While Pakistan’s stock-market losses and risk of return to the MSCI frontier index occupy specialist investors’ thoughts, with the announcement of another US$6 billion International Monetary Fund fiscal and balance-of-payments rescue, Sri Lanka’s quieter year-long extension of its program after drawing $1 billion also raises eyebrows.

The request was not as abrupt a departure as with Prime Minister Imran Khan’s initial spurning of an IMF deal, and then replacing his finance minister and central bank head with former officials of the maligned Bretton Woods institutions. It was sealed after “setbacks” including a delayed budget from last year’s political standoff between the president and prime minister of Sri Lanka over possible new elections, and the multiple church and hotel terrorist bombings in April, which killed and injured hundreds.

The authorities declared a state of emergency in the aftermath of the bombings, as retaliation attacks targeted Muslims and leading sources of foreign visitors issued travel warnings. Fresh parliamentary and presidential polls are scheduled over the coming year, but both bond and equity buyers continue to track erratic debt-refinancing and economic-reform signals closely amid the security contingency and additional donor lifeline.

In March the Sri Lankan government tapped external bond markets through a $2.5 billion dual issue at 7% yield to shore up dwindling reserves, which were below $7 billion at the end of last year. The exercise helped steady the exchange rate, which tumbled almost 15% in 2018 against the US dollar on a current-account gap of 3% of gross domestic product from a combination of lagging agricultural exports and high oil imports.

In the latest IMF review, not yet incorporating the terror incidents’ fallout, that deficit is projected to improve slightly on 3.5% commodities and manufacturing-driven growth. Despite food-price stabilization with normal weather, inflation will be 4.5%, and global financial and trade “adverse shocks” threaten tourism, capital flows, and foreign direct investment.

Public debt is 90% of GDP, with “lumpy” near-term repayments increasing rollover risk, and the fiscal-deficit target of 3.5% will stay out of reach without state-enterprise restructuring and sales.

The electricity, petroleum and airline companies had 1.5% of GDP in losses in 2018, and governance and subsidy overhauls are long overdue, according to the IMF document. Divestiture through stock-exchange listings could boost foreign investor sentiment after temporary currency controls ended in March, it suggests.

While debt owed to China is in the headlines with the $1 billion takeover of the Hambantota Port, it accounts for less than 10% of the external total, compared with heavier loads due the Asian Development Bank and Japan.

A new central bank law aims to phase out government lending, limit currency intervention and boost independence. It steadied the rupee in the aftermath of the April carnage, but net purchases in the $150 million range have been minor compared with $1 billion last year.

A cap on foreign buying of local-government bonds remains in place at 5% of the outstanding amount, following large fund outflows during the early 2019 skirmish between the president and prime minister.

Annual credit growth will approach 15% this year, with bank and non-bank bad-loan ratios at 3.5% and 7.5% respectively. Non-banks need fresh capital to meet Basel III standards, and comprehensive deposit insurance for the entire system will soon be introduced as anti-money-laundering procedures are also upgraded to Financial Action Task Force compliance levels, the IMF commented.

South Korea

Korean stocks that were positive through April, on the other hand, also got an excess-credit non-bank warning in a May Article IV report by the IMF. It forecast lackluster 2.5% growth on China-related semiconductor export drag that will only be partially offset by fiscal stimulus.

Unfavorable demographic and productivity trends, rising income inequality, and rigid labor and product markets stifling small-firm competition against the chaebol conglomerates are longer-term structural obstacles, joining the geopolitical uncertainty on the peninsula with diplomatic negotiations with North Korea in limbo.

Household credit expansion is still above 5%, with the ratio to disposable income at a dangerous 160%, and two-thirds of the total at variable rates.

Macro-prudential debt-service limits will be extended to non-banks in the coming months, as they shift client emphasis from personal to corporate borrowers in a possible pre-emptive strategy. Their business-real-estate lending is up 30%, as aggregate company leverage tops GDP and property defaults raise the specter of a non-nuclear chain reaction.