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