Fitch Ratings has warned that ending the suspension on Sri Lankan bank investments in international sovereign bonds (ISBS) could lead to increased bank exposure to sovereign and foreign-currency funding and liquidity risks.
The dire state of Sri Lanka’s banks is highlighted in Fitch’s statement which notes that an estimated third of bank assets were exposed to the central government at the end of 2020 and face threats “foreign-currency risks, including through their US dollar-denominated ISB investments”.
On 16 June, the Central Bank of Sri Lanka (CBSL) revoked the previous indefinite suspension on investments in ISBs by banks. Whilst permitted in the secondary market, Banks must provide that their investment is funded by fresh overseas borrowings.
Fitch writes that “Sri Lankan banks had invested heavily in ISBs, which prompted the CBSL to halt investments in ISBs by banks from December 2020, due to concerns about the pressure on the domestic foreign-exchange market through dollar outflows”.
Fitch further notes its expectation that Sri Lanka banks would “continue to face difficulties in accessing foreign-currency funding due to the sovereign's low credit rating”. It goes on to highlight the decline in the borrowing of an estimated 881 billion LKR in the first quarter of 2021.
“Refinancing needs remain high as short-term loans made up around 63% of the banking system's external debt at end-2020” Fitch adds.
They also highlighted that Sri Lanka’s poor “CCC” rating reflects “the sovereign's challenging foreign-currency external debt repayment burden over the medium term, low foreign-exchange reserves, and high and rising government debt that gives rise to sustainability risks”.
Earlier this year, the World Bank published a detailed report on the economic crisis Sri Lanka faces. In the last year, the country experiencing its worst growth rate on record, contracting 3.6 per cent throughout 2020, with a massive 16.4 per cent contraction in the second quarter alone. Economic recovery, the World Bank notes, will be reliant upon foreign direct investment and normalising tourism.
Read more here: 'Deeper into poverty' - Sri Lanka's economic devastation detailed in World Bank report
Read the full Fitch report here.