Moody’s Credit Rating Agency on the 23rd of November 2018 announced that they have downgraded Sri Lanka’s sovereign credit by one notch from B1 to B2. Many political statements have been made of this downgrade.Let us examine what it really means to Sri Lanka.
Table-1-Credit rating range From Aaa to Ca
Source: Econsult & moody’s
Each country is rated based on their governments likelihood to default on their external borrowing obligations. The credit rating therefore looks at the default probability of the state. In doing so Credit rating agencies take into account GDP growth, per capita growth, monetary conditions, fiscal deficits, external debt burden and a host of other quantitative and qualitative data in arriving at the credit rating political risk is also one such variable.
Moody’s have an established rating score which is Aaa which indicated the highest quality of credit with a probability of default of 0.03 percent while speculative grading’s are from Ba1- Ba3 with a probability of default 2.60 percent. The lowest credit score is classified as High risk or Highly Speculative obligations which are rated by Moody’s as B1, B2 and B3 (probability of default 9.58 percent). With the lowest and most riskiest being Carated sovereign credits (two year default probability of 35.9 percent).
Sri Lanka Credit Rating B1 to B2
In this regard Sri Lanka was already rated as a high speculative country B1 (stable) since July 2013 and later the rating outlook downgraded from stable to negative rating reaffirmed in 2016, 2017 and 2018 . Therefore Sri Lanka a B1 credit was below investment grade to begin with the outlook changing from ‘stable’ in 2013 to ‘negative’ from June 2016. (Source: countryeconomy.com). The corrective action plan could have reversed this outcome; however, the trajectory was unadjusted.
Moody’s appears to place a higher weight on GDP growth, inflation, growth in per capita income in order to achieve a higher grade rating, while lower inflation and lower external debt also consistently relate to higher ratings.
Therefore the overall credit rating of Sri Lanka in terms of its high risk rating has become more pronounced as the external debt and external foreign reserves situation has decreased since 2014 with warnings not heeded by persons responsible for managing the external debt. Added to this our external Foreign exchange reserves too has continued to decline and has declined by 30pct from USD 9.9 billion in April 2018 to 7.0 billion as at November 2018
Chart-1-External Debt Maturities
Source: Econsult & moody’s
Putting the Impact into perspective
The credit rating impact thus must be seen as a testimony of the shift in the economic model which has seen a shift to consumption demand which is supplied by external sources, thus this has lead to the trade deficit widen to USD 14 billion. Non-consumer import demand during the past three year have witnessed an increase by 47pct growing from USD 1,700 million to USD 2,500 million over the period 2012-2014, 2015-2017 With the rupee depreciation rapidly to stem the imbalance in the overall current account.
Therefore the reason for the downgrade is three fold a) Sri Lanka’s growing debt to GDP ratio which had increased from 71% of GDP in 2014 to 85% of GDP as at 2018 June and b) its deteriorating external finances and c) the deterioration in GDP growth from 9% in 2012 to 3.1% in 2017 and also a stagnant per capital growth over the past 3 years.
Chart-2-All Share Index and USD/LKR price behavior
In fact the financial markets had already factored the credit downgrade of Sri Lanka since June this year (Chart-3) as depicted in the Colombo Stock Exchange All Share Index breaking the 6000 mark (Yellow line) and the flight of foreign bond holders from the government debt securities market which resulted in the Rupee depreciating by 15% on year to date basis (Purple line) therefore it is not professionally correct to underpin the downgrade to the last two weeks of political swings
Chart-3- Sri Lanka Sovereign Bond secondary market behavior
Source: Econsult & moody’s
The deterioration in the country’s external finances also had a significant bearing the ability raise finance as the 2025 USD Bond with a coupon of 6.875pct witnessed a sell off in the secondary market. The sell off of the Sovereign bond (ISIN 85227SAQ9) was witnessed since January 2018 but exacerbated during the past one month, reaching a yield of 9.04pct
This negative sentiment has thus prevented Sri Lanka tapping the Euro bond markets for refinancing its external maturities. This can pose a short term stress condition.
