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
VARUNI AMUNUGAMA FERNANDO ( Jt. Managing Director – Triad, Director – Derana Media Network )
When the world froze in shock in the face of the Covid-19 pandemic, Sri Lanka in my opinion managed the situation in a timely manner, placing the welfare and health of our people first.
Living in ‘the new normal’ is undoubtedly a work in progress, and just like the rest of the world, our nation is trying to balance conventional methods of managing a crisis with our own indigenous innovations. There is an inherent resilience in this blessed land where no matter the challenge, we always find a way.
It was sadly inevitable that the economy would be adversely affected, leaving many of our key industries struggling. As we work towards managing the pandemic and beyond, what is important is the steadfast vision of the political leadership, efficiency and integrity of the administration, and the participatory action of the business sector.
As a group, we took the leadership in calling on corporates to reconsider salary cuts, layoffs and redundancies as a first course of action at the very outset of the pandemic. Founded on a people-driven strategy of management, our group was proud to set an example of ‘shared resilience’, where we deployed all our verticals, especially our communications network to support emergency national initiatives.
It is not the past but the future that matters. We will take every step to continue to create wealth for this country, and uplift the lives of people by focusing on entrepreneurship development, crafting positive mindsets, and building the next generation to be global locals.
We have always believed that ‘Sri Lanka Can’. We will continue to do our best using our resources and acumen to transform our motherland.
Nanda Fernando ( Managing Director, Sampath Bank PLC )
After facing back-to-back challenges, 2021 is the year we are looking forward to, and one that we expect will usher in an era of sustained economic prosperity. We are hopeful that the Covid-19 pandemic will come to an end during 2021, and given the conducive environment created through stable politics, a pro-growth budget presented by the government, and low interest rates, both investment and consumption demand will pick up strongly during the year. Sampath Bank has made all necessary preparations to ride this wave of prosperity together with our customers and other stakeholders.
S. Renganathan ( Managing Director / Chief Executive Officer, Commercial Bank PLC )
“It is not realistic, nor is it sustainable to expect immediate growth following an all-encompassing and on-going global crisis. While we adjust and adapt towards the new normal, it is important to stick to basics; sustainable growth strategies that uplift your stakeholders, business continuity planning, innovation, and most important of all, a positive outlook. “
Ashroff Omar ( Group CEO, Brandix Apparel Limited )
“Against the backdrop of a global pandemic that has affected millions, cost thousands of lives and caused a recession worldwide, it is hard to see opportunities, let alone stay optimistic. However, the pandemic also brought a big pause in our lives; facilitating a mindful intentionality. My biggest learning in this crisis is, for myself and my team, to focus on things we can control rather than worry about things that we cannot. At the heart of this is the welfare of our people.
As organisations, we need to take this opportunity to examine our systems, structures and processes end-to-end. Our goal should be to eliminate waste and rework, further optimise and digitise workflows so that as individuals, we are efficient, best-in-class, and physically and emotionally well rested. This will enable Sri Lankan industries to withstand the current recession, by creating a runway long enough to recapture the market as economies bounce back.
After months of trade war, the US and China agreed to a 90-day truce to work out their differences. It was scheduled to end on Friday, but President Trump lifted the ultimatum to increase tariffs after he was satisfied by progress made in several rounds of talks in Beijing and Washington.
A White House economic official, Larry Kudlow, said on Thursday the two countries were on the brink of a ‘historic’ trade agreement. A meeting between Trump and his Chinese counterpart Xi Jinping, was also expected soon. After the latest round of talks in February, US Agriculture Secretary Sonny Perdue tweeted that China had committed to buying ‘an additional’ 10m tonnes of soybeans as a ‘show of good faith’. US farmers rely greatly on such trade with China: in 2017 around a third of US soybean production – worth $14bn -– was exported there, where it is used for animal feed. Chinese tariffs had already hit America’s farming regions hard. Exports plummeted last summer when China imposed tariffs on US soybeans and other agricultural products.
Donald Trump has requested China to abolish tariffs on US farm produce arguing that it is very important for US farmers.
In the meantime, South China Morning Post on 19th April reported that China regrets WTO ruling that China’s Tariff Freight Quota System for rice, wheat and corn violates international trade rules. The verdict was given in a case filed by the administration of former President Barak Obama in December 2016.
The US government is also seeking a total reforms of the WTO including re-visiting China’s role in the international trading system as the US believes China should no longer designated as a developing country, enjoying favourable trade treatment as China has emerged the world’s second largest economy.
Brexit Deadlock Continues
The British Prime Minister said she would step down if and when her Brexit deal was delivered. There was a desire for ‘a new approach, and new leadership’, she told a meeting of Conservative lawmakers. However, members of the House of Commons voted on a range of measures designed to break the impasse over Brexit — but failed to agree on any of them.
The European Union has requested the UK to accept a six months delay with an option to leave earlier if the UK Parliament can agree to a deal, The European Union leaders agreed to another delay to the UK schedule withdrawal from the EU until October 31. In the meantime, the European parliament election is due in late May and if the UK does not take part in the election process it would be required of the UK to leave on June 01st without a deal as some observed. The Prime Minister of UK has suggested that she could still manage to get her withdrawal agreement passed through parliament, in time to avoid UK taking part in the European elections.
