Moody’s decision to downgrade Sri Lanka premature | Daily FT

The decision to downgrade Sri Lanka’s rating two notches from B2 to Caa1, citing wide budget deficits, slow reforms and weak institutions was according to analysts too harsh and unwarranted given that Sri Lanka has done extremely well in the containment as well as handling of COVID-19 and this has been recognised by the WHO – Pic by Shehan Gunasekara


Moody’s this week downgraded the Government of Sri Lanka’s long-term foreign currency issuer and senior unsecured ratings to Caa1 from B2 and changed the outlook to stable. 

The decision to downgrade Sri Lanka’s rating two notches from B2 to Caa1, citing wide budget deficits, slow reforms and weak institutions was according to analysts too harsh and unwarranted given that Sri Lanka has done extremely well in the containment as well as handling of COVID-19 and this has been recognised by the WHO. Moreover they note that several investors could suffer unnecessary losses and miss out on potential business opportunities. 

A Moody’s Caa rating indicates that debt is judged to be speculative of poor standing and is subject to very high credit risk. The Government on Tuesday severely criticised the sovereign rating downgrade done by international rating agency Moody’s, and insisted that it was “premature” and “unfair”. 

Moody’s assessment is that the coronavirus induced shock, which Moody’s regards as a social risk, could significantly weaken Sri Lanka’s already fragile funding and external positions. Moody’s fear is that heightened liquidity and external risks stem from Sri Lanka’s limited secured funding sources to meet its material external debt service payments over the coming years, during which period market refinancing will remain vulnerable to shifts in investor sentiment. 

In addition, fiscal and external pressures will continue to limit the scope for reforms to address long-standing credit vulnerabilities, denoting weakening institutions and governance, an important driver of today’s rating action. The stable outlook however denotes balanced credit risks at the Caa1 rating level. 

Sri Lanka’s large and recurring financing needs over the near- to medium-term risk can put more pressure on the sovereign’s external liquidity position. Sri Lanka’s latest rating does not however reflect the potential for growth to recover in 2020-21 and to escalate growth rates back to near normal. 

Institutional strength in many areas also provides credible support for the Government’s argument compared to similarly rated peers like Iraq. Moody’s has also lowered Sri Lanka’s local currency bond and bank deposit ceilings to B1 from Ba2, lowered its long-term foreign currency bond ceiling to B3 from Ba3 and lowered its foreign currency bank deposit ceiling to Caa1 from B3. These ceilings act as a cap on the ratings that can be assigned to the obligations of other entities domiciled in the country.

Debt repayments 

Sri Lanka’s debt repayments in 2021 is expected to be around $ 4.5 billion. State Minister of Money and Capital Market and State Enterprise Reforms Ajith Nivard Cabraal emphasised that the Government is ready and able to meet all debt repayments. 

The Minister noted: “We have sufficient reserves to meet our debt obligations without default. There will be no interruptions whatsoever.” 

The Government is already exploring multiple options to boost foreign exchange reserves including a $ 1 billion SWAP agreement with India, attracting investment to the securities market and possible Panda and Samurai bonds. 

Sri Lanka will also receive $ 700 million as the second tranche of a $ 1.2 billion syndicated loan from the China Development Bank. The first $ 500 million has already been transferred in March this year. Import restrictions and oil price reductions have also boosted the reserves significantly. 

Way forward 

An agreement with the International Monetary Fund (IMF) has also not been ruled out. However the State Minister noted that Sri Lanka was not keen to avail itself of the IMF’s Rapid Credit Facility introduced earlier this year to help countries deal with the fallout from the COVID-19 pandemic as it did not provide significant funds. 

The IMF’s mainstream facilities to emerging markets would be more beneficial to Sri Lanka. Sri Lanka’s rating could get reviewed if financing risks diminished materially and sustainably. Going forward the government is best advised to work on a medium-term financing strategy that can deliver a manageable cost of debt, and a faster and more sustained build-up in non-debt creating foreign exchange inflows. 

A progressive Budget and joint Government-private sector led initiatives to attract FDI and further strengthen Sri Lanka’s exports must become a national priority.