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FINANCIAL CHRONICLE™ » DAILY CHRONICLE™ » Sri Lanka's sovereign rating can be upped on better fiscal, monetary policy: Fitch

Sri Lanka's sovereign rating can be upped on better fiscal, monetary policy: Fitch

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Redbulls

Redbulls
Director - Equity Analytics
Director - Equity Analytics
Aug 07, 2013 (LBO) - Sri Lanka's credit rating can be upgraded if fiscal and monetary policy improves leading to greater stability and steady growth and more foreign direct investment and less debt comes for investment, a senior Fitch Ratings official said.

Sri Lanka has a 'BB-' speculative rating, three levels below investment grade with a stable outlook.
Andrew Colquhoun, head of Asia Pacific sovereign ratings at Fitch, said Sri Lanka has seen higher levels of economic growth and also investment in recent years than many similarly rated countries.

Fiscal, monetary and structural and other policy miss-steps that led to excessive demand including, high credit growth, inflation and external sector problems would be negative for the rating.

Effective macro-economic policy would be positive for the sovereign rating, he said.

Central Bank governor Nivard Cabraal said Sri Lanka wanted to get an investment grade rating (at least BBB-) by 2016 and said rating agencies did not take into account individual country differences sufficiently.

Fitch had placed Indonesia on investment grade in December 2011, Turkey in November 2012 and the Philippines in March 2013.

State Power
The state has tools and coercive power that can resist real world or market trends and worsen credit cycles, leading to bigger bubbles and collapses, including central banks which can print money to generate inflation and balance of payments trouble.

Analysts had pointed out that in 2011 the Central Bank failed to let market interest rates rise mostly due to a steep credit demand from state energy utilities, allowing pressures to develop.

The credit was ultimately accommodated by the central bank through sterilized foreign exchange sales leading to a balance of payments crisis and rapid foreign reserve losses.

A government fiscal policy not to adjust energy prices to market rate was a key underlying trigger for the surge in credit from mid 2011 when rains failed for power generation and imported fuel prices also rose.

Large banks under state control, which continued to lend to effectively bankrupt energy utilities - also under state control - to help them make more losses, suppress real market prices and fire a consumption boom, allowed the situation to balloon rapidly.

Fitch also downgraded Sri Lanka to a macro-prudential indicator (MPI) of 3 as bank credit zoomed and a stock market bubble developed.

Authorities allowed market forces to act only around February 2012, pushing up energy prices and interest rates, but sterilized forex sales continued at least until May weakening the currency further.

Policy Frame

Meanwhile Colquhoun said the actions of the past two years if looked at in a in a "glass-half empty" kind of way, may seem the government adjusted polices when "the push came to shove, or pressures became too pronounced".

But from Fitch's perspective, on one hand the government had taken some risks with macro-economic stability in the interests of growth but also had a track record of reigning in demand.

That was a policy track record consistent with a 'BB' rated country, Colquhoun said.

If authorities had allowed the situation to continue further to a level where foreign reserves fell to 2008 levels, that would be negative for the rating, he said.

Authorities are now promising formula based pricing, and allowing the Public Utilities Commission, which is in charge of power pricing to do its job instead of overriding it.

Analysts have said if energy prices are changed every six months and petroleum prices are adjusted monthly, arbitrary or political control of market prices would be taken out of the policy, allowing economic stability, stronger exchange rates and low inflation for the people.

State energy utilities and state airlines made losses of close to two percent of gross domestic product in over the past two years.

Market pricing energy could also mean that people's savings in banks would then be used for investment, leading to growth rather than funding the losses of state enterprises and also reducing dependence on foreign debt to bridge a savings-investment gap.

Colquhoun said it was not unusual for countries that depended on foreign capital inflows to have a "high-growth, high investment" model to have a trade deficit, but Sri Lanka's domestic savings rate was too low, requiring foreign capital to bridge the gap.

Savings Gap

Colquhoun said lower levels of inflation could and lower budget deficits could also improve savings.

Deputy Central Bank Governor Nandalal Weerasinghe said unlike in the 1980s, in recent years Sri Lanka had maintained positive real interest rates.

He said state "dis-saving" was a problem but the situation was getting better.

Weerasinghe said there had been a 'game changing' shift in policy where, a "high-deficit, high inflation" policy framework of 30 years had been changed to allow for several years of low inflation and steadily improving budget deficits.

Analysts say in Sri Lanka domestic savings are low mainly because the state runs about a two percent deficit in the current account of the budget, and state enterprises run similar losses.

Loss-making state enterprises are lumped together with the 'private sector' dragging down 'private savings' giving the impression that private savings are also low, though it is higher in Sri Lanka than some East Asian nations.

Meanwhile Colquhoun said using greater foreign direct investment rather than foreign debt to bridge the investment gap would be help upgrade the rating.

High foreign debt made the country vulnerable to external factors such as Fed tightening rates.

Sri Lanka has already seen some pressure with foreign investors pulling out and others not renewing medium term bonds and moving to shorter term debt in recent days.

Governor Cabraal said Sri Lanka had not allowed too much foreign capital to come into rupee bond when times were good, had placed a cap of 12.5 percent of total debt and also chosen investors who understood the country on a longer term basis.

As a result Sri Lanka had seen less foreign investor pullouts than some other countries, he said.

Colquhoun said while a World Bank indicator showed that the business environment was good, governance was weaker than BB rated countries.

Sri Lanka is expecting about 1.5 percent of GDP worth FDI this year, deputy Central Bank Governor Nandalal Weerasinghe said.

Update II
http://www.lankabusinessonline.com/news/sri-lankas-sovereign-rating-can-be-upped-on-better-fiscal,-monetary-policy:-fitch/2117443441

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