OREANDA-NEWS. Fitch Ratings has revised the outlook on Sri Lanka's telco sector to stable from negative as the new budget, introduced in December 2015, has scrapped the recurring taxes which could have diluted the industry's EBITDA margin by an average of 6%-7%. We believe that Sri Lanka Telecom's (SLT) and Dialog Axiata Plc's 2016 credit profile will now remain intact - given the ratings headroom to absorb margin dilution and lower cash generation.

SLT's and Dialog's 2016 EBITDA margin should dilute by only 100bp-200bp following the budget, due to changes in their revenue mix and lower revenue from profitable international gateway operations. The new budget doubled the government's share in the international telco levy to USD0.06s from USD0.03 per minute. The telcos' strategy to pass on this increased levy to consumers could affect usage, as users will be likely to move to cheaper 'over the top' applications like Skype and Facebook. Fitch estimates that international termination revenues contribute around 12% of SLT's and Dialog's revenues.

Fitch revised the sector outlook to negative in March 2015, and maintained this in December 2015 - based on uncertainty over proposals to increase taxes that could lower profitability and raise leverage for telcos. The original proposals included the imposition of a one-off "super gains" tax of 25% on profits, a tax of LKR250m (USD1.8m) on each telco, and a one-off tax of LKR1bn (USD7.5m) on companies offering satellite direct-to-home (DTH) TV with more than 50,000 subscribers. The proposals would also have shifted the burden of a recurring telecom levy (of 25% and 10% on prepaid voice and data revenue, respectively) on to telcos from consumers.

SLT and Dialog had already paid LKR1.02bn and LKR2.04bn, respectively, by end-2015 for one-off taxes which were originally introduced in February 2015. The one-off tax on satellite direct-to-home TV operators and the recurring tax on prepaid services have been scrapped.

The 2016 budget also proposes to structurally separate fibre, towers and spectrum assets - currently owned by telcos - to a special purpose company to be regulated by the Information and Communication Technology Authority. The impact of such a structural separation on telcos is uncertain as the regulator is yet to disclose the finer details of such asset separation. Furthermore, government's decision to impose a tax of LKR50,000 per tower on telcos is not likely to have a major impact on the credit profile of SLT and Dialog.