Macro Analysis /
Global

Sri Lanka: 2020 recession likely; govt. measures to mitigate structural decline

  • Our scenario analysis indicates a contraction in GDP growth for 2020

  • Sovereign curve reflects heightened risk concerns

  • 2019 Fiscal deficit comes in at 6.5% of GDP

Asia Securities
31 March 2020
Published byAsia Securities

The COVID-19 outbreak gripped both local and global economies this month, with Sri Lanka going into a lockdown. The government has taken a number of proactive steps to curtail the outbreak, and has also implemented a number of fiscal and monetary measures to help curb the overall impact on the economy. Most of the government’s stimulus packages were aimed at variable income earners, as curfews resulted in significant loss of workdays. However, despite these measures we forecast GDP growth to contract by ~4.0% - 4.5% YoY in 2020 on our base case (assuming the spread of COVID-19 is contained by end May). Meanwhile, March saw significant outflows from the government bond market, with foreign bond holdings currently at less than USD 250mn. The sovereign yield curve clearly factors in a higher risk premium, especially in the short end of the curve. The currency recorded a 4.9% MoM depreciation in March, averaging at ~USD/LKR 184.12 for the month (currently at USD/LKR 190.50). We note that our economic forecasts except GDP growth are currently under review pending revision on the COVID-19 impact.

Our scenario analysis indicates a contraction in GDP growth for 2020

While the government has taken several proactive steps to curtail the economic impact of COVID-19 through fiscal and monetary policies, we expect a significant negative impact on growth in 2020. Given that the lockdowns and related hiatus in economic activity drives much of the impact, we first look at a top-down approach, accounting for the possible contraction in activity. This points to ~5.0% - 5.4% YoY decline in GDP for 2020. Next, we look at a bottom-up approach, quantifying the impact on each of the sub-sectors; agriculture, industrials and services. Our bottom-up approach combines input from our sector analysts covering the manufacturing, consumer, financial services, and leisure sectors. Given the complexity of predicting COVID-19 contagion curve with a meaningful statistical significance, we focus on three probability-weighted scenarios. Our highest probability scenario (i.e. the spread of the virus contained by end May) yields a ~4.0% - 4.5% YoY contraction in GDP for 2020.

Sovereign curve reflects heightened risk concerns

At this point in time, a key concern for investors is the heightened sovereign risk. The current 10-year Sovereign yield (ISB maturing in 2030) passed 16.50% (as of 30th March), up ~894bps for the year so far as foreign investors priced in higher risk. As expected, the higher risk in the short term has been factored in, with the short end of the curve picking significantly over the past 10-day period, currently at 36.11% (as of 30th March). While the USD 1.0bn Sovereign bond maturity falls in October, in our view, the government has a tight window to roll over the maturity with a new sovereign bond issuance in the coming months, in the current global context.

2019 fiscal deficit comes in at 6.5% of GDP

The fiscal deficit for 2019 amounted to LKR 1.02tn, ~6.5% of GDP, compared with 5.3% of GDP in 2018. This comes in marginally below our forecast of ~6.8% but significantly better than the government’s expectation of over 7.0%. Overall deficit for 2019 widened 33.6% YoY largely due to higher expenditure (+8.2% YoY) coupled with lower revenue (-1.7% YoY).