Economy needs robust reforms for growth - Ravi Abeysuriya

by Chandani Jayatilleke

Sri Lanka needs to attract a significant amount of foreign direct investments and increase exports to build the foreign reserves; that will help the country get a rating upgrade, said Director and Chief Executive Officer, Candor Equities Limited, Ravi Abeysuriya,

In an interview with the Sunday Observer following the Fitch downgrade of the sovereign rating on February 29, he said the government will have to move fast. “It urgently needs to make a strong effort to reduce the general government debt which is around 75% of GDP now and narrow the fiscal deficit by broadening the government revenue base and put public finances on a sustainable path for a rating upgrade,” he said.

Abeysuriya who is also the President of the Colombo Stockbrokers’ Association (CSBA) said the success of the government implementing long-overdue predictable and robust policy reforms are, however, in the midst of current political undercurrents, yet to be seen.

Excerpts:

Question: What does Fitch downgrade means for Sri Lanka at this juncture?

Answer: Fitch Ratings downgraded Sri Lanka’s sovereign rating by one notch from BB- to B+ with a negative outlook. The negative outlook implies there is a probability of the credit rating being further downgraded in the future.

According to the Fitch, the country’s increasing external vulnerability (weaker foreign reserves, significant foreign debt servicing commitments) and weaker fiscal consolidation are the main factors for the rating downgrade.

Moody’s and S&P already have a B1/Stable and B+ ratings respectively for Sri Lanka. For now, Sri Lanka’s credit rating is in the same rating level within the ‘High Speculative’ risk category from all three rating agencies as shown in the chart. (See page 47 for two charts)

Credit rating reflects the ‘credit worthiness’ or capacity of Sri Lanka to meet debt commitments. A downgrade of Sri Lanka’s credit rating is a signal that there may be greater risks for investors when investing in Sri Lanka. As shown in the graph below investors were attributing a greater risk premium for Sri Lanka’s sovereign bond issues before the Fitch downgrade, which means the increasing macroeconomic risks were already factored in the bond yields.

Question: How bad is it for a country’s rating to be downgraded?

Answer: This would be negatively impacted for the country’s portfolio flows and international market access for sovereign bond issues. This means Sri Lanka will have to pay a slightly higher risk premium for future sovereign bond issues. In other words; Sri Lanka will incur a higher cost for commercial borrowing from global capital markets, in the future.

However, if Moody’s and S&P downgrade as well, it will prove more costly as Sri Lanka will move further down in the rating scale to B category.

Following a sovereign downgrade, financial institutions and corporates in Sri Lanka that are at the sovereign ceiling are generally downgraded, while firms below the sovereign bond are not necessarily downgraded. Moreover, bond firms are downgraded not because of a deterioration of their fundamentals, but simply because of the sovereign ceiling. The sovereign rating downgrade generated a significant stock market reaction with the ASPI declining 78 points on March 1 itself. So the direct impact of the downgrade will be felt in the bond and fixed income market, with a secondary shock in currency and then finally in equities.

Question: How will the downgrade affect foreign and local investor sentiment?

Answer: Yes, a downgrade may lead to sentiment driving nervous investors to sell out government bonds and equity investments of Sri Lanka deemed to be riskier. When it comes to domestic government bonds, certain investors may sell these bonds.

This could have a knock-on impact causing local interest rates to increase and stabilise around a new level that makes them attractive to investors. This increase in yields potentially could lead to a capital loss on the sale of the bond in the short term and increased volatility for an asset class that most investors seem to be ‘rather safe’.

Question: In your opinion what should the government do to get the rating upgraded?

Answer: Sri Lanka faces significant foreign debt maturities in 2016 due to excesses in the past with debt service commitments of USD 4 billion in 2016 with only USD 6.3 billion reserves in hand at present. For a rating upgrade, Sri Lanka will have to work hard to attract a significant amount of FDIs and increase exports to build the foreign reserves.

The government urgently needs to make a stronger effort to reduce the general government debt which is around 75% of GDP now and narrow the fiscal deficit by broadening the government revenue base and put public finances on a sustainable path for a rating upgrade.

The success of the government implementing long-overdue predictable and robust policy reforms are, however, in the midst of current political undercurrents is yet to be seen.