Sri Lanka secures its first sovereign rating: BB-

Standing left to right – Mr. Dinesh Jebamani (Chief Manager Liability Product Management and New Age Media – Seylan Bank), Mr.Sudesh Peiris (Senior Manager – Digital Banking Channels – Seylan Bank), Ms. S.Senevirathne (Representative of the Revenue Department – Western Province), Mr. Tilan Wijeyesekera (Deputy General Manager – Retail Banking – Seylan Bank) and Mr. Malik Wickremanayaka (Deputy General Manager – Operations – Seylan Bank)

Sri Lanka on Thursday secured its first sovereign rating of BB- from Fitch Ratings International but the rating agency warned that ‘peace and politics’ will hold the key to the island future. Sri Lanka on Thursday secured its first sovereign rating of BB- from Fitch Ratings International but the rating agency warned that ‘peace and politics’ will hold the key to the island future. The BB- rating comes with a stable outlook, which is based on Sri Lanka’s fragile security situation and weak public finances.

“Peace and politics hold the key to Sri Lanka’s future,” said Paul Rawkins Senior Director in Fitch’s Sovereign team in a statement.

Sri Lanka’s near four-year ceasefire agreement with the Tamil Tiger rebels has produced tangible benefits in the shape of an improved economic and business climate.

The statement comes in the backdrop of escalating violence in the northeast that has killed 29 and raised fears that the country could slip back into war.

Were the violence to become more widespread, however, Fitch warns that the adverse impact on the economic and business environment would bring downward pressure on Sri Lanka’s ratings.

“But the absence of an enduring peace continues to hang over the country, intruding into the everyday business of government and the longer-term commitment to economic reform.”

The agency said weak coalition governments and concerns about the sustainability of public debt, has weighed down Sri Lanka’s US$ 20 billion economy, which derives its revenues from foreign remittances and selling garments and tea.

“Weak coalition governments…have impeded fiscal consolidation and the absence of an enduring solution to a long-running civil conflict in the Tamil-dominated areas of the island.”

He added that a fresh outbreak of full-scale hostilities would be very damaging for the rating.

“Not because the public finances are so much weaker than they were and external financial assistance could be put at risk if donors lost confidence in the peace process.”

Sri Lanka is set to unveil a revised welfare laden budget on Thursday, banking on peace to jump-start economic growth.

Treasury Secretary P B Jayasundara declined to disclose budget figures on Thu., but said government revenue and spending plans for 2006 will be aimed at achieving an annual eight percent growth up from 5.4 percent in 2004.

The Central Bank expects the economy to grow by between 5.0 and 5.5 percent this year.

Full statement from Fitch Inc:

Fitch Ratings-London/Hong Kong-08 December 2005: Fitch Ratings
has today assigned the Democratic Socialist Republic of Sri
Lanka Long-term foreign and local currency ratings of ‘BB-‘ (BB
minus). At the same time, the agency has assigned the country a
Short-term foreign currency rating of ‘B’ and a Country Ceiling
of ‘BB-‘ (BB minus). All the Long-term rating Outlooks are
Stable.

“Sri Lanka has proved resilient to adverse shocks over a long
period of time, its institutions are strong and it has an
unblemished debt service record,” said Paul Rawkins, Senior
Director in Fitch’s Sovereign team. “However, weighing in the
balance are concerns about public debt sustainability, weak
coalition governments that have impeded fiscal consolidation
and the absence of an enduring solution to a long-running civil
conflict in the Tamil-dominated areas of the island.”

The main constraints on the rating are the fragile security
situation and weak public finances. Fitch acknowledges the
recent deterioration in the security situation, which has
followed closely on the heels of the presidential election in
November, causing some turbulence in local financial markets.
Nonetheless, Sri Lanka’s ‘BB-‘ (BB minus) rating incorporates a
potentially volatile security situation and Fitch still expects
the 2002 ceasefire agreement to hold, especially given the
increased focus of the international community on the peace
process. Were the violence to become more widespread, however,
Fitch warns that the adverse impact on the economic and
business environment would bring downward pressure on Sri
Lanka’s ratings.

With respect to public finances, Fitch expects a gradual
reduction in the public debt burden over the medium-term
reflecting the low effective interest rate on government debt
and relatively strong economic growth. However, given current
debt levels, there is little room for manoeuvre for an easing
of fiscal policy. Conversely, faster than expected progress in
terms of fiscal consolidation and in securing a final peace
settlement would support an improvement in Sri Lanka’s
creditworthiness and ratings.

Sri Lanka’s economy has experienced negative growth only once
since 1950 and GDP per capita at market exchange rates
surpassed USD1000 in 2004. Fitch attributes this resilience to
strong institutions, a relatively high level of human capital
development and successive governments’ commitment to an open,
market-oriented economy. Such factors have fostered new pillars
of growth and prosperity like garments and tourism, reinforced
by external migration and workers’ remittances. While
recognising that economic reform has tended to be sporadic,
reflecting political instability and civil conflict, Fitch
notes that no administration has sought to reverse what has
already been achieved.

“A key support for the rating is Sri Lanka’s impeccable
sovereign debt service record, an attribute which is rare among
sub-investment grade countries,” said Mr. Rawkins. This record
owes much to the favourable structure of Sri Lanka’s external
debt, most of which has been extended on highly concessional
terms. At around 67% of current external receipts in 2004 the
net present value (“NPV”) of gross external debt was less than
half its face value of 142%, a factor reflected in very low
external debt service costs. Only 5% of public external debt is
owed to commercial creditors and none has been raised on
international capital markets.

Persistently large public sector deficits – averaging over 9%
of GDP since 1990 – impair the country’s macroeconomic
performance, crowd out private investment and repress financial
sector development. Though central government debt equivalent
to over 100% of GDP and 668% of revenue is high when compared
with similarly-rated sovereigns, Fitch notes that the public
finances benefit from foreign funding on concessional terms and
preferential access to a captive pool of domestic savings
channelled through public institutions at low real interest
rates. Adjustments for the lower NPV of external public debt as
well as intra-public sector holdings of government debt yields
a public debt/GDP ratio much more closely aligned with the ‘BB’
median of 60%.

“Peace and politics hold the key to Sri Lanka’s future,” said
Mr. Rawkins. “The ceasefire agreement has produced tangible
benefits in the shape of an improved economic and business
climate, but the absence of an enduring peace continues to hang
over the country, intruding into the everyday business of
government and the longer-term commitment to economic reform.”
He added that a fresh outbreak of full-scale hostilities would
be very damaging for the rating, not least because the public
finances are so much weaker than they were and external
financial assistance could be put at risk if donors lost
confidence in the peace process.