Material near-term improvements in Sri Lanka's fiscal strength unlikely: Moody's

Moody's Investors Service says that Sri Lanka's (B1 negative) high general government debt levels, very low debt affordability, and fragile external payments position continue to present the sovereign with material credit challenges.

In particular, persistently high government liquidity and external vulnerability risks will maintain pressure on the sovereign's credit profile, as large external payments come due in 2019-2022.

Looking ahead, continued advancement of reforms that support fiscal consolidation and reduce external vulnerabilities under Sri Lanka's current IMF program will be critical to mitigating macroeconomic risks and strengthening the sovereign's credit profile.

Moody's analysis is contained in its just-released report titled "Government of Sri Lanka: FAQ on fiscal reforms, and exposure to liquidity and external vulnerability risks".

The report provides Moody's view on the following three questions:

1) Have recent fiscal reforms improved Sri Lanka's sovereign credit profile?

2) What is your assessment of government liquidity and external vulnerability risks?

3) Will Sri Lanka's GDP growth contain credit risks?

On the issue of whether fiscal reforms in Sri Lanka have improved the sovereign's credit profile, Moody's says that material near-term improvements in the country's fiscal strength are unlikely. Moody's explains that beside the implementation of the Inland Revenue Act — aimed at broadening the tax base through a simplification of the tax system — more sustained fiscal consolidation will be challenging.

Moreover, contingent liability risks related to state-owned enterprises will persist.

Moody's also points out that Sri Lanka's low tax efficiency and tax collection methods provide significant scope to broaden the tax base, increase tax revenue and eventually lower its elevated debt burden, which was equivalent to just under 80% of GDP in 2017. Ongoing revenue reforms under the IMF program, particularly in tax policy and administration, will support a gradual decline in the debt burden over the medium term.

Moreover, particularly large external maturities are due in 2019-2022. With significant market access required to refinance maturing debt — including a sizeable portion denominated in foreign currency — government liquidity and external vulnerability risks will remain elevated.

Moody's points out that an ongoing accumulation of reserves and implementation of an effective, predictable and transparent liability management strategy would support the sovereign credit profile, by reducing uncertainty around the cost of future refinancing.

With the question of whether Sri Lanka's GDP growth contains credit risks, Moody's says that the country's growth potential and relatively large economy and high income levels when compared with similarly rated sovereigns provide the economy with some shock absorption capacity and will help limit some of the risks from its high debt burden.