Sri Lanka outlook on 'B1' rating cut to stable by Moody's

July 02, 2013 (LBO) - Moody's Investors Service has cut the outlook on Sri Lanka's 'B1' credit rating to 'stable' from 'positive' on rising bank foreign debt and continuing budget deficits and high state debt.

Moody's said foreign reserves have stabilized at 6.9 billion US dollars and the rupee was no longer being pegged tightly to the US dollar.

But foreign liabilities of banks have doubled to 3.4 billion US dollars by February 2012 from July 2011 which could "lead to pressure on the external payments position, if creditor sentiment deteriorates," Moody's said.

"The second driver behind the rating action is a slowdown in the pace of fiscal consolidation," Moody's said.

"While progress has been made in reducing both debt and deficits, much of this consolidation took place between 2009 and 2011, and since then, the pace of improvement has slowed," Moody's said.

"As a result, Sri Lanka's debt burden remains considerably higher than the 44% of GDP median in 2012 for Sri Lanka's B-Caa rating peers."

Budget deficits have fallen from 9.9 percent in 2009 to 6.4 percent in 2012 and national debt has fallen from 86 percent of GDP to 79 percent.

Related to the debt level was slowing economic growth. After growing 8.1 percent in 2010 and 2011, economic growth had since slowed.
"Looking ahead, the government projects highly favorable macroeconomic developments," the rating agency said.

"By 2015, it expects growth to accelerate to 8.3 percent, the current account deficit to diminish to 1.4 percent of GDP, and official foreign reserves to surpass $10 billion, in large part as a result of a substantial increase in foreign direct investment.

"However, Moody's also believes that internal policy challenges, and global economic headwinds and financial cross-currents will make achieving such targets challenging."

Moody's said a said a "sustainable rise in official foreign exchange reserves" and reduction of its external vulnerability indicator below 100 percent, higher growth and lower deficits would help upgrade the rating.

A shift away from debt financing to foreign direct invest would help the rating.

A worsening of political stability and reconciliation after the end of a civil war that would hurt investor confidence or worsening deficits would trigger a downgrade.

Update II

The full statement is reproduced below

Rating Action: Moody's changes outlook on Sri Lanka's sovereign rating to Stable

Singapore, July 02, 2013 -- Moody's Investors Service today changed the outlook on Sri Lanka's B1 foreign currency sovereign rating from positive to stable, and affirmed its B1 foreign currency government bond rating.

The action was prompted by:
1) The stabilization in the external payments position, following the sizable loss of foreign reserves in 2011, but without enough improvement to support a positive rating action at this time; and

2) The pause in the decline in the government's very high debt burden, as ongoing large deficits impede a reduction that would be credit positive.

RATINGS RATIONALE
The first driver underlying Moody's decision to affirm Sri Lanka's B1 rating and revise its outlook from positive to stable is a decline in the strength of the external payments position in the past two years. In defending the currency in the face of a sharply widening current account deficit, reserves fell from a high of $8.1 billion in July 2011 to a low of $5.5 billion in February 2012. In addition, the rapid rise in banks' net foreign liability position since July 2011 -- involving an almost doubling to $3.4 billion as of February 2013 -- could lead to pressure on the external payments position, if creditor sentiment deteriorates, or if the current account deficit widens.

Nevertheless, since late last year there has been a stabilization of the external payments position. The government has taken remedial measures, including abandoning the de facto currency peg to the dollar, tightening monetary policy, and raising tariffs on imports. These measures have reduced the current account deficit somewhat, and official foreign exchange reserves have stabilized, standing at $6.9 billion as of April 2013.

However, these reserves remain considerably below the peak achieved when the outlook was changed to positive in July 2011.

The second driver behind the rating action is a slowdown in the pace of fiscal consolidation. The fiscal deficit has narrowed from a peak of 9.9% of GDP in 2009 to 6.4% in 2012. The debt/GDP ratio has also been on a generally declining trajectory, falling from 86% of GDP in 2009, the year the civil war ended, to 78% of GDP in 2011, although it edged higher to 79% of GDP in 2012 due to currency depreciation.

