30 September, 2020

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Moody’s Downgrade Of SL Sovereign Debt: A Pat For Central Bank, While Slapping The President

By W A Wijewardena –

Dr. W.A Wijewardena

Sacking of a Government and harvesting a credit downgrade

Moody’s Investors Service, in a recent ratings change, downgraded Sri Lanka’s sovereign debt from B1 to B2, while improving the country’s economic Outlook from Negative to Stable.

Its prompt move to revise Sri Lanka’s rating status is understandable, since rating agencies had been blamed for not warning the investors in time before Greece bonds became worthless in 2009. The other two rating agencies, Standards and Poor’s and Fitch Ratings, are yet to come up with their own analysis of the country’s changed debt profile after President Maithripala Sirisena on 26 October summarily sacked his three-year-long companion in power, Prime Minister Ranil Wickremesinghe, and appointed his arch enemy, the former President Mahinda Rajapaksa, in his place.

The economic fallout of this rash action was analysed by me in a previous article in this series in which I argued that the economy was to be the casualty unless the man-made constitutional crisis was resolved quickly. Yet, the crisis lingered on moving from bad to worse in each passing day without any sign of a sound resolution in sight.

This made investors in Sri Lanka’s sovereign debt nervous and anxious. For instance, the Sri Lanka government sovereign bonds that are to mature in January and April 2019 witnessed a rate jump from around 5.5-5.8% to around 9-10.8% within a week. This is quite contrary to the behaviour of bonds which have a tendency for market prices to converge to face values when the maturity date comes closer. What it implied was that the holders of these bonds have attempted to quit them by dumping them in the market wholesale. Hence, Moody’s has fulfilled its obligation to investors by coming up with a revision in rating and faulting the rating agency for doing so may not be in order.

Two components of rating results

The rating results pertaining to a sovereign borrower have two components. One is an ‘alpha-numerical value’ it assigns to a country indicating the probability of a sovereign borrower defaulting a particular borrowing. The other is the subjective assessment about the short to medium term outlook of the economy, whether it is healthy, stable or unhealthy.

An alpha-numerical value to denote the probability of credit default

In the case of Moody’s, the alpha-numerical values with low default risk have ranged from Aaa denoting the best to Baa3 denoting passable. These are known as investment or prime grade borrowings. Those assigned from Ba1 to C carry a high default risk and are normally known in the market as speculative or non-investment grade borrowings. In the market terminology, these bonds are derisively known as ‘junk bonds’ or simply ‘junkies’.

Since the profit is the degree of risk which an investor would take, there is a demand for these junkies too. The only difference is that the investors will expect a higher profit or yield to compensate for the higher risk they are taking. This additional profit they are expecting is called the ‘risk-premium’ and it changes from 4% at best to even 10% at worst.

Sri Lanka had been rated at B1 earlier by Moody’s or its equivalent at B+ by Standards and Poor’s and Fitch Rating. This was four notches below the investment grade borrowings and, hence, were categorised as junkies. Since the risks were high, the risk premium which investors put on Sri Lanka was about 4-4.5% over the rate which a best borrower at Aaa would have got. With the downgrading from B1 to B2, this risk premium will jump at least by about half a per cent or in market terminology by about 50 basis points.

Since the risk premium in the case of bonds to mature in 2019 has already jumped to about 8%, the risk is that Sri Lanka would not be able to issue sovereign bonds in the market for less than 10% immediately. That is why a Sri Lankan Government official in a recent press briefing had opined that it was not time for the country to go to the international sovereign debt market immediately and would look for funding from elsewhere.

Subjective assessment of economic outlook

The second component of a debt rating, the country’s economic outlook, is a subjective assessment of the state of the economy based on what the assessor has read about its plans, developments and actual achievements. This subjective assessment can be one of the three positions, Positive, Stable or Negative.

This can be compared with the opinion expressed by a physician on a patient based on the latter’s reaction to the medication administered to him. If the physician opines that the condition of the patient is negative, his health conditions are fast deteriorating, he does not answer to medication and he needs to have special care in an intensive care unit for otherwise it is not possible to save his life. It is a hopeless case. If the condition is stable, he has improved a lot, can be transferred from the Intensive Care Unit to the ward and will, with good medication, have the chance of recovering fully. If it is positive, he has recovered, answered well to medication and could be discharged from the hospital with only follow-up wellness treatments.

