IMF deal holds the key to Sri Lanka’s improving prospects
The borrower will not challenge Indian safety for the foreseeable future, but faith in the emerging market (EM) is justified by its improving risk score.
Sri Lankans are holding their heads above water, but their position is precarious
On 44.7 points from a maximum 100 in Euromoney’s survey, Sri Lanka’s country risk score has improved since the second quarter, resulting in a two place rise in the global rankings to 75th.
Such news will be received warmly by investors snapping up the country’s sovereign bond offerings lately on the back of increased interest in EMs and a new three-year financing arrangement agreed with the IMF.
The economy has been growing reasonably briskly, with GDP registering a 4.8% real-terms rise in 2015, and year-on-year inflation is low, slowing to 5.5% in July from a peak of 6% in June.
Political risks are largely subdued. The next election is not until 2020, and the main two political parties are committed to a coalition government until then, boosting the government stability score – one of 15 risk indicators experts value as part of the country risk profile.
This will allow the passage of reforms in parliament, as the government will continue to have a two-thirds majority.
Standard Chartered Bank economist Samantha Amerasinghe says: “Sri Lanka’s country risk score has improved largely because it has been pushing through these domestic reforms, even though external risks remain high.”
The appointment of prominent economist Indrajit Coomaraswamy as the governor of the central bank in July is another key positive, believes Eshini Ekanayake, an economist at JB Securities in Colombo.
“While it might still be a little too early to tell whether the governor is able to create a platform of macroeconomic and institutional stability in the years to come, he has been able to already restore some sense of credibility and independence since his appointment,” she says.
The central bank increased its policy interest rate for the second time this year by 50 basis points in July to quell potential inflation pressure.
“This policy move is suggestive of a more forward-looking monetary policy stance in the country, which has been lacking in the last decade,” Ekanayake believes.
These positive reactions must be tempered with a dose of reality.
Sri Lanka’s risk score had been broadly flat-lining for three years, and the borrower is still mired in the fourth of five tiers – one below India – consistent with a B- to BB+ credit rating.
Fitch, Moody’s and Standard & Poor’s rate Sri Lanka a B+/B1 credit; compare that to tier-three India, 18 places higher in Euromoney’s survey, rated investment grade.
The fiscal situation is the main short-term risk.
The government finances are broadly consistent with the IMF’s targets, but there has been a setback in the tax changes, including the rise in value-added tax (VAT) from 11% to 15% required to improve government revenue.
“A petition was filed by an opposition lawmaker challenging the administrative notice as unconstitutional, despite this being the practice since VAT was implemented in 2002, and the three-bench panel of judges agreed with the petitioner,” says JB Securities’ Ekanayake.
That makes it unclear if the tax changes will be implemented this year, or in the 2017 budget bill to be unveiled in November.
The confusion might harm business confidence, and it means Sri Lanka might not meet its fiscal target, narrowing the deficit from 6.9% of GDP last year to 5.4% in 2016.
The government has increased diesel tax to make up some of the shortfall, but might also cut back on public investment, which would impair GDP growth.
Foreign-exchange reserves are also low, at $6 billion, covering less than four months of imports.
“The unfavourable Brexit outcome could also potentially limit government debt-raising plans and poses further external risks,” says Standard Chartered’s Amerasinghe.
Therefore, while domestic reforms are gradually moving forward, the short-term external risks are still weighing on Sri Lanka’s slowly brightening outlook.
This article was originally published by ECR. To find out more, register for a free trial at Euromoney Country Risk.