Macro Analysis /
Sri Lanka

Positive of low oil prices dampened by Covid-19; we adjust our macro forecasts

  • Sri Lanka's import bill would drop cUS$861mn in 2020 on our base case scenario (US$40.80/bbl by end-2020)

  • But, Covid-19 is starting to impact demand in key markets, dampening business outlook

  • We revise GDP growth to 3.5% (from 4.0%); current A/C deficit to 4.0% of GDP (from 3.6%) and inflation to 5.6%

Asia Securities
11 March 2020
Published byAsia Securities

Oil prices became the latest exogenous factor to shock global markets. The offensive by Saudi Arabia on Sunday (9th March), has led to a repricing of the global oil benchmarks, with Brent and WTI sustaining ~24.0% drop overnight on 10th March. As a net oil importer, we calculate that Sri Lanka’s import bill would drop ~USD 861mn in 2020 on our base case scenario (our calculations take into account December oil Futures at USD 40.80/bbl and Landing cost at USD 51.83/bbl).

Amidst this, a downward fuel price revision in the near term is almost certain, especially as the country heads towards Parliamentary elections. In our view, the cut in retail petroleum prices would go ahead as a cabinet decision, despite the Parliament having being dissolved. Lower global and local fuel prices are a positive for the economy on multiple fronts. The direct, and the most prominent impact would be on lowering inflation, with a positive bearing on both food and non-food inflation. With a lower fuel bill, we believe the fiscal condition would also improve, and the savings – if prudently used – could lead to reducing the SOE debt of the Ceylon Petroleum Corporation (CPC).

Locally, the positive spin from oil prices was dampened by a further outbreak of Covid-19 that dragged down the business sentiment. With the virus spreading across Europe and the US, we now see the economic impact of Covid-19 shifting to slowing down global demand vs. the initial concerns on primarily supply chain disruptions. Europe and the US are two of Sri Lanka’s largest export markets (especially garments and seafood), and we revise down our GDP growth to 3.5% vs. our initial estimate of 4.0%.

Global markets reacted sharply to both factors, and – led by the US – saw sharp adjustments on Monday. Sri Lanka’s ASPI dropped 4.1% on Tuesday while the S&P SL20 dropped over 5.0% in the morning trade, triggering a trading pause. Along with this, Sri Lanka’s 2030 maturity ISB yield has spiked 125bps to 9.50% on 09-Mar compared to Friday’s close, leading to the spread widening to ~875bps, compared to ~700bps for a set of B-rated peers. In addition, the CDS spreads have widened by over 130bps since early February, largely in line with the B-rated peer group, indicating that a similar level of risk is being factored in. With most Frontier and Emerging Markets also sustaining heavy outflows in the past few weeks, we believe the muted foreign interest in Sri Lanka is primarily non-endemic. 

The ongoing de-risking process factors in the real economic consequences of Covid-19, and we note that the current cycle has more room to unfold, with the economic and the earnings impact yet to be seen both globally and locally. The sharp drop locally has triggered margin calls, which we believe could exacerbate the downward spiral further. With valuations remaining ultra-low, we believe investors should give more weight to market momentum in making investment decisions.

Given the above, we update our key forecasts/view which we highlight below.

Trade 

Our base case calculations indicate an improvement in the trade balance from ~9.3% of GDP in 2019 to ~7.6% of GDP in 2020.

Our calculation of a ~USD 861mn reduction in the country’s oil bill comes from our estimate of landing costs (CIF) of USD 51.83/bbl vs. USD 75.16/bbl on average in 2019 (according to Asia Securities calculations). While lower imports will help ease pressure off the trade balance, we expect slowing global trade to add a headwind to export demand, which would partially negate the positive impact. 

Current account

Our base case indicates that the current account deficit would reach ~4.0% of GDP in 2020 (3.6% in 2019). 

The two underlying drivers of this are 1) Remittances recording a ~10.4% drop owing to lower oil prices, combined with a declining trend in overall remittances from the Middle East and the slowing demand due to Covid-19 and 2) Tourism forecasted to generate USD 3.8bn of revenue (+5.8% YoY).

Currency

With an improving trade balance, we expect relatively lower pressure on the LKR. However, significant outflows from the government bond and equities markets have continued from end January. We don’t expect significant inflows in terms of FDIs at this point of time, as we see little reason for optimism for new major FDI until Covid-19 fears have subsided combined with the overall uncertainty in global markets. As such, we expect the LKR/USD at 186.00 in 2020.

Inflation 

We expect the benefit of lower global oil prices to result in lower fuel prices locally. With CCPI at 6.2% YoY by February, this is much needed, in our view. We factor in a LKR 8.00- LKR 10.00 reduction in average fuel prices, leading to inflation at 5.6% YoY in our base case.

Fiscal deficit

Lower oil prices will benefit Ceylon Petroleum Corporation (CPC) which incurred a loss of LKR 21.2bn in 4M 2019 (latest available data). We expect the government would pass on part of the gains to the public in the form of a retail price cut to fuel, and utilise the balance to reduce SOE debt. We note that credit to public corporations have increased 15.3% YoY in January. While we do not have sufficient visibility to determine the Government’s stance on how it would utilise the opportunity of lower global oil prices, we expect the Government to use this opportunity to reduce fiscal pressure. At this point, we maintain our fiscal deficit forecast of 6.9% of GDP but, note that this will be revised once further clarity on the government’s revenue-generating policies are known.

Corporate level impact

We expect companies that are energy intensive to benefit from the fall in global oil prices. We expect companies (LIOC and LGL) within the energy space to see some risks in the near-term as the prices re-adjust and the likelihood of a cut in regulated prices. For LIOC, we see a sharp fall in oil prices as a large threat to its Bunkering profits (which have accounted for majority of profits over the last two quarters). Furthermore, given the regulated nature of pricing, we see the GoSL looking to pass the benefits in auto fuels and LPG to support a lower cost of living ahead of the Parliamentary elections in April ’20, absorbing any large gains from low prices.