Greater clarity over economic policy matters more for the credit than the party composition of Sri Lanka’s next government, Fitch Ratings said in a statement issued last week. Noting that improved economic policy credibility and coherence would strengthen Sri Lanka’s resilience to growing investor uncertainty towards emerging Asia, Fitch said that the establishment of a new government with a clear electoral mandate following parliamentary elections, should mitigate some political uncertainty, though the direction of economic policy and the stability of the likely coalition remain unclear.

”The broadly peaceful election campaign, which follows the orderly transition of the presidency in January 2015, will further reinforce the perceptions of Sri Lanka as a functioning democracy with relatively strong institutional capacity – in line with its ‘BB-’ rating,” the statement said.

”The new administration inaugurated in January under President Maithripala Sirisena has made some progress in addressing perceived governance shortcomings, in particular by adopting a constitutional amendment limiting presidential powers and launching anti-corruption investigations. However, there has been no corresponding strengthening in economic management. A populist budget was introduced in February that raised public sector wages and reduced publicly administered prices.

The government has also disclosed that the 2014 budget deficit was around 1pp higher than previously thought, owing to revenue shortfalls. This indicates that fiscal consolidation has stalled. Sri Lanka has the fourth-highest share of government debt – 72% of GDP – of any country in the ‘BB’ range, after Portugal, Hungary and Croatia.”

Fitch said that monetary policy has also been accommodative, allowing credit growth to accelerate sharply to 17.6% yoy in May 2015, from almost 0% in 3Q14. This has fuelled a 45% yoy rise in consumer goods imports in the first five months of the year at a time when exports were unchanged owing to stagnant agriculture and textiles. A rise in tourism receipts and remittances has acted as a buffer, although the trade deficit widened to USD3.4bn in May, up from USD3.1bn in May 2014.

The current account deficit had narrowed to 2.7% of GDP in 2014 from 7.8% in 2011, but should widen back to 3.0% this year.  Head of Asia-Pacific Sovereign Ratings at Fitch Ratings, Andrew Colquhoun, says that alienating China was not a good idea since the country needed investment to bridge a ‘yawning’ gap in its external finances.

In a recent interview with Bloomberg, a top financial news portal said that the weak economic policy resulted in pressure on foreign reserves and the currency. “Sri Lanka needs foreign investment to plug that gap to meet the deficiency in its domestic savings, so alienating one of its biggest investors (China) is not a credit constructive thing to do,” he told Bloomberg.

“Our concern is the persistent current account deficit, the buildup in external debt, as in short term external debt,” he added.
He added that even though the change in Government in January proved positive in terms of governance and corruption, Sri Lanka continued to have weak policy. “One of Sri Lanka’s weaknesses for some time has been an overly growth biased approach policy making and in February the new government introduced a populist budget. Monetary policy has been easy, credit growth has accelerated, and the pressures are showing on the external finances,” Colquhoun added.