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Fitch: Sri Lankan Telcos Outlook Negative; Uncertain Tax Regime

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Fitch Ratings has maintained a negative outlook on Sri Lanka's telecom sector. This is based on uncertainty over proposals to increase taxes, which are likely to lower profitability and increase leverage for telcos, if implemented.

The original tax proposals were to impose a one-off "super gains" tax of 25% on profits, and a tax of LKR250m (USD1.8m) on each telco. The proposals also shift the burden on to the telcos of a recurring telecom levy of 25% and 10% on prepaid voice and data revenue, respectively, having previously been borne by consumers. These tax proposals were originally introduced in February 2015, and in October 2015 government withdrew only the recurring taxes. The government may still re-introduce recurring taxes in part, or full, in 4Q15.

Fitch now expects the industry's 2016 revenue to grow by the mid-single-digit percentage, driven by data services as cheaper smartphones proliferate. Yet, apart from the tax impact, profitability may still decline in 2016 as low-margin data services replace traditional, more profitable voice/text revenue.

The ratings agency also expects both Sri Lanka Telecom and Dialog Axiata to invest around 22%-25% of their revenue on capex. Both firms are exposed to depreciation of the Sri Lanka rupee - given that 95% (USD180m) and 81% (USD170m) of their respective debt are US dollar-denominated - while we estimate they each generate only around 15% of their revenue in US dollars.

Two smaller, unprofitable telcos - Hutchison Lanka and Bharti Airtel Limited's Sri-Lankan subsidiary, Airtel Lanka - may exit the industry amid competition and the uncertain tax regime.

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Tags: Sri Lanka