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.
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 decision of 29 October 2019 by the outgoing Cabinet to sign a compact with the Millennium Challenge Corporation (MCC) has given rise to extensive public discussion and debate. A new President has been elected on November 16, 2019, with a new Prime Minister and a new Cabinet sworn in soon after. The new government is bound to reconsider its predecessor’s decision to sign the MCC agreement.
The proposed MCC compact, once signed, would make a US government grant of USD 480 million available for expenditure in two Sri Lankan projects – a transport development project (costing $400 million) and a land project (costing $80 million). These two projects are supposed to address two binding growth constraints in the country: inadequate infrastructure of transport logistics and restricted access to land for investment purposes. The MCC grant funds will be disbursed in stages over a period of five years. Unlike other official grants, the MCC grant will not be disbursed to the Sri Lankan government. Instead, these funds will be channelled into a Sri Lankan private company specially set up in Colombo for this purpose by the MCC to be used in the implementation of the two accepted projects. This company will monitor the progress achieved in the projects concerned and grant funds will be released step by step if progress achieved in each stage is judged satisfactory. The US government reserves the right to terminate the operation of the project at any time if the MCC is not satisfied with project implementation progress.
It is good to begin this brief article about the desirability or otherwise of signing the MCC compact by placing the MCC in its proper global perspective. The “Western development establishment” led by the US has dragged increasing numbers of developing countries into the net of neoliberalism since the 1970s and 1980s. Sri Lanka has the dubious reputation of having been a pioneer to be so dragged into a neoliberal policy framework. The use of foreign aid conditionality has been the mechanism widely used by the Western development establishment to neo-liberalise developing countries.
The IMF and the World Bank have formed the institutional mechanism used in the process. Under conditionality, the countries receiving grants and loans on concessionary terms were required to gradually meet the laid down policy conditions after loans were authorized and dispensation commenced
in tranches. The grant “assistance” to a developing country1 through Millennium Challenge account of the US signifies a different way of converting the developing country victims into a neo-liberal policy framework. This method has been described as “preemptive” development assistance. It entails refusal and withholding of funds until demands made by the donor country are met.
The conditions to be met are listed under three broad headings, namely
1) ruling justly (good governance);
2) investing in people (health and education for all);
3) “economic freedom” (sound economic policies that foster enterprise and entrepreneurship)