In the case of an economy, changing from Negative to Stable means that the economic patient of Sri Lanka has answered to past medication and could recover completely provided proper curative treatments are administered to him. It is out of danger and could be transferred to the ward for normal treatments. It is indeed a good sign for Sri Lanka’s ailing economy.

Subjective assessment is based on evidence

In the past 10 year period since Sri Lanka was subject to international credit rating, the country had never been in the Positive category. It had hovered between Stable and Negative positions, moving from one to the other quite frequently.

As I mentioned earlier, this is a subjective assessment based on evidence. The evidence is gathered by rating agencies from a variety of sources, namely, plans of the country, published and unpublished data, interviews with public officials, political leaders, officials in international agencies like IMF, World Bank, ADB or UN System and private sector think tanks and thought leaders. All the evidence gathered is screened, assessed and synthesised to form a single opinion on the country: whether the economy shows good signs, remain at an acceptable level or has moved into worse conditions.

Once again, if this subjective assessment is not to the liking of the authorities, all they can do is to change the behaviour so that those who provide information on the country will paint a favourable picture about the prevailing economic status. Fighting a war with the rating agency on that count will prove unproductive.

The man-made political crisis is the culprit

Moody’s has reasoned out the downgrading from B1 to B2 as follows: ‘The decision to downgrade the rating to B2 is driven by Moody’s view that ongoing tightening in external and domestic financing conditions and low reserve adequacy, exacerbated most recently by a political crisis which seems likely to have a lasting impact on policy even if ostensibly resolved quickly, have heightened refinancing risks beyond levels anticipated when the rating agency affirmed the rating at B1 with a Negative outlook in July. Moody’s projections include a slower pace of fiscal consolidation than assumed in July to reflect disruption to fiscal policy implementation in a period of political turmoil.’

The crisis will have a lasting impact on the economy

The main culprit has been the political crisis which has worsened the country’s ability to raise new funds to meet its prevailing debt servicing obligations. This crisis is the handiwork of the President, as many analysts had pointed out, by taking a hasty decision to fire a government based on his personal vendetta against its Head and appointing a government which does not command majority in Parliament.

The inability of the government appointed by the President to show its majority in Parliament has been demonstrated by a score of defeats it has suffered in the House in the last 10-day period: two no-confidence motions, one policy statement and a further one involving the composition of the Selection Committee in Parliament. As the world saw it, the members of the President’s government had resorted to unruly behaviour within the House, walked out of it without facing a vote and resolved themselves to the tactic of briefing the media on what they were planning to do to gain power in Parliament.

Moody’s feels that even if this crisis is resolved by using ‘ostensible’ tactics, it will have lasting impact on the country’s decision making processes. In other words, in the opinion of Moody’s, the country’s ability to get out of the present economic crisis is not within sight due to the man-made political crisis.

Credit downgrade is a slap for the President

Moody’s has also noted that the prevailing political crisis has weakened Sri Lanka’s ability to implement a full-scale economic reform program which it had promised the IMF when the country sought its assistance in 2016 under an Extended Fund Facility or EFF.

Says Moody’s: ‘A steady and credible implementation of planned fiscal and economic reforms would improve Sri Lanka’s ability to sustain investor confidence through the upcoming period of large debt maturities. However, the likelihood of the government pursuing its reform agenda on the previously planned schedule has fallen following recent political events that have interrupted the reform momentum. Moody’s does not expect the current political crisis to be fully resolved rapidly, and the crisis is in any event likely to leave its mark on the pace and content of the reform program. Even if past episodes of political disruption have not changed the broad direction of reforms in Sri Lanka, delays in the pace of reform will at a minimum limit the government’s ability to respond to changing market conditions.’

The important reading here is that the current political crisis will not be resolved quickly and even if it is resolved, it would affect both the speed and the coverage of the reform program. In other words, they would be too slow as well as too short. Hence, the downgrade of the country’s credit rating from B1 to B2 is a slap for the President.

