Fitch Ratings says Sri Lanka is the only twin-deficit country in Asia whose growth has not been affected by currency volatility.
In a statement released Thursday, Fitch Ratings says it sees the relative currency stability as due to a less open onshore capital account which provides insulation from volatile global capital flows, as well as an increasing ability to tap offshore global bond inflows.
However, the strategy is adding to the stock of gross and net external liabilities and carries medium-term credit risks, Fitch says.
The global rating agency projects a 6% growth rate for Sri Lanka this year, somewhat less than the 7.0% Central Bank expects.
The annual inflation has been reduced to below 7% from a near-double-digit rate in late 2012 which has brought on monetary easing and the policy rate was cut by 125bp since November 2012, to 8.5%.
Fitch says monetary easing coupled with softer inflation should support robust GDP growth which they project at 6% this year, and 6.6% in 2014.
However, Sri Lanka's benign growth-inflation story does not improve the overall sovereign credit profile ('BB-'/Stable), for two key reasons,
Secondly, Sri Lanka has been unable to attract much foreign direct investment (FDI) inflows following the end of its civil war, with net FDI averaging just 1.2% of GDP since 2009. This is low in comparison with most regional peers, and has fueled a reliance on debt-creating capital, according to the rating agency.
"The country has therefore banked on the promise of higher future growth to successfully issue more foreign debt.
This has kept the external debt burden at 57% of GDP, and which is much higher than all other Asian emerging markets, except Mongolia," Fitch said in its statement.