Worth Watching
Sri Lanka foreign financed domestic credit share among highest in Asia July 10, 2014 (LBO) - Countries with high levels of externally financed domestic credit should be careful about loose monetary policy, a report by Standard and Poor's which found Sri Lanka to be most exposed in the region after New Zealand said.Several Asian countries including China were loosening policy in response to a slowing economy, but loosening policy could increase financial risks even though it may lift short term growth, the rating agency said.
"The risks are greater where significant external funds support domestic lending," S&P said in a mid-year review of 22 Asia Pacific sovereigns rated by the agency.
"These economies are vulnerable to negative swings in sentiments among international lenders. This also means that these governments have little room for policy mistakes."
Earlier this week S&P confirmed Sri Lanka's B+ speculative grade sovereign rating, citing low inflation and gains in state enterprise balances.
On 5 parameters looked at by S&P Sri Lanka's Economic Structure and Growth was considered Neutral and Monetary Flexibility also Neutral.
But Institutional and Governance Effectiveness was considered a Weakness, Fiscal Flexibility and Performance a Weakness, External Liquidity and International investment Position a Weakness and Government Debt Burden a Weakness
"Only Pakistan, Papua New Guinea, and Sri Lanka have more than three weaknesses," the report said.
In Sri Lanka over 25 percent of domestic credit claims were ultimately financed externally, only the second highest after New Zealand at 30 percent, the report found.
This compared to less than 15 percent for Australia and Mongolia, a little over 5 percent for Thailand and below 5 percent for Indonesia, India, Fiji and Bangladesh.
Sri Lanka's banks have been borrowing heavily in international markets, and lending domestically including in domestic currency. Some of the currency risk has been taken by the Central Bank.
Sri Lanka also has a deposit dollarization, where banks operate foreign currency denominated books, held by qualified individuals and firms earn in foreign currency, which have been stable in the past due to a promise of free capital mobility.
Wholesale foreign borrowings have been made easy in recent years by extraordinarily deadly money printing (quantity easing) by the US Fed which is due to end in October, though no actual contraction of its balance sheet is yet contemplated.
The announcement to end quantity easing last year send jitters in international bond market sending rates of emerging market debt including that of Sri Lanka sharply higher.
"Despite the continuing scale-down of bond purchases by the U.S. Federal Reserve, investors appear to be returning to emerging markets," S&P said.
"Sovereigns and related entities in the region have been able to borrow in international markets at favorable rates in the first half of the year.
"Although the risk of a renewed global slowdown triggered by events in the U.S. or Europe is receding, it could still hurt sovereign creditworthiness in this region."
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