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Moody’s puts Sri Lanka’s Caa1 rating under review for downgrade on default risk; Sri Lanka disputes

LONDON, July 19 (Reuters) – Moody’s Investors Service on Monday said it had placed the government of Sri Lanka’s Caa1 rating under review for downgrade, citing the risk of default due to falling foreign exchange reserves.

The ratings agency said the decision, which applies to Sri Lanka’s foreign currency long-term issuer and senior unsecured debt ratings, reflected an increasingly fragile external liquidity position.

Investors and analysts are weighing the likelihood of Sri Lanka defaulting on its debt, with a fiscal deficit expected by Moody’s to average 8.5% over the next two years and interest payments likely to remain around 60-70% of government revenue over the next few years.

Central bank governor W. D. Lakshman this month expressed confidence in an improvement in Sri Lanka’s external situation and voiced confidence that it could avoid an International Monetary Fund bailout.

Moody’s said its decision reflected governance weaknesses in the ability of institutions to take measures to mitigate urgent risks to the balance of payments.

Without an IMF programme, Sri Lanka would need to secure more loans from China or India to help maintain sufficient reserves to repay the $3.7 billion of bond payments by the end of 2023, Oxford Economics estimated last week.

Sri Lanka, whose vital tourism industry has been devastated by the coronavirus pandemic, could get $800 million worth of reserves from the IMF as a part of a new allocation of special drawing rights by August or September, Lakshman said earlier this month.

Moody’s said Sri Lanka’s financing options remained narrow, with borrowing costs in international markets still prohibitive.

“Absent large and sustained capital inflows through a credible external financing strategy, Moody’s expects Sri Lanka’s foreign exchange reserves to continue declining from already low levels, further eroding its ability to meet sizeable and recurring external debt servicing needs, and increasing balance of payment risks,” the ratings agency said.

However, Sri Lanka has disputed a warning by Moody’s Investors Services that it may further downgrade the island’s sovereign rating saying it was ill-judged as funds were lined up to repay foreign debt including s sovereign bond maturing in July.

Sri Lanka’s Finance Ministry said the review for downgrade of Sri Lanka’s rating which was already at ‘Caa1’ was ill-judged and unacceptable.

“..Moody’s action could create uncertainty among investors who have kept faith in Sri Lankan ISBs and other investments,” a Finance Ministry statement said.

“As experienced in the past, such undue uncertainty created by the rating agency could lead to price volatilities in the market for ISBs and for other investments.”

Sri Lanka’s economy is picking up and Coronavirus vaccination drive is underway, the Finance Ministry said.

The full reaction is reproduced below:

Statement by Moody’s Investors Service is ill-timed, ill-judged and hence unacceptable

The Government of Sri Lanka (GOSL) wishes to express its surprise over today’s announcement by Moody’s Investors Service, at a time when the GOSL has diligently lined up adequate funds to repay its maturing foreign debt liabilities, including the International Sovereign Bond (ISB) maturing at end July 2021.

Moody’s has placed Sri Lanka’s rating ‘under review for downgrade’, although this does not imply a downgrade. However, Moody’s action could create uncertainty among investors who have kept faith in Sri Lankan ISBs and other investments.

As experienced in the past, such undue uncertainty created by the rating agency could lead to price volatilities in the market for ISBs and for other investments.

In any case, the GOSL has taken all measures to repay the upcoming ISB maturity of US dollars 1,000 million due in end July 2021. The GOSL also observes that this is not the first time Moody’s has taken such surprise action on the eve of an assured imminent payment.

Moody’s downgraded Sri Lanka on 28 September 2020, just a few days before a US dollar 1,000 million ISB was to mature on 04 October 2020 and the GOSL successfully settled the liability without any hesitation. GOSL continues its unblemished debt service payment record.

The Sri Lankan economy has shown strong signs of bioad based recovery, with a real GDP growth of 4.3 per cent in the first quarter 2021. The domestic vaccination drive is continuing at full force, providing confidence of a continued improvement in economic activity, combined with a possible strong rebound of the tourism sector.

Ongoing developments in the domestic production economy are expected to improve the country’s export potential, while facilitating import alternatives. Improving domestic economic sentiments are reflected in the activity in the Colombo Stock Exchange as well.

The pickup in economic activity is also expected to improve the fiscal position of the Government, from both revenue and expenditure aspects, and the Government remains committed to achieving its announced medium term fiscal path towards a budget deficit of 4 per cent of GDP by 2025.

The unwarranted announcement by Moody’s also re-emphasises the need for the GOSL to revisit its relationship with rating agencies. Unwarranted announcements of this nature are also not in the best interest of investors.

Investors are invited to approach the Sri Lankan policy authorities at the highest levels who always remain open for constructive dialogue and will welcome any one-on-one engagement or roadshow discussions, without being dissuaded by such unsubstantiated announcements.

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