Cause of downgrade has been the worsened ‘eyeball fundamentals’

The Central Bank, as usual, has issued a protest statement against the downgrade. The bank has argued that the downgrade has not done justice to the improved macroeconomic fundamentals of the country in the recent past. In fact, as I have presented above, the cause of the downgrade has not been any worsened macroeconomic fundamentals.

Indeed, they have improved slightly with promise to deliver better results in the near to medium term. Inflation has been subdued, exchange rate corrected to reflect better market conditions and the budget on a pre-planned consolidation path. The cause of the downgrade has been the worsened ‘eyeball fundamentals’ as demonstrated by the lingering political crisis with no resolution in sight and a government totally non-functioning due to lack of majority in Parliament. These are visible fundamentals to concerned Sri Lankans as well as foreign investors.

No budget for 2019, no expenditure as well

For example, take the case of the government’s expenditure and revenue programs for 2019. With the prorogation of Parliament and due to the riotous behaviour of parliamentarians, there is no possibility for presenting a budget now in Parliament and get it approved before the end of 2018. Even if a temporary vote on account is presented by the Rajapaksa group, it is unlikely that it will get the sanction of the legislators.

Unless the government spends money, tax people and borrow funds by violating the Constitution, the government services will come to a standstill in 2019. That is because without a budget, it will have no powers to spend money, raise new taxes or borrow money to meet any gap in the revenue. The repayment of debt is also at risk, though some have argued that the governing debt legislations have empowered the Deputy Secretary to Treasury to charge it to the Consolidated Fund, a fictitious account that does not exist in reality.

The fictitious Consolidated Fund

As I have argued in a previous article, the Consolidated Fund which is always overdrawn is simply a summary of the cash-flow of the Treasury and if there are no adequate credits to that cash-flow, no debits can also be made to it. To repay foreign debt, for example, the government has to buy foreign exchange from the Central Bank which has enough of it now by delivering rupee funds.

In the past, if rupee funds are not available, the Central Bank made a temporary arrangement by supplying the same by issuing a Treasury bill to itself. Without Parliamentary sanctions, this also cannot be done in 2019. In the past, the government was a beneficiary of the provisional advances given to it by the Central Bank up to 10% of the estimated revenue of the government for the forthcoming year. Since that revenue was always bigger than the previous year’s revenue, there was always a net gain for the government by way of fresh money.

Without a budget for 2019, this source is also closed for the government. Hence, there is the overdrawn Consolidated Fund and debiting it to generate rupee funds to buy foreign exchange is a farcical exercise. These are the hard ‘eyeball fundamentals’ which Moody’s has used to downgrade the country’s credit rating. Hence, instead of finding fault with Moody’s, a solution has to be sought to overcome the present budgetary impasse.

A pat for the Central Bank for good achievements

Meanwhile, the Central Bank should be happy because the decision to upgrade the country’s economic outlook from Negative to Stable has been due to the positive action taken by the bank to bring about a better set of macroeconomic fundamentals.

Moody’s has justified the upgrade as follows: ‘Over the medium term, planned changes to Sri Lanka’s Monetary Law Act should help the Central Bank anchor inflation expectations and ensure monetary policy independence from fiscal developments. A shift toward market-oriented policy frameworks – including inflation-targeting and floating exchange rate policies – could increase the effectiveness of Sri Lanka’s monetary policy by helping to stabilise the cost of debt at lower levels than in the past and bolster fiscal flexibility’. Thus, the Central Bank should not take offence since it is a pat on its back.

To resolve crisis, go back to pre-26 October state

The way to resolve the crisis, as I have suggested in my previous articles, is for the President to keep a step backward, go back to pre-26 October state after the withdrawal of the support to Wickremesinghe Government by UPFA but before swearing in of Rajapaksa as the premier and allow Parliament to select a government which can present for the time being a vote on account to cover expenses at least for the first three months of 2019.

