Sri Lanka’s Economic Dependency Deepens After Moody’s Rate Cut

By Shihar Aneez | Published: 2:00 AM Oct 10 2020
Columns Sri Lanka’s Economic Dependency Deepens After Moody’s Rate Cut

By Shihar Aneez

A rating cut by two notches followed by the government’s denial. Sri Lanka has yet to come out of this vicious cycle in managing the economy. 

Moody’s Investors Service last month downgraded Sri Lanka’s sovereign rating to Caa1 which is “very high credit risk.” equal to the rating of Iraq, Mali, Angola, and Congo, from B2 or “high credit risk”, the ratings enjoyed by countries like Turkey, Kenya, and Nigeria.

Moody’s said the coronavirus-induced shock will significantly weaken Sri Lanka’s already fragile funding and external positions. It also said the 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. 

Though the government, rejecting the Moody’s action, has said the rating downgrade was “unfair” and “premature”, it cannot be a surprise to the Central Bank and the Finance Ministry. 

On 17 April this year during the lockdown, Moody’s placed Sri Lanka’s B2 ratings under review for downgrade. Moody’s downgrade follows the rating cut by both Fitch Ratings and Standards and Poors’ early this year. The government rejected their downgrade as well. With all three downgradings, the government’s borrowing cost from international markets is likely to be expensive than earlier. So the government is unlikely to tap the global capital markets for ISBs this year. 

No default at any cost 

State Finance Minister Ajith Nivard Cabraal last week assured that Sri Lanka will never default any sovereign debts and said the decision to ban imports was to repay the foreign loans. The government will have to pay nearly $4.5 billion per annum for the next three years and this means it needs a lot of foreign borrowing. 

Cabraal separately in the Parliament this week said the government will not cut down any government expenditure to manage the ballooning fiscal deficit, adding, the authorities are looking at all the options including panda bonds, samurai bonds, treasury bond swaps, and syndicated loans to boost the reserves.

“We will use the appropriate option at the appropriate time,” he told the Parliament.

Foreign direct investments (FDIs) could slow down in the next few months if not for years as global corporates are looking for cost cutting to survive in the business. 

Sri Lanka’s key foreign exchange earner remittances could slow down as most countries are struggling to recover from the pandemic. Tourism earnings will only be possible after the authorities open the airport, which has been postponed indefinitely due to the latest situation on COVOD-19. 

Export earnings from garments also could slow down unless the world increasingly demand more personal protection equipment (PPE), which helped Sri Lanka’s exports to rise recently. With the latest cluster found in Brandix, export revenue from the textiles could have a hit. 

As a result, Sri Lanka’s economic dependency on large economies for bilateral loans and grants will deepen and the island nation hardly has many options. 

Debt, Economic crisis 

Successive Sri Lankan governments have rejected the claims of deteriorating economic conditions. Each government blamed the previous administration for the economic woes, but no concrete remedies were implemented to address a looming economic crisis. 

Sri Lanka is likely to see a contraction in her growth this year, if the fear of COVID-19 spreading persists. It will be the first negative economic growth since 2001following the terrorist attack on the main Colombo airport.

Sri Lanka’s debt to GDP has risen to 86.8% in 2019 from 83.7% in the previous year. The rupee was under pressure until imports were banned. Foreign inflows are expected to slow. The fiscal deficit is expected to hit 11-year high of 9% this year due to lack of revenue and unavoidable high expenditure amid long lockdown. The island nation is also facing a heavy debt repayment schedule until 2023. 

The data from January to end April show we need more loans to bridge deficit. According to the official numbers, Sri Lanka has spent 1.95 rupees for every rupee earned as government revenue in the first four months. It has spent 70 cents to pay loan interest, 1.0 rupee for salaries, pensions, and welfare payments, while it also allocated 25 cents for public investment. As a result, the government had to borrow 94 cents for each rupee it earned. The government also had borrowed further 1.24 rupees separately for every rupee it earned in the first four months to repay loan instalments. 

If the government is unable to borrow, an economic collapse is inevitable. So, Sri Lanka will have to depend on bilateral loans. 

Japan’s LRT woes 

Sri Lanka’s new Government will need some time to repair the severed diplomatic ties with Japan after it abruptly and unilaterally decided to cancel over $1.5 billion Japan International Cooperation Agency (JICA)-funded Light Rail Transit (LRT) project. 

The JICA signed a concessionary agreement with Sri Lanka for about ¥30 billion in March last year under the previous government and the total cost of which would be about ¥246.6 billion ($2.2 billion).

Not only was the project cancelled, P. B. Jayasundara, the Secretary to the President Gotabaya Rajapaksa, in a letter dated 21 September, and circulated on social media, also called the JICA-funded project as “very costly and not the appropriate cost-effective transport solution for the urban Colombo transportation infrastructure.”

The government spokesman Keheliya Rambukwella later said the government is thinking of a more efficient project that can achieve the same results but within $500 million. Adding to the woes, Trade Minister Bandula Gunawardena is quoted to have said that the project would be awarded to a Chinese company at a 6 per cent interest rate. 

The Japanese loan carries an interest rate of 0.1 percent and is repayable over 40 years with a 12-year grace period. Japan has already funded sections of new expressways and a key bridge to reduce traffic congestion in and out of the capital.

With this new development, the Japanese government is highly unlikely to come forward for any soft loan or grants for Sri Lanka. The Central Bank has been in discussion with its Japanese counterpart for a $500 million borrowing through Samurai bonds. However, this deal has yet to reach final stages, government officials say. 

Some government official say Japan has been very stringent on its project procurement process. This means local politicians cannot play with the Japanese funded projects and siphon off money unlike in some other projects. 

