Colombo, November 22 (newsin.asia): Sri Lanka’s Central Bank has strongly objected to the statement released by Fitch Ratings on 20 November 2019 titled “Sri Lanka Election Result Increases Policy Uncertainty”.
The CBSL said in its statement released on Friday, that the Fitch Ratings’ grim scenario does not match reality.
“It is the complete opposite of the positive market response to the outcome of the Presidential election,” the CBSL asserted.
Coming within days of the assumption of office by the newly elected President Gotabaya Rajapaksa, Fitch Ratings’ assessment is not only premature but is based only on speculation of what the government might do, the CBSL pointed out.
The domestic foreign exchange market, as well as debt and equity markets have responded positively to the outcome of the election.
The Sri Lankan rupee has appreciated by more than one rupee against the US dollar during the four days since the conclusion of the elections. During this period, there has also been a sharp decline in the forward premia, reinforcing expectations of a further appreciation of the rupee.
In the Government securities market, primary market yields declined sharply at the auction for Treasury bills held on 20 November 2019 while the secondary market yields have also declined notably across the yield curve. Meanwhile, ISB yields have behaved orderly since the start of the business week.
Foreign investors have continued to invest notable amounts of funds in the Sri Lankan rupee denominated Government securities.
Moreover, the All Share Price Index of the Colombo Stock Exchange has Communications Department 21.11.2019 2 increased significantly over the past few days. Ignoring these positive market trends is a material omission in the statement issued by Fitch Ratings.
As the government is still being formed, the Central Bank is of the opinion that it is premature for any analyst to express a view on the precise policy path of the new government and its potential outcome.
There is a high likelihood that the aforesaid positive market sentiments could strengthen further in the period ahead, with the dissipation of political uncertainties.
Initial measures introduced by the government thus far indicate His Excellency the President’s resolve to maintain a professional and strong governance structure in the new administration.
Accordingly, the contents of the Statement issued by Fitch Ratings, which are purely based on loose assumptions, cannot be endorsed, particularly as they are very much at variance with actual market developments and expectations.
Fitch Ratings’ Statement
In its statement Fitch Ratings had said: “Sri Lanka’s presidential election significantly increases policy uncertainty and could prompt loosening that exacerbates fiscal weaknesses and a rollback of reforms, Fitch Ratings says. However, whether these risks materialise remains to be seen as a clear policy direction may only start to emerge after parliamentary elections.
Gotabaya Rajapaksa of the Sri Lanka Podujana Peramuna (SLPP) defeated Sajith Premadasa of the ruling United National Party (UNP) in Saturday’s election. He is a former defence secretary and the brother of SLPP leader and ex-president Mahinda Rajapaksa. Mahinda Rajapaksa has been named prime minister following the resignation of the UNP’s Ranil Wickremesinghe, and an interim cabinet is likely to be appointed.
The policy environment in Sri Lanka (B/Stable) had improved following the resolution of the 2018 political crisis, supporting the resumption of fiscal and economic reforms and of Sri Lanka’s IMF programme. However, political tensions could resurface ahead of elections to parliament, where the UNP is the largest party. These are expected early next year. The new president’s constitutional reform plans could resurrect controversial proposals to enhance the executive’s powers.
Gotabaya Rajapaksa’s economic manifesto targets average growth of 6.5% or higher, compared with 3.2% in 2018 and a Fitch-forecast 2.8% in 2019, by promoting commodity and apparel exports, construction and tourism. Strengthening growth and exports would be credit positive, but we think there is a risk of a more expansionary fiscal stance after the parliamentary elections.
Under Mahinda Rajapaska’s presidency from 2005-2015, an aggressive infrastructure drive pushed up government debt. Gotabaya Rajapaksa’s manifesto targets a budget deficit below 4% of GDP and inflation below 5%. Although detailed economic plans are yet to be announced, we think achieving ambitious growth targets could entail stimulus measures that erode fiscal headroom, which is limited by high public debt (about 83% of GDP). This could undermine policy credibility, investor confidence, and potentially complicate relations with the IMF.
The new president’s manifesto suggests that the undermining of monetary policy credibility that was a feature of Mahinda Rajapaska’s presidency will not recur. An important measure of this commitment will be the status of a planned amendment to the Monetary Law Act, which would establish price stability as the central bank’s primary objective and support the shift towards flexible inflation targeting.
Gotabaya Rajapaksa’s commitments on social spending and public-sector wages and pensions could jeopardise deficit reduction unless government revenue (which is low at just over 13% of GDP) increases. His manifesto includes plans to replace the Inland Revenue Act, a lynchpin of fiscal reforms under the IMF programme, to unify VAT (currently 15%) and the Nation-Building Tax (2%) with a single VAT rate of 8% and cap personal income tax rates at 15%. If these lead to revenue losses, they could put Sri Lanka’s medium-term fiscal consolidation plan at risk.
A 4% deficit may therefore prove challenging. We forecast the deficit to stabilise at about 5% of GDP in 2020-2021, as GDP growth recovers from the April bombings in Colombo.
Contingent liabilities from major state-owned enterprises (SOEs) pose risks to debt sustainability.
Gotabaya Rajapaksa’s manifesto says that SOEs will not be ‘a burden to the exchequer’ but SOE reform has been difficult to achieve. A high share of foreign-currency debt could also pressure debt sustainability if investor confidence deteriorated and the rupee fell sharply.
The market reaction to the election has been mildly positive. The Sri Lankan currency has appreciated by about 0.5% against the dollar and the Colombo stock index rose by about 2%.
A row-back on reforms could have implications for Sri Lanka’s IMF programme, which has been extended to June 2020.
The sixth review was completed in September and, coupled with USD4.4 billion of sovereign bond issuance this year, has eased near-term external pressures. But external debt repayments are substantial at USD 19 billion in 2020-2023 (against reserves of USD 7.8 billion).