Fitch Ratings expects rising domestic interest rates to hurt Sri Lankan corporates over the next 12 months. Their borrowing costs have increased more than 200bp in the 12 months to March 2017 as the Central Bank of Sri Lanka increased policy rates by 125bp and the statutory reserve ratio by 150bp in an attempt to reign in aggressive credit growth. 

Fitch does not expect the pressure on interest rates to ease in the near term owing to rising inflationary pressures and weak external finances. Annual inflation as measured by the Colombo consumer price index rose to 8.4% in April 2017 from 4.3% a year ago. Corporates with high short-term working capital requirements such as retail and manufacturing companies are hurt the most by the recent rate increases. 

In Fitch’s view, the two large consumer-durable retailers, Singer (Sri Lanka) PLC (A-(lka)/Stable) and Abans PLC (BBB+(lka)/Stable), are the most affected of the entities we rate as most of their borrowings consist of short-term working capital financing and will have to be rolled over at higher rates. Furthermore, both companies realise 30%-40% of their sales through hire-purchase schemes which can meaningfully weaken with rising interest rates and slow EBITDA growth. Fitch believes Singer has more headroom in its current rating to withstand these challenges compared with Abans. Kotagala Plantations PLC (CC(lka)) may also face further liquidity pressure on account of higher interest payments. Fitch believes Hemas Holdings PLC (AA-(lka)/Stable) and Sunshine Holdings PLC (A(lka)) to be the least affected due to their low refinancing requirements during the next 12 months. 

The interest coverage (EBITDA/gross interest expense) of corporates that Fitch rates deteriorated to 6.9x on average in the 12 months ended March 2017 from 9.2x a year ago because of the rising rates and higher debt. Debt increased mostly on account of investments in new capacity in sectors such as retail and manufacturing, which may take longer to translate into meaningful cash flows. 

Fitch estimates interest coverage may fall to 5.2x by the end of the current financial year if interest rates were to rise by 100bp. If interest rates were to rise by 200bp, coverage would weaken further to 4.8x. These estimates are based on our expectations that Fitch-rated corporates’ EBITDA will grow by around 1% on average over this period, and debt will increase by 6%. 

-Reuters
-Agencies