While progress has been made in reducing both debt and deficits, much of this consolidation took place between 2009 and 2011, and since then, the pace of improvement has slowed. As a result, Sri Lanka's debt burden remains considerably higher than the 44% of GDP median in 2012 for Sri Lanka's B-Caa rating peers.

Related to the near stall in debt reduction is the slowdown in economic growth. Real GDP grew an average of 8.1% between 2010 and 2011. However, this rate did not prove to be sustainable and the policy framework allowed an over-heating of the economy in late 2011, as manifested in a sharp widening in the current account deficit and a rise in inflation. Through 2013 and 2014, Moody's expects growth will remain in the 6% to 7% range, and pose less of a risk in terms of possible overheating pressures.

Looking ahead, the government projects highly favorable macroeconomic developments. By 2015, it expects growth to accelerate to 8.3%, the current account deficit to diminish to 1.4% of GDP, and official foreign reserves to surpass $10 billion, in large part as a result of a substantial increase in foreign direct investment. However, Moody's also believes that internal policy challenges, and global economic headwinds and financial cross-currents will make achieving such targets challenging.

FUTURE RATING TRIGGERS

Upward pressure on the rating would come from:
• A strengthening of the external payments position, as reflected in a sustainable rise in official foreign exchange reserves and reduction in the external vulnerability indicator well below 100%. A shift away from external debt financing towards greater reliance on foreign direct investment (FDI) could be a key element of such improvement, or from

• The maintenance of relatively strong GDP growth -- coupled with a steady reduction in fiscal deficits -- to the extent that the government debt burden declines at a faster pace to narrow the wide divergence from its peers and, more importantly, to reduce the high government debt-service burden. On the other hand, triggers for a downward rating action would include:

• A reversal in progress on fiscal consolidation,

• A substantial worsening of the country's external balance and foreign currency liquidity position, or

• A reversal in post-war political stability and reconciliation, which would undermine investor confidence and both fiscal and economic performance.

GDP per capita (PPP basis, US$): 5,582 (2011 Actual) (also known as Per Capita Income) Real GDP growth (% change): 6.4% (2012 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 9.2% (2012 Actual)

Gen. Gov. Financial Balance/GDP: -6.4% (2012 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -6.6% (2012 Actual) (also known as External Balance)

External debt/GDP: 56.7% (2012 Actual)

Level of economic development: Low level of economic resilience

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 27 June 2013, a rating committee was called to discuss the rating of the Sri Lanka, Government of. The main points raised during the discussion were: The issuer's economic fundamentals, including its economic strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. External payments position has weakened over the past two years Other views raised included: The issuer's institutional strength/ framework, have not materially changed. The issuer has become less susceptible to event risks.
http://www.lankabusinessonline.com/news/sri-lanka-outlook-on-b1-rating-cut-to-stable-by-moodys/1881565586

I understood this early

Harsha on rating outlook downgrade and Treasury’s mid-year report:

UNP MP Dr. Harsha De Silva said the government’s smoke and mirror tricks were no longer effective after sovereign ratings agency Moody’s downgraded the country’s rating outlook from ‘Positive’ to ‘Stable’.

"It comes as no surprise that the international investor community is losing confidence in Sri Lanka.  To cut the outlook from ‘positive’ to ‘stable’ is a huge indictment on the government’s current economic management and the validity of the purported development story in the coming years.  The recent sell down of foreign held government paper seem only the beginning of an emerging crisis of confidence," UNP’s economic spokesman Dr. De Silva said. 

