S&P downgrades Sri Lanka's rating on rising external financing risks

Topics S&P | sri lanka

The outlook is stable, reflecting the risks of external deterioration balanced against accommodative policies over the next 12 months
Global rating agency Standard and Poor’s has downgraded Sri Lanka’s sovereign credit rating from 'B-' to 'CCC+' on rising external financing risks and fiscal deterioration.

With the implementation of expansionary budget measures in Sri Lanka, the country's fiscal position is expected to deteriorate materially over the next few years in the absence of favourable economic and financial conditions, S&P said in a statement.
Existing funding support from official sources does not appear sufficient to cover financing needs. This means that Sri Lanka may need external commercial funding, which can be difficult and costly.

The outlook is stable, reflecting the risks of external deterioration balanced against accommodative policies over the next 12 months. Risk of external deterioration is partially offset by accommodative policies that are likely to boost domestic demand recovery.

The risks to debt servicing capacity have risen, as the government's access to external financing has become increasingly dependent on favourable business, economic, and financial conditions.

The downgrade stems in part from the impact of Covid-19, which has significantly narrowed the government's fiscal space and its capacity to generate earnings through sectors such as tourism, S&P said.

The latest expansionary budget measures are likely to further weaken the government's fiscal position. High fiscal deficits and excessive domestic liquidity will put downward pressure on the exchange rate and worsen the risks associated with the government's already-high debt burden.

“We forecast the economy will contract sharply by 5.3 per cent in 2020 largely due to the Covid-19 pandemic. Although the negative economic impact likely peaked in the second quarter of 2020, the nascent recovery was derailed by another wave of infections in early October," S&P said.

While the country has not re-imposed stringent lockdown measures, leading indicators, including the Purchasing Managers Index, showed a sharp pullback in activity. Any economic recovery before widespread availability of a vaccine is likely to be muted and prone to reversals as Covid-19 developments could be unpredictable and many neighboring countries experienced repeated waves of infections.

“Nevertheless, we believe Sri Lanka's economy will recover in 2021, boosted by a stabilization in domestic activity and expansionary monetary and fiscal settings. External demand should also recover more strongly, particularly if tourism flows could restart”, it added.

The real gross domestic product growth is expected to accelerate to 4.3 per cent in 2021, albeit from a low base, and average 4.5 per cent in 2021-2023, S&P said.

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