The Moody’s Investors Service has changed the outlook for Sri Lanka from stable to negative. The MIS has affirmed that Sri Lanka’s foreign currency issue and senior unsecured sovereign ratings at B1 and changed the outlook from stable to negative.

Moody’s points out two key drivers that underpin the change in outlook.

1) Expectation of a further weakening in some of Sri Lanka’s fiscal metrics.

2) The possibility that the effectiveness of the fiscal reforms envisaged by the government may be lower than currently expected.

Moody’s expects the government’s debt burden to increase further, from high levels, which could intensify external vulnerabilities and refinancing risks.

Moody’s expects a more moderate reduction in budget deficits than outlined in the projections published as part of the International Monetary Fund’s (IMF) Extended Fund Facility (EFF). Moody’s forecast that the budget deficit will narrow to slightly under 5% of GDP by 2020, from 7.4% in 2015 and compared with 3.5% projected by the IMF as part of the EFF.

The report also notes that a number of state-owned enterprises are under financial stress, pointing to sizeable contingent liability risk for the government. Some of these risks have already crystallised with the government taking responsibility for SriLankan airlines’ (unrated) liabilities, worth Rs. 461 billion or around 4% of GDP. These liabilities will inflate government debt, at least temporarily.

Moody’s also believes that funding from the IMF and other international agencies will likely not fully finance the balance of the current account and foreign direct investment.