Moody’s say IMF funds to Sri Lanka is ‘credit positive’
Rating agency Moody’s has described the recent IMF’s release of $ 427 million under its Stand By Arrangement (SBA) program worth $ 2.6 billion to Sri Lanka as ‘credit positive.’
“The disbursement is credit positive because it will help restore investor confidence and shore up foreign exchange reserves, which had been drained owing largely to an ineffective exchange rate policy in the second half of 2011,” Moody’s said.
Sri Lanka is rated B1 positive by Moody’s whilst the IMF loan program had been on hold since August 2011.
Moody’s said the reactivated IMF support program is also a tacit endorsement of Sri Lanka’s policy initiatives since February 2012, which were taken to stem currency and foreign exchange reserve losses, and which we also think will be effective.
Foreign exchange reserves diminished to a low of $5.8 billion in January from an all-time high of $8.1 billion in July 2011 (see exhibit). January foreign exchange reserves were insufficient to fully cover external debt payments due throughout this year should external lending to Sri Lanka stop suddenly ($7.8 billion of reserves would be required for such a severe stress scenario).
The July 2011 high was buoyed by a first-quarter balance of payments surplus and a successful global bond issuance. But a strong rebound in domestic demand, fuelled by private sector credit growth of 34.5% in 2011, coupled with an upswing in Sri Lanka’s oil import bill, pushed the trade deficit to $5.8 billion in the second half of 2011, a 140% increase over second-half 2010. As the central bank intervened by buying Sri Lanka rupees to stem downward pressure on the currency, reserves dropped by nearly $1 billion from August to September, and then by a further $900 million by November 2011.
Key corrective measures enacted by the authorities two months ago should stem foreign exchange reserve losses. In early February, regulators allowed the rupee to float, resulting in an immediate 5% depreciation against the dollar. This followed a 3% depreciation of the exchange rate in late November 2011. Policy rates were tightened and banks were directed to limit credit growth. The Government raised domestic petroleum and electricity prices to pass the cost of higher international energy prices to consumers, which will both limit losses to the state energy corporations and rein in the oil import bill and the current account deficit. The IMF referenced these adjustments in its press release announcing the completion of the seventh review and disbursal of $427 million under a stand-by arrangement originally signed in July 2009.
Two tranches of the loan had been pending since late summer 2011 when the IMF released a statement critical of the Government’s foreign exchange interventions. The stand-by arrangement has now been extended to July 2012 to allow for the eighth and final review. For the last tranche of the loan to be released, Sri Lankan authorities will have to be prepared to adjust monetary and exchange rate policies if necessary, depending on global conditions. We believe the authorities will not relapse to the abandoned policy stance, as it proved unsustainable. On the other hand, the Government has established a track record for gradually reining in the budget deficit and so fiscal policy will not likely derail the IMF program
With supportive policy measures in place and the IMF disbursement, Sri Lanka’s foreign exchange reserves have stabilised and recovered a bit of lost ground, standing at $6.1 billion as of 4 April. Policy consistency and continued support from the IMF program will be critical for reducing vulnerability to external shocks brought about by Sri Lanka’s weakened foreign exchange position.
