The Easter Sunday terrorist attacks in Sri Lanka led to 258 casualties including 46 tourists. A month later, the immediate risks have been contained, and the equity markets have traded sideways following the initial drop, albeit on muted volume. Overall, we expect a 27.0% dip in CY19E tourist arrivals and 26.3% dip in income. GDP growth will see an inevitable setback in CY19E (we expect 2.5%) with a large impact from moderating household spending, while the current account deficit would widen to 3.6%, on our estimates. However, we note that the economic fundamentals have been strengthening prior to the attacks (primary surplus, improving trade balance, and inflation under check) which would lend itself to a mid-term recovery.
From a sector perspective, in addition to tourism, consumer-related segments are seeing an immediate impact from weaker personal income, while the banks and NBFIs are likely to suffer a mid-term impact from rising NPLs and impairment charges, further weighing on profits. As such, we change our sector views for Banks, NBFI, Consumer, Alcoholic Beverages and Manufacturing to negative. We also remove HNB, HEMS, SAMP and LION from our key picks. However, we believe that Telecommunications and Healthcare will not see a major impact, while niche players in insurance will see resilient growth.
Market trading sideways – no panic selling as risks are well-understood
A month past the Easter-day attacks, swift action by the Government has ensured that the immediate risks have been contained. Since the initial drop, ASPI continues to trade sideways with both local and foreign investors taking a wait-and-see approach as indicated by muted trade volume (ADV LKR 375mn since April 23rd vs. LKR 835mn in CY18). On the positive, no panic selling has taken place given that this is not an endemic threat and tells us that the risks are well understood by the market. Taking a cue from similar events, the initial negative market reaction by investors will be followed by a focus on economic fundamentals.
Growth to take an immediate hit, but stable policies reduce external sector risk
The short-term growth prospects have taken an inevitable setback, and we adjust our GDP growth forecast for CY19E to 2.5% (vs. 3.2% immediately after the impact). The largest impact, on our estimates, comes from muted household consumption (1.5% growth vs. 2.5% previous). On the positive, we expect the boost from consumer-friendly policies in the budget (LKR 2,500 for gov’t employees, added allowance for pensioners and increased drawdown for Samurdhi recipients) will take effect and support growth to some extent. On the other hand, the drop in tourism inflows would lead to worsening current account deficit, which we now set at 3.6% (vs. 2.5% previously). While the lower tourism receipts will add pressure on the reserves position, we understand that majority of the CY19E debt maturities are already settled (LKR 330mn remaining in 2Q CY19), and the next large outflow is only due in October 2020. The CBSL has also lined up several credit lines to be used in an emergency, which gives us comfort.
Tourism, the first victim; spillover effects in consumer through CY19E
As widely understood, tourism sector will see the worst hit from the attacks, and based on our estimates, arrivals would see a 27.0% drop YoY in CY19E, while earnings will see a 26.3% drop. An immediate impact will be seen by the related sectors such as alcoholic beverages and retail sector, especially in clothing, shoes and accessories market which were driven by large tourist groups. The third layer of impact that we expect to see in 2H CY19 is a slowdown in overall consumer spending on the back of a drop in income levels. Based on our analysis, ~38.0% of the labor force will see a hit on income (differing levels based on the industry) that will lead to muted consumer spending. Consequently, we now expect a delay in consumer spending recovery to 2Q CY20 vs. our previous estimate of 2H CY19 (see page 14 for the impact pyramid). With the short-term stress seen in several core sectors, we believe that the banking and NBFI sector NPLs will continue to rise. Along with this, we expect a rise in impairment charges, adding pressure on profits.