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Sri Lanka’s Outlook Goes To Positive From Stable

Sep 21, 2010 10:56:20 AM - thesundayleader.lk

Fitch Ratings today (21) affirmed Sri Lanka’s long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘B+’, and simultaneously revised the Outlook to ‘Positive from Stable’.

Following is the full text published by Fitch on Sri Lanka:

Fitch Ratings has today affirmed Sri Lanka’s Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘B+’, and simultaneously revised the Outlook to Positive from Stable.

Fitch also has affirmed Sri Lanka’s Short-term IDR at ‘B’ and Country Ceiling at ‘B+’.

The Outlook revision is in large part a reflection of Sri Lanka’s economy benefitting from the end of a prolonged civil war in 2009, from a more disciplined policy framework put in place under the Stand-By Arrangement (SBA) with the IMF, and from an improved external liquidity position bolstered by the IMF programme. Fitch believes these developments support the prospects for Sri Lanka to achieve sustained medium-term growth, without a resurgence in inflation or another bout of external liquidity stress (as experienced over end-2008 to early 2009). Foreign exchange reserves stood at USD5.8bn at end- July 2010, well above the low of USD1.1bn in March 2009, bolstered by USD1.0bn of IMF funds.

Sri Lanka’s authorities have made headway in rebuilding and integrating the two war-torn Northern and Eastern provinces into the rest of the local economy, which is helping to boost Sri Lanka’s productive capacity, particularly in the agriculture and tourism sectors. This is highlighted by real GDP growing 8.5% yoy in Q210, from a 7.1% yoy rise in Q110. Fitch is forecasting real GDP growth to average 7.2% in 2010-2012, versus an average of 5.1% over the last 20 years.

The authorities look to be implementing a more prudent macroeconomic policy framework under the IMF SBA. The Central Bank of Sri Lanka (CBSL) appears to have shifted the focus of monetary policy towards fighting inflation and away from supporting growth. As evidence, the CBSL has maintained a positive real interest rate environment since February 2009 (versus an average of -12% in 2008). Fitch views the CBSL’s management of monetary policy as broadly appropriate, which along with more benign global energy and food prices, is helping to keep the inflation rate in the single-digit range (up 5.6% yoy in January-to-August 2010).

Sri Lanka’s authorities also appear more ready to tackle the sovereign’s biggest ratings constraint – weak public finances. The budget deficit of 9.9% of GDP in 2009 and public debt of 86.2% of GDP were both well above the medians for the ‘B’ rating peer group of 4.9% and 37.3%, respectively. Similarly, the government revenue-to-GDP ratio stood at just 15% in 2009, which is well below the ‘B’ rating peer group median of 28.1%.

The Presidential Commission on Taxation is set to release its final recommendations in November 2010. New tax measures will be crucial in determining if the authorities can get the public finances on a more sustainable path. Equally vital, the end of the civil war should provide the authorities much needed flexibility in cutting spending on defence and resettling refugees.

Maintained policy discipline would support the case for a ratings upgrade. If the Sri Lankan authorities can sustainably boost the tax revenue base and restrain spending to consolidate the budget deficit, this would help lower the country’s overall public debt burden and directly address a key rating weakness.

Similarly, a sustained period of stronger GDP growth that does not see a return to accelerating inflation or a sharp deterioration in the current account deficit would also support Sri Lanka’s ratings. Fitch would also view a pick-up in foreign direct investment as a positive development as this could help bolster the country’s external finances and also improve the overall competitiveness of the economy.

More specifically, this could help stem concern over Sri Lanka’s export sector following the loss of reduced tariff rates via the GSP Plus facility to the European Union in mid-August 2010.

On the other hand, the agency would negatively view an erosion of macroeconomic policy discipline as an acceleration of inflation would undermine Sri Lanka’s export competitiveness and result in a sharp rise in domestic borrowing costs for the fiscal authorities and raise overall interest payments. These already stood at 43% of government revenues in 2009, which is well above the ‘B’ rating peer group median of 5.7%.