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April 28 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Sri Lanka’s Long-Term Foreign and Local Currency IDRs at ‘BB-'. The issue ratings on Sri Lanka’s senior unsecured foreign and local currency bonds are also affirmed at ‘BB-'. The Outlooks on the Long-Term IDRs are Stable. The Country Ceiling is affirmed at ‘BB-’ and the Short-Term Foreign Currency IDR at ‘B’.
Sri Lanka’s ‘BB-’ IDRs reflect the following key rating drivers:
- Real GDP growth is relatively high and less volatile compared with its peers. The five-year average of 6.7% compares well with the 3.6% median for peers in the ‘BB’ rating category (sovereigns rated ‘BB-', ‘BB’ and ‘BB+'). Fitch expects real GDP growth to stabilise in 2014 at the recorded 7.3% in 2013 and to rise to 7.5% in 2015. A pick-up in tourism will continue to support growth.
- Official data do not point to overheating of the economy, as inflation (4.2% in March) and credit growth (4.4% in February) are low. However, average inflation over the past five years has been high (6.2%) and volatile compared with peers (5.0% median for the ‘BB’ peer group) and the potential for a build-up of future imbalances exists. The authorities’ pro-growth bias is illustrated by persistent “twin deficits” and easing monetary policy measures since December 2012, even at high real GDP growth levels.
- The public finances are weak relative to peers despite fiscal consolidation. Both the budget balance (-5.9% of GDP in 2013) and government debt burden (78.3% of GDP in 2013) are more than double the ‘BB’ category medians of -2.7% and 35.9% of GDP, respectively. The 2014 budget signals commitment to medium-term debt reduction to maintain a gradual fiscal consolidation path, although the process is slow and to a large extent built on revenue projections that may turn out too optimistic.
- The current account deficit has fallen from 6.7% of GDP in 2012 to 3.9% in 2013 and is expected by Fitch to narrow further to 3.2% by 2015 due to solid income from tourism and remittances. Nonetheless, the current account deficit remains persistent and is only for a relatively small part financed by FDI inflows, which are relatively low. Hence, net external debt (45.1% of GDP in 2013) is almost triple the ‘BB’ peer category median of 15.9% of GDP. External liquidity is weak, as illustrated by a low liquidity ratio (84.4%) and lower foreign exchange reserves (3.6 months of current external receipts) compared with ‘BB’ peer group medians (139.5% and 4.3 months respectively).
- Quantitative easing (QE) by the U.S. Federal Reserve has so far not led to severe market pressures for Sri Lanka. The country benefitted less than many other emerging markets from the QE-related search for yield given its relatively closed capital account. The government has been able to secure some US dollar financing through issuance on the bond markets twice in 2014.
- The level of basic human development, including education, health and literacy, is relatively high, as indicated by a favourable UN Human Development Index score (Sri Lanka ranks 92 out of 187 countries, better positioned than all other South Asian and most Southeast Asian countries).
- Banks’ performance is supported by high real GDP growth and monetary easing, but the non-performing loan ratio (NPL ratio) for the banking system was relatively high at 5.6% in 2013, and it may rise further to more than 6% in 2014. However, the banking sector is not very large relative to the economy, with the credit to GDP ratio at only around 40% at end-2013. Rapid credit growth in the past elevated Sri Lanka into the highest ‘3’ category of Fitch’s Macro-Prudential Indicator.
A Stable Outlook reflects Fitch’s assessment that upside and downside risks to the rating are well balanced.
The main factors that individually, or collectively, could trigger negative rating action are:
- Economic overheating, which could be illustrated by a surge in inflation, pressure on the rupee and widening of the trade deficit.
- Failure to achieve a reduction in government budget deficits from currently high levels.
- Intensification in external financing risks, particularly a renewed widening in the current account deficit combined with a fall in capital inflows, or a decline in foreign exchange reserves.
The main factors that individually, or collectively, could trigger positive rating action are:
- A prolonged period of real GDP growth that is consistent with moderate and stable inflation and external equilibrium.
- A material improvement in Sri Lanka’s public finances that would be underpinned by a credible fiscal consolidation strategy that includes a reversal of the consistent negative trend in the government revenue-to-GDP ratio and leads to a large decline in the general government debt-to-GDP ratio.
- Significant improvement in external finances, with sustained smaller current account deficits, higher levels of non-debt capital inflows (foreign direct investment) and a lift in foreign exchange reserves.
- Sri Lanka’s political landscape remains broadly stable and there is no renewal in the civil conflict that previously lasted 26 years and ended in 2009.
- No sustained rise in commodity prices, particularly in crude oil, in line with Fitch’s Global Economic Outlook.