets, particularly in the developing world. “So, looking at the equity market, there has been some reaction to the tapering talk since June 2013. This Fed tapering talk spooks investors, it hurts the emerging market assets,” Colquhoun stressed.
Taking into account the outlook for global sovereign credit, by contrast, developing markets have seen a positive sovereign trend and when looking at the Emerging Market Bond Index (EMBI), the credit is noted to have risen to nearly 80% as of March 2013.
Focusing on Sri Lanka, Colquhoun said the nation, being a high growth high investment economy, attracts its Asian peers. He acknowledged that in terms of growth, the country grew slightly above the sustainable rate since 2012. “The good news is that the growth rate is faster than some of the Asian peers,” Colquhoun added.
He elaborated that with Sri Lanka being a high growth high investment economy, the country needs to keep an eye on domestic savings where the difference will be the demand for foreign savings. “Although this (Sri Lanka) is a high investment economy, it is still relatively low in savings and the difference is made up in foreign capital inflows. The relatively bad news for the credit is that FDI inflows have been weak,” he said.
When comparing Sri Lanka with its BB rating peers, the country has an average of 1% GDP per year whereas it should be about 2-3%. Sri Lanka, with a high demand for foreign credit, a relatively small share of business is observed to be coming in the form of FDIs. Therefore, by implication, according to Colquhoun, the consequences are that the difference is made up in the form of debt.
“Sri Lanka’s external debt is higher and is rising. The high rising external debt have some implications for external equity. If I look at Sri Lanka’s external debt as a percentage of exports, this has been on the rise since the start of the global crisis,” he added.
Exploring the nation’s vulnerability to tighter global equity, when taking into account 2013’s gross external financial requirement as a percentage of end-2012 official foreign reserves, it is observed that Sri Lanka has a ratio of 80. This ratio is roughly double the median for developing countries which is 40. Therefore, it is understood that the country is doubly exposed to tighter global funding conditions than its global developing market peers.
Venturing further into the relative weakness of FDI inflows to the country, when considering the standards, international measures and quality of business, Sri Lanka scores relatively well. In the Ease of Doing Business Index, the nation scores higher and is well above the median score of the BB and B sovereign.
However, in areas such as political stability, government’s effectiveness, rule of law, control of corruption, regulatory quality and voice and accountability, Colquhoun said Sri Lanka didn’t score well and attributed this to the relative weakness in the FDI inflows.
While lower inflation rates could help domestic savings, the latter is weak in Sri Lanka due to higher Government budget deficits compared to its peers who are in the BB range. According to Colquhoun, the public sector is not saving as much as other countries. Colquhoun stressed that the country’s external finances remain a source of concern due to a heavy external debt refinancing schedule where an average of US$ 1.9 billion per annum in sovereign debt is projected to mature from 2013 to 2015.
Although foreign reserves remain at a healthy level, standing at US$ 6.9 billion as of end-April 2013, progress on fiscal consolidation is noted to be slow as the budget deficit fell to 6.4% of GDP in 2012.
Observing the key rating drivers, Colquhoun shared that on the upside is the sustained improvement in both the public and external finances. However, on the downside, there is intensification in external financing risks, an extended period of overheating or a significant deterioration in the public finances.
Pix by Lasantha Kumara
| Prospects for development of Sri Lanka’s capital markets in a Fed-exit world In an attempt to present views from a macro and corporate perspective, a panel discussion on the prospects for development of Sri Lanka’s capital markets took place at the roundtable. The discussion, at which John Keells Holdings Director and Economist Dr. Indrajit Coomaraswamy was moderator, had four other speakers. Expressing views on this regard was Central Bank Deputy Governor Dr. Nandalal Weerasinghe, International Monetary Fund Resident Representative Dr. Koshy Mathai, Carson Cumberbatch Director Chandima Gunawardena and Fitch Ratings Head of Sovereign Ratings Asia Pacific Andrew Colquhoun. Acknowledging statements made during the presentations of the roundtable, Weerasinghe expressed the country too is not satisfied with the current FDI levels. “Based on recent experiences, it can be said that foreign investors are highly cautious with their approach. We certainly have made progress in this area but the levels are unsatisfactory,” he said. The Governor stated during his keynote that rating agencies should take into account other factors to its rating grid and Weerasinghe opined that this is absolutely correct and pointed out two additional areas. According to him, agencies should consider a longer period of the country’s performance and situation while comparisons on performance should also be made with peer countries on the extent of progress achieved. “The IMF has been quite positive about Sri Lanka over the last few years and we will continue to hold the view that things are not that bad here,” IMF’s Dr. Mathai said. He pointed out that improvements have been observed in the inflation rates and fiscal deficit but advised to keep a close eye on the external debt. “While the overall picture looks all right, the 80% credit ratio is too high, and this should be watched closely. However, what Sri Lanka has in favour are its debt dynamics. With regard to the debt to GDP ratio, the leverage is coming about slowly but there is a tendency for it to come down and this will help Sri Lanka greatly,” he added. A perspective from the private sector was given by Gunawardena from Carson Cumberbatch. Questioning if ratings are exploited enough by the private sector, he opined that the positive environment in which businesses are operating gives enough room to do so. “If we are on positive footing, we can make the most of the resources available to benefit both the economy and the companies we represent, but if on negative footing, we will certainly not be able to exploit this in a way that is advantageous for all,” said Gunawardena. |
