Data released by the Department of Census and Statistics shows that the Sri Lankan economy contracted 1.6% YoY in 1Q 2022, following the 2.0% YoY growth recorded in 4Q 2021. This came in steeper than our forecast of a 1.0% YoY contraction owing to the slower than anticipated growth in the Services sector, combined with a steep contraction in the Agri sector during the quarter. The Services sector which accounts for over 50.0% of GDP grew by a moderate 0.7% YoY (+4.3% YoY in 4Q 2021), while the Industrial Sector contracted 4.7% YoY (+1.4% YoY in 4Q 2021). Meanwhile, the Agri sector recorded a sharp decline owing to the fertiliser shortage, contracting 6.8% YoY (-3.1% YoY in 4Q 2021). Looking ahead, with the Dollar shortages leading to extended power cuts and fuel shortages, lower chemical fertiliser availability and low fiscal space to support consumers, we expect near-term momentum to be impacted. With continued inflationary pressure, we expect real household income to face significant pressure, leading to low spending capacity. Given the steeper than anticipated contraction in 1Q 2022, we revise our 2022 GDP forecast and now expect a contraction of 7.5% - 9.0% YoY (5.5% YoY contraction previously). While we note that an IMF Staff level agreement will support fiscal assistance from entities like the World Bank and ADB, with a Dollar funding requirement of USD 5.0bn (including USD 500mn/month for fuel imports alone) for the next 6 months, pressure on overall economic activity will continue. Our key near-medium term concerns are 1) rising interest rates and inflationary impact, 2) currency speculation, 3) potential fiscal tightening and 4) low reserves buffer in 2022. We factor in an IMF Staff level agreement in July/August.
Services sector records 0.7% YoY growth in 1Q 2022 as Accommodation, F&B activities and IT programming support growth
The Services sector, which accounts for over 50.0% of GDP was the only sub-sector to record a positive trajectory. However, this came in below our forecast for the quarter despite the resumption of tourism activities for the first part of the quarter. This was evident in the Services sector, with the Accommodation, F&B sub sector growing 25.2% YoY in 1Q (+63.6% QoQ). Meanwhile, IT programing and consultancy services also grew 5.5% QoQ (+12.3% YoY in 1Q). Looking ahead, we expect the momentum in these sub-sectors to decline owing to the lack of fuel and electricity supply. Namely for tourism, we expect the Russia-Ukraine tensions combined with political uncertainty to negatively impact momentum for most of the year.
Meanwhile the financial services sub-sector contracted 21.3% QoQ (-1.0% YoY in 1Q) as credit growth remained positive albeit slowing down. As such, private sector credit growth averaged 14.5% YoY in 1Q (+13.3% YoY in 4Q 2021). However, with a sharp increase in interest rates, appetite for credit looks to slow down considerably.
Industrial sectors contracts 4.7% YoY amidst fuel, electricity shortages, challenges to opening LCs for raw materials
The industrial sector (which contributed to 31.1% of GDP in 1Q 2022) contracted by 4.7% YoY (+6.0% YoY in 1Q 2021) as all sub-categories recorded a decline in growth. With low Dollar liquidity and fuel shortages, the impact of the on-going challenges were evident in the sector. The steepest contraction was recorded in the “Manufacture of coke and refined petroleum” sub-sector which was down 24.3% YoY. Construction activities which contributes most towards the Industrial sector also recorded a 2.2% YoY contraction while the “Mining and quarrying” sub-category was down 1.5% YoY.
Looking ahead, we expect 1) the lower availability of fuel and electricity supply, 2) continued Dollar liquidity impacting the opening of LCs and 3) elevated global commodity prices to dampen overall growth momentum in the Industrial sector. While we note that import controls and higher duties may support domestic manufacturing, in our view, the negatives for the sector currently outweigh this.
Impact of fertiliser ban emerges; Agri sector recorded steepest contraction since 2015
Meanwhile, the agricultural sector which accounts for 27.3% of labor force participation, recorded a 6.8% YoY contraction in 1Q 2022 (-3.1% YoY in 4Q 2021). The impact of lower fertilizer availability was evident in the sector, where the “Growing of rice” sub-sector recorded a 33.8% YoY contraction (-23.0% YoY in 4Q 2021), while the “Growing of Tea” also contracted 15.0% YoY (-15.7% YoY in 4Q 2021). The lower tea supply was evident in tea auctions, with prices increasing during the quarter. Our discussions indicate that the supply of tea has continued to decline in 2Q 2022.
Looking ahead, our conversations indicate that yields from the Yala season are down 40.0% - 50.0% while the fuel shortages have caused significant supply chain challenges to vegetable crop distribution. We expect these barriers to continue in the near term, negatively impacting the Agri sector. We note that this will also add further inflationary pressure in the near term.