*W.A. Wijewardena, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at waw1949@gmail.com

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Latest comments

  • 1
    2

    Dr. Wijewardane: CHAVEZ of Venezulla who drank the Polonium cocktail from his friends, I suppose the opposition political party, who could not be saved even by the cuban hospitals tols that Wealthy Venezula because they had Oil resources, was not doing economically. that was Lehman Brothers bigger than Moody who writes reports for MCC cohorts. I understand what you are doing andI suppose even MS + RW will understand it. How about their public debt is 13 Trillion. business debt is 9.5 billion. They import a lot. Yet they have AAA rating ? Who fund those ? Even we pay those.

    • 5
      0

      Thanks for this Dr. Wije.
      1. Would you please give us an assessment of the breakdown of who owns Sri Lanka’s sovereign debt? From Central Bank figures it seems that 55% is owned by US linked bond traders. Of the remaining 45% of debt, most of which are long-term concessionary loans the ADB and JICA around 23%, World Bank 12%, IMF ?, China 10.3 % and India 3%. Is this correct?
      2. There is no transparency about the 55% percent owned by bond traders some of which are maturing in in 2019-20, who are primarily responsible for the crashing rupee. The Central Bank should release this information to the general public.
      3. This info. re. Lanka’s sovereign debt ownership is necessary for debt restructuring and a discussion on the external players who have colluded with corrupt local politicians and Bondscam Ranil in an Economic War against the Sri Lankan people to put the country in a debt trap, crash the rupee and asset strip the island’s strategic resources (land, transport and energy security infrastructure, data platforms for big Data and logistics info. systems).
      4. As you know there is a Cold war in the Indian Ocean between Trumpland and China and Sri Lanka sits on a choke point of Undersea cables and internet traffic, trade and oil flows. There has also been a cyber-war with fake news against China to blame it for Lanka’s debt trap ,when in fact China has only 10.3 percent of the debt.

      • 1
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        “I have presented above, the cause of the downgrade has not been any worsened macroeconomic fundamentals. Indeed, they have improved slightly with promise to deliver better results in the near to medium term.”

        If this is so, it seems that Sri Lanka which is a small economy, is being played and preyed on at this time, by those with geopolitical interests who want to put us in a Greece-like, debt trap, and then control economic and security policy and also asset strip Lanka to benefit global 1 percent. US’ Asia proxy Japan’s Nomura ratings (which bought Lehman brother after the crash) started the run on the Lankan rupee when it published Fake data on Lanka’s debt figures in its useless Democlese Index. Moodys is playing the same game.Let’s hope that Fitch and S&P do a better job on ratings.
        Clearly, Moodys and Nomura are part of a nexus of rating agencies that work of the Global 1 percent and America first.
        Also, why has IMF-WB which are supposed to be in charge of global financial governance turn a blind eye to the Bondscam at CBSL and not helped recover funds of those named in Panama Papers who pumped and dumped on the CSE?
        At this time there is a Washington-triggered “economic war” against the people of Sri Lanka and a cyber war against China which is being accused of “debt-trap diplomacy’ by Trump-land deep state related Economic hit men, because of China’s growing influence in the Indian Ocean and tiny but strategically located Sri Lanka.
        Those practicing the dismal science need to learn about geopolitics too!

  • 13
    0

    Do not waste your time in advising these people ….
    We can not make them understnad political economy…
    Today ; politics and economy are intertwined…
    But ; these people do not understand ..
    50% Mps would not understand what you talk.
    I doubt president can understand this type of economic consequence ..
    If he knows that he would not put the country in this situation..

    • 0
      0

      Not just the polticians per se, but those in the financial institutes for ages should be made responsible for the setbacks.

      Dr Wijewardhana may be an expert, but his has sometimes been abused by SIRASA all along MS-RW govt. That wasseen not fine.

      Susiripala T was the other parrots that worked with SIRASA to paint almost even good things as bad just because they stood bitterly against Ranil W.

      But very same SUSIRIPALA is made silent today

      Wijewardhana is seen as valid how come ? None of them seem to have guts to stand against RAJAKASHEs and their dangerous involvements in lanken finances.

      How on earth, a govt can be run without getting a budget passed in the parliament ?

