Bangkok--9 Aug--Standard & Poor's Standard & Poor's Ratings Services said today that it had affirmed its 'B+' long-term foreign currency and 'BB-' local currency sovereign credit ratings on the Democratic Socialist Republic of Sri Lanka (Sri Lanka). The 'B' short-term foreign and local currency sovereign credit ratings were also affirmed. At the same time, the outlook on the ratings has been revised to stable from negative. The outlook revision to stable takes into account positive fiscal developments, including improvements on both the revenue and expenditure sides. Tax rises and ongoing fiscal administration reforms lifted the government's tax revenue to a nine-year high of 15.3% of GDP in 2006. The progress in the Fiscal Management Reform Program is noteworthy, particularly with respect to tax collection and compliance, and the strengthening of fiscal and macroeconomic coordination. This program has been monitored by donor agencies. On the expenditure side, the elimination of the oil subsidy, which allowed full pass-through of market prices, and the increases in electricity tariff are set to ease the government's fiscal and external vulnerability and reduce misallocation of resources. "These measures foreshadow the continuation of a modest deficit reduction, which, combined with high nominal GDP growth, should yield further improvements in the sovereign's still high debt ratios," said Standard & Poor's credit analyst Agost Benard. "The ratings on Sri Lanka reflect the high level of government indebtedness and still weak revenue mobilization, together with risks posed by the unresolved separatist conflict," Mr. Benard added. Moreover, the sovereign's positive debt dynamics largely rely on a monetary policy stance, whereby negative real interest rates allow the financing of large fiscal deficits without a significant corresponding rise in public debt as a share of GDP. "These factors are balanced against the economy's demonstrated resilience and favorable medium-term growth prospects, as well as the benign terms of external debt, which impose minimal stress on external liquidity," noted Mr. Benard. The stable outlook also takes into account the limited impact on the economy from the gradually unraveling cease fire with the Tamil separatists and the rising violence. "Unquestionably, Sri Lanka's economy has demonstrated much resilience to the conflict that has been ongoing for the past two and a half decades," said Mr. Benard. "However, depending on how it unfolds, it could yet become the source of downward pressure on the ratings. Downward pressure may occur if the separatist conflict deteriorates to an extent that it depresses investor sentiment, impairs revenue generation and foreign exchange earning capacity, and compels a rise in defense expenditure." Standard & Poor's nevertheless expects that, in line with government plans, an all-party peace proposal will be tabled before the end of the current calendar year. While this may not entirely satisfy Liberation Tigers of Tamil Eelam's demands to end the conflict, it will ease tensions and help buoy economic growth. The ratings could also come under downward pressure, or the outlook could return to negative, if there are signs of fiscal slippage, where, either through expenditure pressures or lower revenues, deficit reduction grinds to a halt. Complete ratings information is available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor's credit ratings, research, and risk analysis, at www.ratingsdirect.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com; select Ratings in the left navigation bar, then Credit Ratings Search. Media Contact: David Wargin, New York (1) 212-438-1579 [email protected] Analyst Contacts: Agost Benard, Singapore (65) 6239-6347 Sani Hamid, Singapore (65) 6239-6346