At a time of global financial crisis, Sri Lanka’s reliance on borrowing combined with plunging foreign exchange reserves, spiraling inflation and poor fiscal policies are making Sri Lanka the most vulnerable in the region, according to international monetary experts.
In its annual report, the International Monetary Fund (IMF) directors expressed their concern on the risks of public debt distress arising from the increasing reliance on dollar-denominated, short-term commercial debt.
That risk has grown more acute since the dollar has strengthened against other currencies in the last month.
IMF said the global financial crisis, which has drastically cut the availability of credit, had made "
Since October 2007,
Rupee depreciation
IMF also said the real exchange rate of the rupee has been overvalued and the central bank's protection of it could create the risk of attracting short-term speculation and volatility.
Since mid-September, the Central Bank of
After withdrawal of the 6-week long policy of defending the currency at 108 per dollar costing 100 million US dollars per week, the currency fell to 110 per dollar by the end of the week, its lowest level since late last year.
Bankers and currency dealers said they saw more rupee weakness and a foreign banker in Colombo said on condition of anonymity said: “I expect we can see some more of the same, with depreciation of the rupee,"
FX reserves
In addition to the Central Bank’s attempt to peg the Sri Lankan rupees against US Dollars, Citigroup Global Markets Asia in a market commentary attributed foreigners exiting Sri Lanka T-bill and bond market for driving the decline in FX reserves.
Citigroup estimated foreign holdings to have fallen from $670 million in early October to around $380 million in bonds and bills combined by end of October.
"We also expect the FX reserves to continue to come under pressure - we think there is still more near-term pressure of foreigners liquidating their LKR bonds and bills, especially if LKR is at increased risk, thus, presenting possibly another $380m possible outflow (assuming foreign holdings could go to zero).
"How externally vulnerable is
External borrowing
Analysts estimate the government will need external financing of between $4-$6 billion in 2009 to cover the budget deficit, short-term debt, and debt amortisation but point out the depreciating Rupee, record inflation and the global finacial downturn make it hard to raise debt.
James McCormack, Fitch Ratings' head for Asia-Pacific sovereign ratings raised concerns about the instability of the exchange rate and said any sizeable depreciation of the rupee would impact the government's repayment capacity," said.
In addition
Eurasia Group analyst Maria Kuusisto in a report issued earlier this month said, with the inflation hitting 23.4 percent in October Sri Lanka would have to offer "painfully high interest rates" to raise debt.
"This would add expensive debt to Sri Lanka's already sizable foreign borrowing," she wrote.
Rating agencies blame increased government expenditure as the main reason for high inflation.
Sri Lanka sold its first sovereign bond for $500 million in October last year and on October 7 this year announced plans for two syndicated loans this year for up to $300 million each.
IMF is of the view that the global crisis had drastically cut credit availability, making Sri Lanka's external account "vulnerable to a reduction in international investor risk appetite."
Citigroup also shared this view in its commentary saying “the recent announcement seeking proposals for a $ 300m syndicated loan looks very difficult under the current environment”.
Economic growth
In addition to increasein cost of borrowing SDri Lanka is also faced with a steep drop in revenues with its key revenue making industries facing the impact of global credit crisis.
With much of the developed world considered by economists to be in recession, analysts said Sri Lanka's exports growth will weaken this year, such as in its garment and tea sectors, the country's biggest and third-biggest export earners.
Sri Lanka’s $27 billion economy only grew 6.8 percent last year, slowing down from a two-decade high of 7.7 percent in 2006, and the IMF said it expects economic growth to slow to 6.1 percent in 2008 and drop even further to 5.8 percent in 2009.