  • 0
    2

    “The way to resolve the crisis, as I have suggested in my previous articles, is for the President to keep a step backward”
    You got it wrong again Dr. Wijewardena. The only way forward is for the SINHALA MOADAYA to get a brain transplant from some animal with a better IQ. If not the best suggestion is to experiment with our state leadership to appoint minority member as our leader who may be better than any Sinhalese idiot who cannot govern. I think even a minority party leader like Hon. MP Anura Dissanayake would be a better suggestion. But this is not something majority of the Sinhala bigots and the Saffron robed terrorists like the Ganansara, the Jaathika Hela Urumaya and karummay baiya’s or the Mahanayaka Sangha pumbaya’s would agree to. Hence, never ever will we see a Barak Obama type of USA president or a Manmohan Singh type of a Indian PM emerge in our Sinhala BALLU racists banana republic.

  • 2
    2

    We are becoming a banana republic by the day, this is what happens when a gamrala is appointed to run a country, actually the problem lies with the people as they are uneducated doesn’t have a clue on what is required to run a country

    This is the reason in the private sector executives are chosen and compensated based on their qualifications and experience

  • 1
    2

    Wait till end of this year to see the next rating, Also will have to see S & P ratings. Some of the debt will mature at the end of this year and if not honored the ratings will take a nose dive.

  • 3
    1

    Dr. Wijewardena,
    “This crisis is the handiwork of the President, as many analysts had pointed out, by taking a hasty decision to fire a government based on his personal vendetta against its Head and appointing a government which does not command majority in Parliament.”
    I am an admirer of you as a person who provides impartial analysis on economic issues but I tend to differ with you on this statement. I do not think the reason for firing Ranil is a personal vendetta. It is no longer a secret that Ranil used Sirisena to grab power and discarded him as a partner in the so called ‘Yahapalana Government’. Ranil, with his ‘Royal Gang’ took over decision making ignoring the views of the partner. I think two things triggered President’s decision to fire Ranil.
    1. His determination to bulldoze the Federal Constitution at any cost to please the paymasters of ‘Regime Change’.
    2. Exposure of the plot to assassinate President and Gotabhaya.
    If these two things happened, country could have plunged into a bigger crisis than what the country is experiencing now.
    Remember that although President wanted to remove Ranil, he did not want to put the ‘Yahapalana Government’ into jeopardy. He did not stab U.N.P. in the back as he did with Mahinda Rajapakse in 2015. He told the problem he is facing to U.N.P. politicians but none of them had guts to go against the autocratic leader and rescue the ‘Yahapalana Government’. Mahinda Rajapakse was his third choice. He decided to sleep with one time enemy to save the country from a political and even an economic disaster. In politics there are no permanent friends or permanent enemies!

  • 1
    0

    Subjective assessments have been the facts all along with Susiripala et al together with SIRASA for the last 2 years.

    They talk high about BOND SCAM, but not much is being criticised why on earth they the rulers did not go to investigation it after 2008 ?

    What was with Kabral ?

    Why the ballige putha Kabral was not made accoutable to high losses to that time ?

    Just let these buggers to utters to their hearsays, was the part of the deal of SIRASA on and on.

  • 0
    0

    Hopefully “Moody’s Downgrade Of SL Sovereign Debt” is non-political.
    This must not be ” A Pat For Central Bank” or “…Slapping The President”.
    The President is busy shoring up the ‘Self-preservation Fortress’. He has no time to worry about this ‘Moody Rating’ thingy. This will only affect the lay-Lankans.

  • 0
    0

    “ To repay foreign debt, for example, the government has to buy foreign exchange from the Central Bank which has enough of it now by delivering rupee funds.
    In the past, if rupee funds are not available, the Central Bank made a temporary arrangement by supplying the same by issuing a Treasury bill to itself. Without Parliamentary sanctions, this also cannot be done in 2019.

    Let me understand this. The Treasury is writing up an income line or a loan line that does not really exist, in its books, to manage the temporary difficulty. In that case, to maintain the safety level, it seems serious precision has to be maintained by talented bankers and economist. That may not be a difficult issue because the Treasury is a Going on Concern and the staff should have experience to check the thermostat. But what I am wondering is why the 8th graders voting on this? Honestly how much they get when this come to parliament? I really don’t mean the batta, whether it is 15% or 25% of the bill, but how do they judge that they are signing up for correct amount at least?

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