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Fitch Ratings last week said that it expects rising domestic interest rates to hurt Sri Lankan corporates over the next 12 months.

In a statement, the rating agency said that borrowing costs of corporates have increased more than 200bp in the 12 months to March 2017 as the Central Bank increased policy rates by 125bp and the statutory reserve ratio by 150bp in an attempt to reign in aggressive credit growth.

“Fitch does not expect the pressure on interest rates to ease in the near term owing to rising inflationary pressures and weak external finances,” the report said.
Annual inflation as measured by the Colombo consumer price index rose to 8.4 percent in April 2017 from 4.3 percent a year ago.

“Corporates with high short-term working capital requirements such as retail and manufacturing companies are hurt the most by the recent rate increases.”

According to Fitch, two prominant consumer-durable retailers, are the most affected of the entities they rate as most of their borrowings consist of short-term working capital financing and will have to be rolled over at higher rates. Furthermore, both companies realize 30 to 40 percent of their sales through hire-purchase schemes which can meaningfully weaken with rising interest rates and slow EBITDA growth.

The interest coverage (EBITDA/gross interest expense) of corporates that Fitch rates deteriorated to 6.9x on average in the 12 months ended March 2017 from 9.2x a year ago because of the rising rates and higher debt.

“Debt increased mostly on account of investments in new capacity in sectors such as retail and manufacturing, which may take longer to translate into meaningful cash flows.”
Fitch estimates interest coverage may fall to 5.2x by the end of the current financial year if interest rates were to rise by 100bp.

“If interest rates were to rise by 200bp, coverage would weaken further to 4.8x. These estimates are based on our expectations that Fitch-rated corporates’ EBITDA will grow by around 1% on average over this period, and debt will increase by 6%,”

“We have assumed that 100% of corporates’ short-term debt and 40% of long-term debt will be re-priced at higher rates immediately. Most of the long-term debt stems from banks and around half of such debt are at a variable interest rate,” the ratings agency said.

As of end-March 2017, almost 50 percent of the outstanding borrowings of Fitch-rated corporates consisted of short-term borrowings primarily funding working capital, exposing the companies to modest interest-rate risk at the point of refinancing. Only 12 percent of the outstanding borrowings of Fitch-rated corporates consisted of debenture financing, which is predominantly on fixed rates.