"Over the last couple of years we have been pointing to the fact that the economy would lose the artificial growth momentum and that the external payment position would weaken due to economic policy being dictated to be short term political objectives.  We have been very critical of the unsustainable external debt levels the government was getting in to and also the danger in pushing banks and other state enterprises to get in to high cost foreign borrowing.  We have also been pointing out that the incentive to maintain a competitive exchange rate would also be hampered if the volumes of external debt held by these entities become significant.  In this context the UNP has also stated our objections to any moves to shift the exchange risk of the proposed Eurobonds by the National Savings Bank, NDB Bank and DFCC Bank to the tax payers.  It now seems that others are in agreement.   

"With this ratings cut something else that is clear is that however much the Central Bank is attempting to spin a make-believe positive story on the post war economic performance of the country, even going to the unprecedented extent of hiring public relations agencies at enormous costs, the rating agencies and the investor community has and will continue to see through the smoke and mirrors," Dr. De Silva said.

He also commented on the Treasury’s Tuesday release of the Mid Year Fiscal Position Report 2013.

"The government has finally succumbed after dodging our continuous questions on why the Finance Ministry was hiding estimated versus actual data on revenue and expenditure in violation of the legal requirement in the Fiscal Management (Responsibility) Act for almost three years.   This marks the first time since assuming office in 2004 this government has provided information to the public on how its finances are performing in relation to the estimates provided in the budget.    

"That there is a 20 percent reduction in the already low tax revenue from the estimate for the first four months of the year puts in perspective the stories floated by all and sundry in the government that there is almost miraculous development taking place across the country.

The reduction of the thus far asymmetrical fiscal information will certainly help the public make better informed decisions.  After all, increasing public awareness of the government’s fiscal policy was a key objective of the FMRA when it was introduced by the then UNP government," Dr. De Silva said.
http://www.island.lk/index.php?page_cat=article-details&page=article-details&code_title=82697

As usual Kabba counterattack against Moodys as well.  

