SL’s large debt portfolio makes borrowings expensive Painful fiscal consolidation only hope – Fitch

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By 2017-11-15

By Paneetha Ameresekere

Fitch Ratings Hong Kong/Singapore, a subsidiary of the London/New York headquartered Fitch Ratings, in a report released yesterday (14) said that 'Budget 2018' sticks broadly to the targets for fiscal deficit reduction under its three-year International Monetary Fund (IMF) programme which began in June 2016, but high Government of Sri Lanka (GoSL) debt and the large cost of debt servicing weigh heavily on Sri Lanka's credit profile.

The implication of the Fitch statement is that credit will become more expensive for the GoSL. Fitch further said that the only recourse is sustained fiscal consolidation over the long-term, an action that will have to be supported by expenditure cuts, leading to the rationalization of expenditure and higher revenue growth, probably backed by higher taxation.

The recently announced budget targets a fiscal deficit of 4.8 per cent of the Gross Domestic Product (GDP) next year (2018), which is only slightly above the 4.7 per cent target agreed with the IMF and continues the consolidation thatbegan last year (2016), said Fitch.

Floods and the drought weighed on the economy and public finances this year (2017) and contributed to theGoSL missing its initial 2017 fiscal deficit target of 4.6 per cent of the GDP, which is expected to expand to 5.2 per cent, but less than last year's deficit of 5.4 per cent of the GDP.

Consolidation this year has been driven by measures to boost the tax revenue, including a hike in the value-added tax (VAT) to 15 per cent in November 2016 from 11 per cent. The GoSL expects revenue to rise strongly again in 2018, to 15.7 per cent of the GDP, from 14.7 per cent in 2017.

Revenue should be supported by the Inland Revenue Act passed in September 2017, provided that the implementation is effective. The Act, which will come into effect from 1 April 2018, aims to simplify the tax laws and improve the efficiency of the system, said Fitch.

"Despite these positive reforms, we see downside risks to the GoSL's revenue projections, given that they are based on a GDP growth assumption of 5 per cent to 6 per cent for next year, compared with our own of 4.5 per cent," the rating agency said.

Lower growth means the inability to collect the higher revenue projected.

On the expenditure side, the GoSL expects public investment spending to rise by 20 per cent in 2018, while recurring spending is forecasted to decline, the rating agency said. Interest payments are expected to account for more than one-third of the total revenue, which is a key weakness in the fiscal profile. Addressing longstanding weaknesses in Sri Lanka's public finances will require an extended commitment to consolidation from the authorities.

"In particular, we highlighted the importance of a stabilisation of the GoSL debt ratios when we affirmed Sri Lanka's rating at 'B+' with a Stable Outlook in February 2017. The GoSL's debt/GDP ratio rose to 79.3% of the GDP in 2016 - well above the 60.9% median for sovereigns rated 'B' or lower - and we estimate that it will increase again in 2017," said Fitch.

"Our baseline projection is still that government debt ratios will stabilise within the next couple of years, but these forecasts are vulnerable to fiscal slippage or an economic downturn. Exchange rate depreciation could also push up the local-currency value of government debt, given that around 40% of the total was denominated in foreign currency as of end-2016, according to Fitch estimates," the rating agency said.

"Foreign exchange reserves rose to US$ 7.5 billion at the end of last month (October), from US$ 6.1 billion at end-2016, and we estimate that reserves could be sufficient to cover 3.3 months of current account payments by end-2017. However, the GoSL's external liquidity ratio at 65.6 per cent is still well below the 'B' median of 134.2 per cent, according to our estimates," said Fitch.

"Sri Lanka faces a challenging external debt service schedule in the near term, with very large external debt maturities coming up over the period of 2019-2022," the rating agency further said.

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