While it also provides Sri Lankan risk takers with the opportunity to buy the Sri Lanka credit at a discounted value, and factor in high yields as part of their investment portfolios
The inception of my career as a banker in the late 70s was about the same time that Sri Lanka acted on a revolutionizing move to become the first South Asian nation to liberalize its trading economy. Ever since I have been hearing Sri Lanka as a “developing” nation. Fast forward to four decades and several regimes later we are still a “developing nation”. What is it to be a developing nation; What is to be a rich nation and what is it to be a poor nation. The Department of Census and Statistics records Sri Lankans per capita GDP for the year 2019 at $ 3,852 per annum whilst Singapore, who’s open trade regime were developed much later recorded a thumping $65,977. Singapore’s benchmark strategies are spoken of at many forums to highlight its economic ascension from what was once a poor country with a GDP per capita of only $320 in par with Sri Lanka. The success story of Singapore’s economic and demographic development surpasses a single systematic exposition, however, it is crucial in this context to act as an expediential comparison and maybe give an insight or two for Sri Lankans.
Following an economic growth of just 5.3% after the civil war ended and low fiscal revenues combined with mountains of debt,Sri Lanka is classified as among the developing economies by the United Nations Secretariat (UN/ DESA). Comparatively, Singapore ranks sixth highest in the world for a country that possesses half the natural resources as Sri Lanka.
How do we allow this term to dominate us?
I have been hearing of Sri Lanka being trapped by this economic definition for as long as fifty years. Our present standard of living is at least ten times behind that of Singapore, and our drastically slow pace is only weighed down by our debt portfolio. Whilst searching for answers, numerous evidence pointed to the lack of persistence and political instability coupled with low demographic development with a relatively large population earning an income that is just enough to survive.
A radical change is required to overcome this crisis, but what will continue to be a barrier to growth is only ourselves, which arrives at the core lesson to be learned before we begin our mandate. To be nationally poor is a public choice; to navigate this crisis is dependent on our determination. Only we are stopping ourselves from capitalizing on our potential.
Mynt (1973) suggests the key indicators of economic development are the level of per capita income, rate of growth of per capita income, and the widening inequality in the distribution of income, but there is much debate on the contribution of economic production to the country’s prosperity. Sri Lanka’s current account deficit in 2018 amounted to $7.57 billion which was exacerbated by a challenging external environment with the Easter attacks and now the latest COVID-19 outbreak. The country’s export performance declined from a growth rate of 4.1% to 1.44% by the end of 2019, losing out on much-needed foreign exchange that can be utilized to pay off debts. With little to no reserves and a declining rate in the exports, a call for transformation in the policies is imperative to focus on export growth.
Performance into perspective:
In 1969 following the independence of Singapore from the Malaysian Federation, a Singaporean Dollar was exchanged at $0.35 against the Sterling Pound whilst the same could be purchased at SLRS 13.40 in Ceylon. Since 1981, the monetary policy in Singapore was centered on the control of the exchange rate, and today, their currency is equal to £0.57 whilst the SLRS is 237. How did we get here? Is it not by choice? Sri Lanka like any other developing nation is a political economy. What does it mean? It means that every economic policy has the flavour or influence of the political agenda of the incumbent regime. The result is that our direct debt to GDP is around 70% and nearly 90% of our national revenue is expended to service these debts. How do we survive? Just imagine if 90% of your family income is used to service debts, how could you sustain your family without sinking deeper into debt?
There is no doubt that our country is in dire need of an effective policy to reduce an approximate one billion trade deficit a month. The deficit stems from importing more than we export which impacts our reserves. The exchange rate against the dollar reached an alltime high of Rs. 191 in April 2020. The early 2000s experienced a 2.8% yearly depreciation and it was as high as 9.1% for the four year period of 2015-2018 alone. The public has failed to grasp the reason behind the depreciation over the rupee – but the Central Bank’s quick-fixes through injection of money contributed towards a further hindrance to the growth.