New Head at World Bank
Following President Trump’s announcement that Mr. Malpass would be the US candidate for election as the next President of the World Bank, Mr. Malpass won unanimous approval from the executive board of the bank, which has 25 members. The US holds a 16% share of board voting power and has traditionally chosen the World Bank’s leader. Traditionally, the US picks the World Bank President, Europeans choose the IMF Managing Director, and the Japanese do the same for the Asian Development Bank. David Malpass has been selected as President of the World Bank Group for a five-year term from April 9, 2019. Mr. Malpass previously served as Under Secretary of the Treasury for International Affairs for the United States. As Under Secretary, Mr. Malpass represented the United States in international settings, including the G-7 and G-20 Deputy Finance Ministerial, World Bank-IMF Spring and Annual Meetings, and meetings of the Financial Stability Board, the Organization for EconomicCooperation and Development, and the Overseas Private Investment Corporation.
In 2018, Mr. Malpass advocated for a capital increase for the IBRD and IFC as part of a larger reform agenda featuring sustainable lending practices, more efficient use of capital, and a focus on improving living standards in poor countries. He was also instrumental in advancing the Debt Transparency Initiative, adopted by the World Bank and IMF, to increase public disclosure of debt and thereby reduce frequency and severity of debt crises.
Prior to becoming Under Secretary, Mr. Malpass was an international economist and founder of a macro-economic research firm based in New York City. Mr. Malpass served as chief economist of Bear Stearns and conducted financial analyses of countries around the world.
Earlier in his career, Mr. Malpass served as the U.S. Deputy Assistant Secretary of the Treasury for Developing Nations and Deputy Assistant Secretary of State for Latin American Economic Affairs. In these roles, he focused on an array of foreign policy and development issues, including the United States’ involvement in multilateral institutions; the World Bank’s 1988 capital increase, which supported the creation of the Bank’s environment division; the Enterprise for America’s Initiative; and Brady bonds to address the Latin American debt crisis. He also served as Senior Analyst for Taxes and Trade at the U.S. Senate Budget Committee, and as Staff Director of the Joint Economic Committee of the U.S. Congress.
Mr. Malpass has served on the boards of the Council of the Americas, Economic Club of New York, and the National Committee on US–China Relations. Mr. Malpass earned his bachelor’s degree from Colorado College and his MBA from the University of Denver. He undertook advanced graduate work in international economics at the School of Foreign Service at Georgetown University.
The World Bank President is Chair of the Boards of Directors of the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). The President is also ex officio Chair of the Boards of Directors of the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency (MIGA), and the Administrative Council of the International Centre for Settlement of Investment Disputes (ICSID).
Some worry that Mr. Malpass, a critic of the bank, will seek to reduce its role. In the past, he has described the World Bank as too big. He has said he would like to lend less to middle income countries like China, which he argues are financially strong enough.
Speaking at an event at the Council on Foreign Relations back in 2017 he said: “Multilateralism has gone substantially too far – to the point where it is hurting US and global growth”. However, when his predecessor Jim Kim asked shareholders for more money, it was David Malpass who – in exchange for reforms at the bank – helped make it happen. Last year, he was part of negotiations over a package of World Bank lending reforms. The US agreed to back a plan for shareholders to inject $13bn (£10bn) into the World Bank and its private lending arm, with conditions that aimed to limit the bank’s lending, and focus resources more on poorer countries. The reforms are aimed at pushing more middle-income countries towards private sector lending, and limiting World Bank staff salary growth.
White House Senior Adviser Ivanka Trump speaking during an interview with Associated Press, Wednesday April 17, 2019 in Abidjan, Ivory Coast, where Trump is promoting a White House global economic program for women said her father asked her if she was interested in the job of World Bank Chief but she was happy with her current role in the administration.
President Trump recently told The Atlantic: “I even thought of Ivanka for the World Bank. She would’ve been great at that because she’s very good with numbers.”
Ivanka Trump worked on the selection process for the new head of the 189-nation World Bank, David Malpass. She said he’ll do an ‘incredible job.’
US Monetary Policy Normalization
President Trump called on Federal Reserve to lower interest rates and wants return of quantitative easing arguing that the Central Bank’s policies have held back the US economy and there is no inflation.The Federal Reserve, which has increased interest rates numerous times in the last few years, recently signalled that it does not plan to increase interest rates any more for the remainder of this year. Beyond simply cutting interest rates, President Trump also wants the Fed to bring back its policy of quantitative easing, to increase liquidity in the market and keep interest rates low. In the wake of the financial crisis in 2007/2008, the Fed enacted QE, but that program ended in late 2017. According to Trump, if the Fed were to undertake those policies, the economy would improve dramatically, despite the fact that in Trump’s eyes, things are already going well.
Global Growth Outlook ‘Precarious’
International Monetary Fund (IMF) Managing Director Christine Lagarde in a preview of the April 12-14 IMF and World Bank Spring Meetings, said that global growth has lost momentum amid rising trade tensions and tighter financial conditions. The IMF Chief explained that the global economy is “unsettled” after two years of steady growth, with the outlook “precarious” and vulnerable to trade, Brexit and financial market shocks. However, she said that the IMF does not anticipate a recession in the near term, and the Federal Reserve’s “more patient pace of monetary policy normalisation” will provide some thrust to growth in the second half of 2019 and into 2020.
Lagarde cautioned, however, that years of high public debt and low interest rates since the financial crisis a decade ago have left limited room in many countries to act when the next downturn arrives, so countries need to make smarter use of fiscal policy. This means striking a better balance between growth, debt sustainability and social objectives and acting to address growing inequality by building stronger social safety nets.
Lagarde also said that the IMF has revised its analysis of the US-China trade war’s effects, showing that if all trade between the world’s two largest economies were subjected to a 25 percent tariff, US gross domestic product (GDP) would fall by up to 0.6 percent while China’s would fall by up to 1.5 percent.
“Nobody wins a trade war,” Lagarde added. “That is why we need to work together to reduce trade barriers and modernise the global trade system.”