First Capital Research has announced in its mid-year outlook that it is highly likely that Sri Lanka will negotiate an International Monetary Fund (IMF) programme within the current quarter, which ends this month.
The outlook comes at a time when former State Minister Ajith Nivard Cabraal, who continuously emphasised that Sri Lanka will not go for an IMF programme, stepped down from the state ministerial portfolio of Money, Capital Market, and Enterprise Reforms and is due to once again become the Governor of the Central Bank of Sri Lanka (CBSL) this week.
While there are rumours of negotiations with the IMF, so far, such a programme is yet to materialise. However, according to First Capital Research, considering the economic indicators of the country which have proved to be worse than the initial estimates for the year, there is an 85% probability that Sri Lanka will consider moving to an IMF programme as soon as possible. This development represents a divergence from the stance of the Government of Sri Lanka (GoSL) over the past 18 months that IMF support wasn’t required.
First Capital Research added that the primary concern for Sri Lanka is the rising debt obligations with the country’s rupee and dollar obligations alone – which includes International Sovereign Bonds (ISBs), Sri Lanka Development Bonds, and Rupee Bond maturities – estimated to be around Rs. 1 trillion for 2021 and is expected to exceed Rs. 1 trillion in 2022.
Foreign debt repayments in particular are of a major concern to the country due to the dwindling foreign reserves of Sri Lanka, which fell to $ 2.8 billion in July 2021, its lowest position since July 2009. The reserves rebounded in August 2021 due to the influx of $ 787 million from IMF’s special drawing rights (SDR) allocation and $ 150 million from the Bangladesh Central Bank under the swap arrangement.
The existing foreign reserves are insufficient to meet the foreign currency debt obligations of the country due for the period from July 2021 to July 2022, which amounts to around $ 7 billion. Currently, this represents the biggest risk to the system and is the primary cause of the weak status of the Sri Lankan currency.
According to First Capital Research, with regard to foreign currency debt repayment, 1Q 2022 and 3Q 2022 will be the most stressful periods. While high levels of debt obligations shall become due in 4Q 2022 as well, a significant portion of it shall be rupee debt.
This situation is exasperated by the limited borrowing options available to the GoSL in this pandemic-affected environment. Potential options for funding for the GoSL include plans for sale of underutilised assets amounting to $ 400 million, a $ 300 million loan from the China Development Bank, potential swaps with India for $ 400 million, and receipts from forex purchases and inflows due to ownership of ISBs by local banks, amounting to an estimate of $ 500 million.
The current pandemic environment has adversely affected foreign direct investment (FDI) inflows into Sri Lanka which fell to $ 687 million in 2020. First Capital Research estimated FDI inflows to fall further in 2021 to around $ 550 million. However, the Port City project is of interest to certain global and local investors who see potential in the financial hub concept to be implemented within the Port City. Therefore, FDI inflows are expected to increase in 2022, reaching an estimated $ 950 million.
According to First Capital Research, the limited borrowing options available together with the decrease in FDI flow shall ultimately result in an estimated balance of payment deficit of around $ 2.1 billion in 2021 and $ 789 million in 2022, and shall lead to the further deterioration of the foreign reserve position of the country. Accordingly, foreign reserves are expected to fall to dangerously low levels of $ 3.5 million by December 2021 and $ 3 billion by June 2022.
Due to the heavy debt burden of the country and its deteriorating foreign reserves, two out of the three foreign rating agencies have indicated potential downgrades. Recently Moody’s announced the decision to place the GoSL’s Caa1 foreign currency long-term issuer and senior unsecured debt ratings under review for a downgrade. Similarly, S&P Global cut the rating outlook of Sri Lanka’s CCC+ rating to negative. Fitch, however, has affirmed the rating for Sri Lanka at CCC. Nonetheless, it should be noted that Fitch does not provide “outlook” for countries with ratings of CCC and below.
Despite these negative developments, Sri Lanka recorded a GDP growth of 4.3% during 1Q 2021 exceeding the 2.4% target set by First Capital Research. However, GDP growth during the 3Q 2021 is expected to be adversely affected by the fourth wave of the pandemic. In comparison, the equivalent period in 2020 was an extremely strong quarter due to the rapid growth observed after the end of the first lockdown. Therefore, First Capital Research has revised its GDP forecast for 2021 to 4.0% as against the previous forecast of 3.2%, while upgrading the 2022 forecast to 4.3% as against the previous forecast of 3.8%.