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| Opposition leader Ranil Wickramasinghe holds currency notes to protest economic policies |
The cash crunch faced by Sri Lanka continued to worsen this month with rating agencies considering down grading the credit rating for the state following recent escalation in the island’s ethnic conflict, a sharp drop in tourism and turmoil in the global credit markets.
Fitch Ratings, which rates Sri lanka as BB- (or three levels below investment grade), announced that the escalation of violence between the military and LTTE and the mounting losses in US sub prime markets, which is forcing investors to shun low-grade debt could lead to a ratings downgrade for Sri Lanka.
“We continue to regard the negative outlook on Sri Lanka's ratings as appropriate,” said Paul Rawkins, London-based senior director of Fitch's sovereign team to an email enquiry by Bloomberg.
“The security situation remains a cause for concern and the macroeconomic policy environment is not encouraging, particularly in the light of current global financial market turmoil,” he added.
On August 2, Sri Lanka hired JPMorgan Chase, Barclays Capital and HSBC to help manage bond sales aimed at raising as much as $500 million overseas.
The launching of offensives by the Sri Lankan forces seeking to drive the LTTE from the eastern province led to an escalation of fighting and has left the cease fire agreement signed in 2002 between the two sides existing only on paper.
With Sri Lankan Defense Secretary Gothabaya Rajapakse, brother of President Mahinda Rajapakse, reaffirming that the Sri Lankan forces intend to capture the LTTE stronghold of Vanni in northern Sri Lanka next, analysts expect more fighting in the coming months.
The combination of prospects of more war and recent global turmoil in credit markets have it made harder for Sri Lanka, which has the highest borrowing costs in Asia, to raise funds overseas, reports said.
Bond Issue
The Economist, commenting on the Colombo’s proposed $500 million bond issue argued that whilst it constituted a temporary palliative, its long term consequences were serious.
“There is no doubt that an additional borrowing of US$ 500 million would add heavily to the country’s debt burden,” the magazine said.
At the end of 2006 the foreign debt had accumulated to Rs. 956,620 million (approximately US$ 8696 million) and at the end of May this year it had risen to Rs. 1,210,900 million - about 11 per cent higher than 12 months before, it said.
“Therefore the additional debt alone would raise the debt burden to Rs. 1,265,000 million. In addition the country has a higher domestic debt as well. At the end of May this year the domestic debt had risen to Rs. 1,560.8 billion,” it said. Public debt had risen to nearly the amount of last year’s GDP.
Last year Sri Lanka’s debt servicing absorbed about 28 per cent of government expenditure.
In the past owing to the most foreign borrowing being from multilateral agencies at concessionary rates the cost of foreign borrowing was manageable - even at the end of 2006 foreign debt payments absorbed only 12.7 per cent of our export earnings.
However, this percentage has been increasing in recent years and the bond issue would raise that as the interest rates are higher than the country has paid in the past when it borrowed little from commercial sources.
The period for repayment is also much shorter than the borrowings from multilateral agencies.
The government has resorted to commercial borrowing as the government can’t meet the conditions of good fiscal management required by these agencies, The Economist charged.
There are also doubts on what the loans would be used for.
The government claims it would use it for infrastructure development. However, the Economist argued that infrastructure development at commercial rates of borrowing is not prudent, as such investments pay off over a long period of time.
Besides, it is alleged that the infrastructure for which the money is to be spent already have been funded.
Therefore, the magazine said, it is contended that the money is in fact for war expenditure.
The bottomline of the bond issue is that the government is passing on a debt burden for the future, the magazine concluded. These questions imply that the borrowing is ill-advised.
Complicating the bond issue further, Sri Lanka’s main opposition United National Party has declared that it would not honour the agreement and suspend payments if and when it comes to power.
Furthermore, the UNP is considering an unusual course of action, of writing to HSBC, JP Morgan Chase and Barclays, the three joint lead managers of the bond issue, questioning their ‘collusion’ in the corrupt activities of the Rajapakse government.
Opposition leader Ranil Wickremesinghe, addressing a public rally at Matara this month said the government was seeking commercial loans for infrastructure projects that are said to be funded by China (Norochcholai power and Hambantota harbour), southern highway (Japan), Colombo harbour (ADB).
He said for 22 projects the government has requested US$500 million in foreign aid, reported the Sunday Times newspaper in Sri Lanka.
“Then why is the government seeking US$ 500 million in a bond issue when some of these projects have already got foreign aid?” he asked.
Mean while Sri Lanka's rupee weakened further to an eighth consecutive life closing low as importers bought dollars to settle trade bills.
Some analysts expect the rupee to weaken to as much as 118-120 per dollar by the end of the year. Others are expecting 114 per dollar. The rupee has depreciated over 4 percent so far this year, after weakening by around 5 percent in 2006.
The rupee is steadily depreciating mainly due to trade-related moves in an economy that runs a hefty trade deficit because of costly fuel imports and the impact of inflation.
The Colombo All Share index fallen around 20 percent since life highs in mid-February amid escalating war between the state and LTTE and high interest rates, which have prompted some investors to turn to fixed deposits and bonds.
The bourse is down around 11 percent so far this year, with renewed war between the state and LTTE hurting sentiment.
Further worsening the island’s economy, the Sri Lanka tourist board announced that tourist arrivals fell 20.3 percent in July from a year earlier.
The renewed war between the government forces and the LTTE reduced arrivals by 23.7 percent in the first seven months of the year and many hotels struggling with low occupancy are discounting rooms in a bid to lure clients.
Tourist arrivals in July totalled 44,142 compared to 55,354 a year earlier. Arrivals in June were down 30 percent.
"The arrivals have come down because of the country's security situation but the (performance) has improved," said S. Kalaiselvam, director general of the Sri Lanka Tourist Board.
"July is an off-season, so arrivals of more than 40,000 tourists is a considerable achievement amid the current situation."
A number of foreign embassies have advised nationals to avoid traveling to Sri Lanka citing the escalation in fighting.