Moody’s change is a contradiction of its own assessment: CB


The Central Bank of Sri Lanka (CBSL) in a statement yesterday, expressed the view that the latest move by Moody’s of changing the outlook on Sri Lanka’s B1 foreign currency sovereign rating from ‘Positive’ to ‘Stable’, is ill-advised and backward looking, and is not a proper reflection of the external position and the recent improvements in the Sri Lanka economy.
The underlying rationale for the latest rating stance is described by Moody’s as (a) inadequate improvement in the external payment position in the past two years, and (b) slowdown in the pace of fiscal consolidation process. In terms of the external payment position, Moody’s asserts that the official international reserves remain ‘below the peak’ level achieved when the outlook was changed to ‘Positive’ in July 2011; while also claiming that the net liability position of commercial banks doubled during July 2011 and February 2013.
However, this assertion disregards several obvious factors that an impartial analysis would have clearly revealed a strong consolidation of international reserves in terms of standard reserve adequacy measures has taken place since June 2012, when Moody’s reaffirmed Sri Lanka’s outlook as ‘Positive’. The import cover of official reserves and total reserves (including commercial bank assets) in July 2012 stood at 4.2 months and 5.2 months respectively; while in May 2013, these figures have risen to 4.3 months and 5.4 months, respectively. Further, the reserve cover for short-term liabilities has improved steadily during the last year.
In the recent past, several commercial banks have raised funds via foreign capital markets, and such funds have been broadly medium to long-term. Hence, there would not be any new additional pressure on Sri Lanka’s external payment position. Accordingly, the claim that a substantial increase in net foreign liabilities of commercial banks has occurred does not recognise the maturity profile of such liabilities.
Sri Lanka’s external sector has performed satisfactorily in the first four months of 2013, with earnings from tourism continuing to grow with increasing recognition of Sri Lanka as an attractive tourist destination; workers’ remittances continuing to rise, supported by the diversification of migrant destinations and further expansion of formal channels for remitting money; foreign investment at the Colombo Stock Exchange (CSE) continuing to grow, with increased activity at the CSE, indicating a gradual build-up of investor confidence. At the same time, inflows in terms foreign direct investments are poised to record a historically high level of $1.8 billion, in 2013, with major projects that are already in the pipeline. Substantial inflows have also been recorded in the government securities market on a cumulative basis. In addition, there has also been a marked contraction in the trade deficit during the first four months of the year.
With regard to Moody’s assertion that there is a slower pace of fiscal consolidation, it needs to be highlighted that the Government has given a strong commitment to continue the fiscal consolidation process, by reducing the budget deficit each year since 2009. The budget deficit declined from 9.9% in 2009 to 6.4% in 2012 and is expected to decline further to 5.8% of GDP in 2013. The Debt to GDP ratio has also gradually declined, even though it marginally increased to 79.1% of GDP in 2012 from 78.5% in 2012 owing to currency depreciation. Further, the financial conditions of major state-owned enterprises have improved, mainly due to market-based price adjustments being made to consolidate the fiscal position further. These developments show that Sri Lanka is on a clear path of fiscal consolidation and hence, the Moody’s statement that there is a “slowdown in the pace of fiscal consolidation”, is not justifiable.
Overall, it must be noted that the CBSL and the Government have acted constructively to address the concerns that Moody’s have raised during the course of pre-announcement discussions, which are summarised below:
Concerns Raised    Current Status
Possible re-emergence of inflationary pressures    Current status indicate that concerns related to inflation have been substantially addressed since Sri Lanka has enjoyed single digit inflation over the past 53 months
Poor performance of state-owned enterprises    Current indications are that these vulnerabilities have now eased considerably
Low revenue to GDP ratio     Notwithstanding low revenue in the short term, the government has given a strong commitment by reducing its budget deficit each year
Persistent risks in debt dynamics     Current developments show that Sri Lanka is now on a clear path of fiscal consolidation
BOP pressure could re-emerge with the deterioration in the current account deficit     The current account deficit has reduced, and further improvements are expected
Reserves are lower than expected    Foreign reserves have strengthened to a comfortable level
External vulnerability risks have not significantly reduced    External vulnerability indicators have improved considerably
In June 2012, Moody’s indicated that the conditions that could change the rating upwards would be an improvement in the Government’s fiscal management and debt position, lower and less volatile inflation, and sustainable improvements in foreign currency reserve adequacy, supported by a flexible exchange rate policy and foreign direct investment inflow. Moody’s also indicated that the conditions that could change the rating downward would be a failure to progress on fiscal consolidation, loss of inflation control, a substantial worsening of the country’s external balance and foreign currency liquidity position, or a reversal of recently achieved political stability which could adversely impact resident and foreign investor confidence.
Accordingly, it would be seen that the Sri Lankan authorities have taken constructive policy measures that would warrant an upward revision of the rating as indicated by the Moody’s in June 2012 instead of a lowering of the outlook. Therefore, Moody’s change of Sri Lanka’s rating outlook from “Positive” to “Stable” is a contradiction of its own assessment in June 2012.

http://www.ft.lk/2013/07/03/moodys-change-is-a-contradiction-of-its-own-assessment-cb/

CB strategy seems to be attack is the best from of defense.

However Moody's has more credibility with lenders than the CB

Moody's under fire from Sri Lanka Central Bank
Sri Lanka’s Monetary Authority says Moody’s change of the Island’s Sovereign Rating Outlook from ‘Positive’ to ‘Stable’ is a contradiction of its own assessment.

The Central Bank in a release issued says the latest move by Moody’s is ill-advised and backward looking, and is not a proper reflection of the external position and the recent improvements in the Sri Lanka economy.

The Bank’s response comes as the Moody’s announced that it has changed the outlook on Sri Lanka’s B1 foreign currency sovereign rating from ‘Positive’ to ‘Stable’.
http://www.news360.lk/economy/news-03-07-2013-central-bank-says-moody%E2%80%99s-change-of-sri-lanka-rating-is-a-contradiction-of-its-own-assessment-788909

http://www.cbsl.gov.lk/pics_n_docs/latest_news/press_20130702ec.pdf