Fitch labels Lanka a ‘highest-risk financial system’

In a major indictment on the country’s macro stability and a wakeup call to policy makers, Fitch Ratings yesterday warned that Sri Lanka has now become one of the four highest-risk financial systems in Asia Pacific and nine in the world.

The warning on and labelling of Sri Lanka comes ahead of Christmas and could dampen the spirits of the Central Bank and the Treasury, both overseen by President Mahinda Rajapaksa, who is also the Finance Minister.

“While many advanced economies ‘de-lever,’ the speed of credit growth and rising asset prices has led to Asia-Pacific harbouring four of the world’s nine highest-risk financial systems, according to Fitch’s macro-prudential risk framework. Hong Kong and China were joined by Indonesia and Sri Lanka in the December 2011 assessment, although Vietnam dropped out as credit growth eased,” Fitch said yesterday in a special report on the Asia Pacific’s Sovereign Outlook.

The inclusion of Sri Lanka as among the latest category of highest risk financial system was as part of Fitch’s concern over emerging bank credit worries.

The rating agency’s apparent indictment comes few days after Central Bank gave the thumbs up on the country’s economy and financial system stability following the December Monetary Policy Review after which policy rates were kept unchanged for the 11th consecutive month.

The Central Bank in its post monetary policy review meeting statement said with respect to monetary developments, broad money (M2b) growth was seen moderating in October 2011 to 19.8%, along with a deceleration in the growth of credit obtained by the private sector.

“This trend is expected to continue in the months ahead as the increases in domestic market interest rates seen in recent weeks as well as the widely expected slowing down of the global economy are likely to have a dampening effect on credit growth and therefore monetary expansion,” it added.

However, the statement also noted that “in the global economy, sovereign debt related issues in several advanced economies have led to uncertainty in financial markets and volatility in international commodity prices’.

Fitch in its yesterday’s report said India and Sri Lanka were the only Fitch-rated emerging Asian countries to run deficits on “basic balance” (the current account plus net foreign direct investment). This structural weakness may help explain why the Indian rupee fell to a record low against the US dollar in December 2011, while Sri Lanka devalued its currency in November.

The report also said Fitch upgraded Sri Lanka’s Long-Term Foreign-Currency IDR to ‘BB−’ with a Stable Outlook from ‘B+’/Positive in July 2011, reflecting the stabilisation and recovery of the economy under the authorities’ IMF programme and efforts to consolidate the chronic budget deficit.

“However, Foreign Direct Investment has been surprisingly slow to recover after the end of the country’s long civil war in 2009, and the authorities devalued the Sri Lankan rupee by 3% in November 2011. Structural reforms to support longer-term growth prospects combined with further fiscal consolidation efforts would increase Sri Lanka’s chances of moving further up the ratings scale,” assured Fitch.

It appears that Fitch hadn’t factored in some recent Government pronouncements including by President Mahinda Rajapaksa on Wednesday during the winding up debate on 2012 Budget, that FDIs in 2011 had exceeded $ 1 billion for the first time in history.

Analysts expect a Central Bank rebuttal of or a response to Fitch’s categorisation of Sri Lanka among highest-risk financial systems next week after the Christmas holidays.

In the statement post-December monetary policy review, the Central Bank said that due to global issues and volatile oil prices as well as import demand associated with the robust expansion of domestic economic activity, the deficit in the trade balance of the balance of payments was seen widening over 2011. Nevertheless, the following circumstances are expected to help cushion the balance of payments in 2011:

(a) Continued increases in inflows to the services account, particularly with respect to tourism;

(b) Higher inward remittances;

 (c) Inflows to the financial account including long-term debt obtained by the government in relation to development projects;

 (d) Foreign direct investment, which is estimated to have exceeded the targeted level of US$ 1 b in 2011;

 (e) Inflows to commercial banks which would help strengthen their capital base, and

(f) Inflows on account of short-term financing obtained by commercial banks. Going forward, banks are also likely to secure more funds from abroad as Tier II capital of banks could potentially increase by a further US$ 1 billion.

With regard to overall assessment on sovereign credit outlook, Fitch said the positive rating trends for emerging Asian countries strengthened in H211, supported by strong or improving public and external finances and relatively strong medium-term growth prospects for most countries. These factors supported Fitch Ratings’ revision of the Outlook on Korea’s ‘A+’ rating to Positive on 7 November, and its upgrade of Indonesia to ‘BBB−’ on 15 December.

High-income Asian diversity: High-income Asia has more mixed credit trends. Australia joined Singapore among the ranks of ‘AAA’ sovereigns on 28 November 2011, while long-standing concerns about external indebtedness caused New Zealand to be downgraded to ‘AA’/Stable from ’AA+’/Negative on 29 September.

Fitch affirmed Hong Kong at ’AA+’/Stable, while Japan’s ‘AA’ Foreign-Currency and ‘AA−’ Local-Currency IDRs remain on Negative Outlook due to the agency’s concerns about medium-term government debt dynamics.