Sri Lanka’s foreign exchange reserves are still low, a credit negative: Moody’s Investors Service

Coupled with limited external financing options and pandemic-related lockdown weighing on the recovery of non-debt generating inflows, the FX reserves data points to a rising risk of debt default, Moody’s Investors Service said in a new report.

According to the report, without sizeable external financing that is relatively secure and long-term, they expect foreign exchange reserves to continue declining over the next two to three years.

On 10 September, Sri Lanka (Caa1 review for downgrade) published details of its foreign currency (FX) reserves position, which was nearly $3 billion (Moody’s definition of FX reserves exclude gold & Special Drawing Rights.) as of the end of August 2021, 43% lower than at the beginning of the year and around $600 million lower compared to the end of June.

Foreign exchange reserves covered less than two months of imports at the end of August, a credit negative. The reserves are also well below the government’s annual external debt repayments of around $4-$5 billion through at least 2025.

Some modest amount of inflows materialised in August, while Sri Lanka also received an International Monetary Fund Special Drawing Rights allocation of around $800 million.

“However, such inflows are piecemeal and boost FX reserves only temporarily and marginally given the government’s external repayment schedule,” Moody’s Investors Service said.

CBSL measures, such as the required sale of a share of all inbound remittances and export proceeds to the central bank, generate additional reserves, while measures restricting imports and outbound remittances and investment help retain some foreign exchange resources in the country.

“Although these measures may be effective in the short term, they could weigh on economic activity and deter investment inflows.”

The government recently reached an agreement with New Fortress Energy to invest in a liquefied natural gas terminal, which it expects will be operational by the second half of 2022.

“We expect net FDI inflows to average $1 billion in 2021-22, compared to a peak of around $2.2 billion pre-pandemic in 2018,” the report highlighted.

Nearly 50% of Sri Lanka’s total population was vaccinated as of 12 September, and authorities aim to inoculate 70% of the population by the end of this year.

“If effective, the government’s vaccination strategy will support the reopening of the economy and borders in 2022 and has the potential to boost the tourism sector and non-debt generating inflows.”