Leading provider of credit ratings, research, and risk analysis, Moody’s Investors Service last week sounded a note of caution stating that the market volatility arising from Brexit is likely to affect Sri Lanka as the country has significant debt repayments due in 2016.
Releasing one of a series of reports on the impact of Brexit on sovereigns in different regions, the agency’s report however noted that it did not expect the UK’s vote to leave the European Union to have a significant direct credit impact on Asia Pacific sovereigns.
“Out of those Asia Pacific countries that have large current account deficits, Mongolia (B2 negative) relies in part on private sector financing flows. Mongolia and to a lesser extent Sri Lanka (B1 negative) have significant debt repayments due in 2016. In the event that it led to severe and prolonged market volatility, Brexit could heighten balance of payment pressures for these sovereigns,” the agency said.

According to Moody’s, although lower GDP growth in the UK will dampen demand for products from the rest of the world, Asia Pacific’s direct trade linkages with the country are generally limited. However, in the months to follow, announcements related to Brexit could trigger market volatility.

“While not our baseline expectation, a shift in portfolio and/or banking flows that resulted in tighter financing conditions in some Asia Pacific markets would hurt growth, especially in countries where fiscal and monetary policy space is constrained,” the agency pointed out.
It noted that since both Mongolia and Sri Lanka had limited policy space to offset potentially lower external flows, the elevated government debt would constrain fiscal policy room to offset potentially lower growth.

“Sri Lanka is also dependent on portfolio inflows to refinance its external debt, albeit to a lesser extent than Mongolia. Funding from the International Monetary Fund (IMF) under an Extended Fund Facility (EFF) and other international lenders, combined with FDI inflows, will relieve pressure on foreign exchange reserves. However, they will not fully cover Sri Lanka’s external financing requirements in the next few years,” the agency highlighted.
It noted that in Sri Lanka, government debt increased to 76.0% of GDP in 2015, significantly higher than similarly rated sovereigns. Under the IMF’s Extended Fund Facility, the government aims to reduce the budget deficit significantly, in particular through higher revenue collection.

“Tighter financing conditions that hamper GDP growth would make the fiscal consolidation goals more challenging. Weakening fiscal metrics, which could lead to renewed balance of payment pressure, were one of the drivers of our change in the outlook on Sri Lanka’s B1 rating to negative from stable in June 2016,” the agency further outlined.