Macro Analysis /

Fitch downgrades Sri Lanka’s sovereign outlook to Negative, affirms B rating

    Asia Securities
    19 December 2019
    Published byAsia Securities

    Sri Lanka’s Sovereign rating was downgraded to Negative, but affirmed at ‘B’ by Fitch ratings yesterday. This was mainly on the back of rising risks to debt sustainability following the stimulus package announced by the government in November. Fitch further states that the move from a revenue based fiscal framework has created policy uncertainty amidst high external debt repayments in 2020. Fitch expects government expenditure to be curtailed in non-essential areas of public investments and recurring expenditure to mitigate some of the revenue loss arising from the stimulus package. 

    In-line with our expectations, Fitch projects government debt which is currently at about 85.0% of GDP to increase (we forecast this at 87.8% of GDP for 2020). 

    Broadly in-line with our estimates, Fitch states that the recent VAT reduction from 15.0% to 8.0% and removal of NBT alone with lower revenue by ~2.0% of GDP (we estimate total tax cuts to shave off ~3.2% of GDP amounting to LKR 560bn). Notably in 2018, revenue generated from VAT accounted for ~24.0% of government revenue.

    Fitch estimatesASEC estimates

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    Source: Fitch ratings, Asia Securities

    Furthermore, Fitch states that the following factors could lead to a further downgrade in ratings;

    • Failure to place government debt/GDP ratio on a downward path
    • Increase in external sovereign funding stresses that threaten the government’s ability to meet upcoming debt maturities, particularly due to loss of international investor confidence
    • A further deterioration in policy coherence and credibility leading to lower growth and macroeconomic stability

    Factors that could lead to an upward revision are;

    • Stronger public finances, underpinned by a credible medium-term fiscal strategy that places gross general government debt/GDP on a downward path, accompanied by higher government revenue
    • Improvement in external finances, supported by lower net external debt or a reduction in refinancing risk
    • Improved macroeconomic policy coherence and credibility

    While we expect an upward revision by the rating agency if the government implements a corrective medium-term fiscal framework, we don’t expect an upward re-rating in the near term. However, we believe that there is a higher probability of an upward rating in the medium term following parliamentary elections and further clarity on policy direction. At this point, we do not expect a further downward rating by Fitch in the near term.