EU, US struggles 

the European Union (EU), except for the current GSP plus trade concessions, is unlikely to help Sri Lanka in its looming economic crisis. With the pandemic, the EU has its own woes to overcome. With no time frame for a possible anti-coronavirus vaccine, the bloc is unlikely to give priority for Sri Lankan debt crisis. 

EU has been constantly campaigning against Sri Lanka over human rights abuses during the war.Even the GSP plus trade concession is linked to the government’s rights performance and in 2009 the country lost the GSP plus because of the alleged war crimes in the final phase of the war. The trade concessions helped the country’s top exports garments to expand its market share in the EU. 

Major EU countries have expressed interest in pumping their money in the private sector. However, bureaucratic measures that had ranked Sri Lanka behind many of its peers in dong business and perception of alleged malpractices involved with approvals in government offices have discouraged EU investors. 

The United States, on the other hand, has been ready to help Sri Lanka through its $480 million grant of Millennium Challenge Corporation (MCC) after government sought for assistance since 2003. The grant was approved by the Cabinet just before the last year’s Presidential Election and that decision was heavily criticised by the present government’s policy-makers when they were in the Opposition. 

The main allegation put forward was that the MCC deal was to grab Sri Lanka’s lands and rural farmers may lose their lands. Some of the ruling coalition partners in the government have clearly said they do not want the MCC assistance which has become a political hot potato. The MCC deal is not completely out of the table yet. 

It is evident that given the upcoming Presidential Election and the worst impact of the pandemic in the world, the U.S. may not be able to help Sri Lanka to come out of its economic crisis. The world’s largest economy will undergo some policy shift if the Democrat Joe Biden wins in the next month Presidential Poll. 

The U.S. Federal Reserve and the Central Bank of Sri Lanka have recently entered into an agreement to use US dollar liquidity as a temporary source when required. The Central Bank has pledged $1 billion worth of US Treasury Bonds to be held in its reserve and enter into a repo facility with the FED. This will help the country, but still they are not investments.

India’s approach 

Being the close neighbour of Sri Lanka, India has been there in many of the Sri Lankan worries may it be the three decade war or development. Unlike in the past, the current government wants to engage with India. Foreign Secretary Jayanath Colombage’s “India First” foreign policy is part of it.

India has already signed a $400 million three-month currency swap to boost Sri Lanka’s reserves while both countries are in discussion for a debt moratorium and a $1.1 billion currency swap.

However, India has its own limitations given it is the second worst COVID-19-hit country in the world. And the perception of Sri Lankans with regard to India has been mostly not optimistic due to historic events. Role of South Indian Tamil Nadu in providing military training for Sri Lanka’s northern Tamil groups including Liberation Tigers of Tamil Eelam (LTTE) is still been discussed among senior Sri Lankan military officials.This is the reason for some Sri Lankan political parties before polls to use anti-Indian sentiment to get attention and win votes. However, India later assisted the Sri Lankan military to defeat the LTTE.

More than everything in the current geopolitical context, India is worried about increasing Chinese influence in Sri Lanka. 

“China’s influence in Sri Lanka has gone beyond the point of no return now,” a Western diplomat based in Sri Lanka says. “But Sri Lanka has an obligation to work with India as agreed in the 1987 deal on Indian Ocean’s regional security,” referring to Indo-Sri Lanka deal which later became the 13th Amendment.

Controversies still surround the 13th Amendment, which is about power sharing; which some Sri Lankan leaders see as an Indian interference. India has been of the view that it could curb any future ethnic clashes. 

China, China, China 

When it comes to Sri Lanka’s bilateral borrowings in the current context, the only country it could rely on with very little or no conditions is China.Though there are many concerns raised by India and the West led by the US on possibilies of China using Sri Lanka for its military purposes, Colombo had been increasingly compelled to depend on China for infrastructure financing and investments.

Government officials say Chinese funding slowed under the Maithripala Sirisena government, after he suspended all Chinese projects following his election in January 2015. That government also wanted to do away with the pro-China policy, which it said was followed by its predecessor. 

It is unlikely that other countries will lend Sri Lanka, at this difficult time given the COVID-19 pandemic in the US, India, and many European nations. Those countries are still struggling to recover from the worst deadly disease since 1918. 

In this background, the visit of the “high-powered Chinese delegation” this week, led by senior Chinese leader and top foreign policy official Yang Jiechi, who is a member of the Communist Party of China Politburo is crucial. 

The visit took place amid worsening India-China relations and rising U.S.-China tensions. The Chinese delegation met Sri Lanka’s President and the Prime Minister and the meeting came two weeks after the virtual meeting between the prime ministers of Sri Lanka and India. 

It also comes days after the ‘Quad’ meeting in Tokyo, where U.S. Secretary of State Mike Pompeo urged to collaborate with the regional allies in Indo-Pacific against what he called Chinese Communist Party’s “exploitation, coercion and corruption.”

China has already lent a $500 million “facility agreement” in March. The meeting was also is seen as crucial for China to move ahead with its $1.4 billion Port City launched by Xi-Jinping in 2014 after the project company was included in a blacklist by the United States.

China has been flexible to Sri Lanka on lending, mostly with no strong conditions like other countries though there will not be any soft loans, says a government official, “As far as Sri Lanka can ensure the repayment on time and deals are only on commercial basis, with no concerns both locally and internationally.”

(The writer is former Reuters Economic Reporter for Sri Lanka and current Head of Training at Center for Investigative Reporting Sri Lanka. He could be reached at [email protected])

By Shihar Aneez | Published: 2:00 AM Oct 10 2020

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