Global coronavirus outbreak exacerbates Sri Lanka’s liquidity & external risks: Moody’s

Apr 29, 2020 (LBO) – Sri Lanka (B2 review for downgrade) is facing simultaneous domestic and external shocks amid the global coronavirus outbreak, Moody’s Investors Service said in an issuer in-depth analysis.

According to the analysis, capital outflows, marked local currency depreciation, wider risk premia and a further decline in real GDP growth will raise Sri Lanka's debt burden, liquidity constraints and the cost of external debt servicing.

This comes at a time when Sri Lanka’s credit profile is highly vulnerable given low reserve coverage of large forthcoming external debt service payments and very weak debt affordability.

Key points in the report

Acute tightening in global financing conditions compounds weaker near-term growth, fragile fiscal and external positions: Higher financing costs, wider deficits and a steeper trajectory for Sri Lanka's debt burden will weaken the government's already fragile fiscal position. The government has sought multilateral and bilateral external financing which will help to cover imminent repayments. However, the government’s external debt service payments amount to around $4 billion annually over 2020-25, on top of wider budget deficits, which will be partially funded externally. We expect that the government will increasingly tap domestic financing sources; however, refinancing external debt domestically would further weaken the rupee and already thin foreign exchange reserve adequacy. We expect the fiscal deficit to increase to over 8% of GDP over the coming years, on weaker government revenue and greater spending. Given wider fiscal deficits, we expect Sri Lanka's debt burden to rise to nearly 100% of GDP, weakening Sri Lanka's already fragile fiscal position.

Limited policy flexibility and effectiveness accentuate risks, while dimming prospects for addressing macroeconomic imbalances: Amid the currently turbulent environment, we expect that Sri Lanka will face difficulties in managing the country's twin deficits. An elevated debt burden and rigid budget structure constrain fiscal policy space. Meanwhile, a trade-off between anchoring inflation expectations and supporting growth, and a potential rise in borrowing costs, will constrain monetary policy effectiveness.
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The lack of an effective and credible policy response to arrest a more severe and prolonged deterioration in credit metrics would further dim prospects for reforms that would meaningfully strengthen Sri Lanka’s fiscal and external positions. The delay in general elections could add to this challenge.

Full report