Fitch assigns Lanka's debut sovereign bond 'BB-' rating

Fitch Ratings has assigned the Democratic Socialist Republic of Sri Lanka's forthcoming debut sovereign bond a rating of 'BB- (BB minus)'.

This rating is in line with Sri Lanka's 'BB-' Long-term foreign currency Issuer Default rating (IDR) which is on Negative Outlook.

Fitch assigned Sri Lanka Long-term IDRs of 'BB-' in December 2005. The Outlook on Sri Lanka's Sovereign Ratings was subsequently revised from Stable to Negative in April 2006, in response to a renewed outbreak of violence between government security forces and the Liberation Tigers of Tamil Eelam (LTTE), which seeks a separate state.

Sri Lanka's economy has displayed a remarkable resilience to shocks over a long period of time, sustaining negative growth only once in recent times, at the height of the last outbreak of hostilities in 2001. Last year, the economy expanded at 7.4 per cent, its fastest rate for more than two decades, underpinned by rising domestic and foreign investment and record inflows of remittances (equivalent to around 8 per cent of GDP).

More recently, however, growth has slowed to around 6 per cent and inflation has risen sharply to 17 per cent year-on-year (from 10 per cent in H106), driving up yields on government paper to similar levels.

"Steering inflation back down to single digits will be essential for sustaining strong economic growth and containing the government's debt service costs," says Rawkins. Fitch says that Sri Lanka has an unblemished debt service record - a rare trait among sub-investment grade sovereigns - while public debt declined slightly in 2006.

Nonetheless, public debt remains high by the standards of rating peers at 93 per cent of GDP and interest payments absorb almost 30 per cent of government revenues, notwithstanding the concessional nature of much external public debt.

Fitch opines that concerted fiscal consolidation is required to reduce the vulnerability of the economy and the public finances to adverse shocks and to smooth the transition to less concessional sources of fiscal and external funding.

Should the security situation adversely affect economic growth and delay planned reductions in the budget deficit from last year's level of 7.3 per cent of GDP (including grants), the government's target of reducing public debt to 76 per cent of GDP by 2010 could be at risk.