Sri Lanka bombings increase economic, external risks; IMF key: Fitch Ratings

May 17, 2019 (LBO) – The tragic Easter bombings in Sri Lanka will result in lower economic growth this year and could increase external financing pressures, Fitch Ratings says.

Full Statement:

Fitch Ratings-Hong Kong/London-16 May 2019: The tragic Easter bombings in Sri Lanka will result in lower economic growth this year and could increase external financing pressures, Fitch Ratings says. These pressures are mitigated by the government's continued adherence to economic policies and targets that have enabled Sri Lanka to get its IMF programme back on track.

Last month's bombings, which targeted major hotels in Colombo as well as churches, will lead to a reduction in tourism receipts, which had risen steadily in recent years to USD4 billion in 2018, or about 5% of Fitch-estimated GDP. The Sri Lankan government had forecast a further rise to USD5 billion this year. In response to the bombings, it now plans to launch an extensive tourism promotion campaign, alongside efforts to support the sector that could reportedly include VAT cuts and subsidies.

The full impact on tourist arrivals will depend on the government's success in restoring security and the effectiveness of the measures to support the sector, particularly once the peak season begins in November. Nevertheless, we think 2019 GDP growth could be 1.0pp-1.5pp lower than our 3.6% forecast when we last reviewed Sri Lanka's sovereign rating in December due to reduced arrivals and spending. Backward linkages to the wider economy have been significant, through job creation and construction activity, and could amplify the impact.

There will also be a significant impact on the current account deficit. Tourism provided nearly half of last year's services receipts (USD8.4 billion) and the Sri Lankan authorities estimate that the current account deficit could widen to 2.7%-2.8% of GDP in 2019, compared with their earlier forecast of 2.3%.

March's USD2.4 billion sovereign bond issue helped ease near-term fiscal and external financing constraints, but vulnerabilities would increase if the bombings undermine market confidence for a sustained period. Foreign-currency-denominated sovereign debt repayments for 2019-2022 total USD16.8 billion against the government's projections of reserves of between USD7.2 billion-USD7.5 billion at end-2019, down from its earlier projection of USD8.0 billion-USD8.2 billion.

These challenges increase the importance of Sri Lanka's IMF programme in catalysing funding support and as a policy anchor. The IMF Executive Board completed the fifth review under the programme this week, noting that it had been successfully brought back on track after being put on hold during Sri Lanka's political crisis last year. Completion of the fifth review releases USD164 million, bringing total disbursements under the programme to USD1.2 billion. Importantly, the IMF also extended the programme by a year, to June 2020, giving more time to complete economic reforms.

The adequacy of FX reserves and refinancing risks remain key for Sri Lanka's sovereign rating, as highlighted in our rating sensitivities. Our downgrade to 'B'/Stable from 'B+'/Stable last December reflect heightened external refinancing risks, an uncertain policy outlook, and the risk of a slowdown in fiscal consolidation due to the political crisis. Political tensions could resurface towards the end of 2019, when presidential elections are due.

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