The sovereign team of the renowned credit rating, research and risk analysis agency, Moody’s Investors Service last week predicted that a potential financing from the IMF can lead to an agreement to widen the small tax base and revisiting the government’s expenditure commitments. In a Credit Outlook report titled “Sri Lanka’s credit-negative external pressures drive requests for multilateral financing”, the ageny however said that such an agreement will likely restore investor confidence in Sri Lanka’s policy framework, and ultimately supporting more stable external inflows.
“Over the next three years, potential financing from the IMF can lead to an agreement to implement fiscal consolidation. Although this will lower Sri Lanka’s high fiscal deficits and debt, it will likely require a widening of the small tax base and revisiting the government’s expenditure commitments. Moreover, such an agreement will likely restore investor confidence in Sri Lanka’s policy framework, and ultimately support more stable external inflows,” Moody’s noted.
According to Moody’s estimates, Sri Lanka ramped up its external debt burden to about 57% of GDP in 2015 from 49% in 2010, when credit conditions were more favourable, and is now left with high repayments. However, global financing conditions have tightened, with higher risk aversion diminishing capital flows to emerging markets.
Meanwhile, commenting on the recent rate hike by the Central Bank to offset some of the risks posed by lower external inflows and higher domestic credit growth, the agency said that the higher rates will likely dampen economic growth.
“The policy rate increases will also raise domestic debt-servicing costs for the government, which are already high. The interest rate on one-year treasury bills was 8% in January 2016, up from less than 6% in December 2014. In addition, with foreign currency debt making up about 40% of total government debt, further depreciation of the rupee will raise external debt costs. Interest expenditures accounted for 32.3% of government revenues in 2015, one of the highest among B-rated sovereigns. A rise in bond yields or depreciation of the rupee will worsen this ratio,” the agency further cautioned.
The report however noted that an agreement with the IMF and financing from the ADB will provide some liquidity and thereby ease immediate financing pressures. At the same time, the financing will likely be at more favorable terms than market borrowing, alleviating debt servicing cost pressures to some extent.