In attempts to achieve the government’s export target or rather reduce the trade deficit, stringent measures and banning mechanisms have come into play. However, the effectiveness of these proposals are far from favourable along with strong opposition from the public. From an accountant’s point of view, where we are today as a nation with political interventions on the implementation of policies, fiscal account deterioration and racks of debt; we will easily be written off as ‘bankrupt’. Sri Lanka is in a fight for survival and it is our responsibility to help the nation get back on its feet.
An appeal for long-term change:
The late Prime Minister Hon. Sirimavo Bandaranaike took oath in 1960 as the world’s first female Prime Minister, yet another disruption against the conventional norms in the political economy. Her regime prioritized incentivizing the local industries and capitalizing on domestic knowledge for production. It is agreeable that the lack of an open economy failed to drive economic opportunities, however, the brutal “produce or perish” notion encourages self-sufficiency that which we lack today due to our dependency on international trade.
‘Tea, rubber, cocoa and coconut is a common man’s answer to what our main drivers of export revenue were, yet it is shameful that during 2018, our imports consisted of 5.13% of rubber and 1.89% of tea. We even import coconuts.
Lee Kuan Yew, the founding father of Modern Singapore implemented systems based upon the development of the country’s resources to improve trade and the quality of life. A notable example being the revival of the Singapore River around which businesses and factories developed. The project which took up to 10 years created a foundation for innovation, improvements in transportation, tourism, and water supply.
We possess abundant resources for our island to thrive; the agriculture industry, tea destinations and massive potential to become a global tourism hub. Known as the pearl of the Indian Ocean, our island is at a prominent location which is of the essence to create a competitive advantage. Yet, it is ironic that we import salt and fish when the sea surrounds us. In 1978 when I embarked on my first trip to India, we carried bags full of spices to be locally sold to a country where the demand for our spices was unaccountable but now we are importing spices from India. The largest contributor to export revenue of spices in 2018 was Cinnamon, which totaled at only 11.1% traded to India. The great voyager Vasco da Gama referred to then Ceylon as the land of spices and we chose to lose out on that status.
Paddy cultivation in Sri Lanka traces its roots back to 161 B.C. when Sri Lankans were skilled at making a living out of this industry. Rice crops occupy 34% of total cultivation with over 1.8 million of our population engaged in producing around 2.7 million metric tons of rice annually. The trading of cheaper and quality rice from other nations exerts pressure on Sri Lanka to improve on production. Sri Lanka has the capacity to gain international recognition as the primary rice exporter as well as create a source of employment to improve the livelihoods of many.
However, the policymakers must prioritize their earnings to invest in equipment for pre-harvest operations and marketing of the produce. According to research done by TB Adhikarinayake, the majority of the problems farmers face are related to high losses in the production chain and lack of skilled workers.
The Choice – a change in direction:
Where are we heading? We are importing what we can produce, increasing the trade deficit, increasing the pressure on the exchange rates, and depriving our children of foreign education. In such a competitive world, the need to solve the Balance of Payment crisis is pivotal to managing the country’s finances in order to avoid a disastrous downfall. The government’s attempt to reduce the deficit by imposing import controls will only create inflationary pressures in the country if we don’t optimize the encouragement given by the government to grow.
Science and technology have given us “formula one” seeds for rice, chilies, and potatoes which can treble the output per acre. Are we making a choice to optimize these opportunities to be self-sufficient?
We have a choice, to change our destiny. Can we, yes, we can! We are poor because we chose to be so. Likewise, we can make the choice to be rich as a nation. Let’s look at a change in direction by seizing opportunities to make exports competitive, using innovative methods of technology, and by utilizing our human resources. It is about time we make use of our knowledge in agriculture, natural resources, land, diverse cultures, and our climate to attract foreign investors.
Every generation has a responsibility towards creating a sustainable nation. It is our choice to change directions to reach the destination we intend. It is our obligation to ensure that majority of our children do not experience a poor quality of life, rather a high standard of living and not to be referred to as people of a poor nation.
The rupee has weakened by 17.5pct on a year to date basis, we feel that most of the correction could be nearing an end as the 20pct targeted weakness could soon be complete. The weakness also seem to be now in line with a REER of 100 and thus could seen some consolidation once the 20pct target is reached i.e. 186.00.