(The following statement was released by the rating agency)
Dec 13 -
Summary analysis -- Sri Lanka (Democratic Socialist Republic of) -- 13-Dec-2012
CREDIT RATING: B+/Stable/B Country: Sri Lanka
Primary SIC: Sovereign
Mult. CUSIP6: 24811E
Mult. CUSIP6: 85227S
Credit Rating History:
Local currency Foreign currency
29-Feb-2012 B+/B B+/B
14-Sep-2010 BB-/B B+/B
15-Dec-2008 B+/B B/B
The sovereign credit rating on Sri Lanka is constrained by weak external liquidity, moderately high external debt, fundamental fiscal weaknesses, the attendant high public debt and interest burden, and political institutions that, in some cases, lack transparency and independence. The rating is supported by improved growth prospects and the government's moderate progress in addressing a number of structural weaknesses through fiscal measures and success in limiting inflation to single digits.
Sri Lanka's gross international reserves rebounded moderately to 4.3 months in September 2012 from 3.2 months in February 2012, to cover payments for the country's imports. The reserves rose because of policy shifts by the government and central bank to control the pace of credit expansion and imports since February 2012 and the government's and domestic banks' external funding. However, the level of reserves remains relatively low.
A narrow tax base, the burden of a civil conflict, extensive subsidies, and a bloated public sector have contributed to the country's fiscal deficit of 7.6% of GDP on average over the past decade, with the change in debt often exceeding the deficit because of currency depreciation. We expect the general government deficit to improve to 6.7% of GDP in 2012 from 6.9% in 2011. However, despite this improvement, the debt burden could increase to 83% of GDP at the end of 2012 from 78% in 2011, mainly because of the 30% depreciation of the Sri Lankan rupee (SLR) against the U.S. dollar. High inflation in the past has constrained investment and raised the general government interest burden to about 40% of general government revenues in recent years. The levels of debt and the attendant interest burden still result in a weak debt score, according to our criteria, and are among the highest in the rating category.
The ratings reflect the country's favorable growth prospects, which we believe are partly due to the "peace dividend"--positive effects from the end of the civil war in 2009. We expect investment to edge upward to 30% of GDP, boosting per capita growth to more than 6% per year in the next few years. If the business environment improves and boosts net foreign direct investment (FDI) above its current pace of about 1% of GDP, we believe stronger growth may be possible in the medium term.
The Sri Lankan administration has started to implement planned fiscal reforms, helped by increased political stability. Further reforms could gradually improve the country's competitiveness as well as fiscal and debt profiles.
The government successfully completed an IMF standby loan program in July 2012, and might start a new financial arrangement with the IMF. If this happens, it could maintain outside confidence toward the country.
The stable outlook reflects our view that the country's strong medium-term growth prospects of more than 6% of GDP per capita and recent measures to improve the fiscal profile are balanced against vulnerable external liquidity and high fiscal and external debt. We also expect a new monetary and foreign exchange policy to keep the country's external position from further deterioration. We may raise the rating on Sri Lanka if there is evidence of progress in addressing external weaknesses and domestic problems, such as fiscal or structural economic reforms that reduce the vulnerabilities from high debt and interest burdens and the still-narrow economic profile. Conversely, we may lower the rating if there is substantial further deterioration of the country's external liquidity, or if Sri Lanka's growth and revenue prospects fall below our current expectations.