Macro Analysis /
Sri Lanka

Sri Lanka: Growth on the rise, but rating downgrade a concern in 2020

    Asia Securities
    2 January 2020
    Published byAsia Securities

    Sri Lanka’s 3rd quarter GDP figures for 2019 were released during the month, where growth came in at +2.7% YoY, above our forecast of 2.2% YoY owing to higher than anticipated activity in the industry sector. Overall, growth accelerated since the second quarter, with all three sectors (Agri, Industries and Services) recording growth ranging from 0.4% – 3.3%. For the 9M 2019, overall growth was at 2.6% YoY. Meanwhile the Central Bank concluded the final monetary policy meeting for the year, chaired by the new Governor, Professor W D Lakshman. Key policy rates were left unchanged during the meeting, in-line with our expectations, following the fiscal loosening policies implemented by the newly elected government in November. Amidst this backdrop, Fitch ratings downgraded Sri Lanka’s Sovereign rating to Negative. Fitch further stated that the move from a revenue based fiscal framework has created policy uncertainty amidst high external debt repayments in 2020. Looking ahead, we expect the recent stimulus package to boost overall growth momentum, specially through higher consumer activity. We forecast GDP growth to reach 4.0% YoY in 2020 and improve to 4.4% YoY in 2021.

    Economy grows by 2.7% in 3Q 2019; impact of April attacks still evident

    Sri Lanka’s 3Q 2019 GDP growth came in at +2.7% YoY, above our forecast of 2.2% YoY owing to higher than anticipated activity in the industry sector. We note that 2Q 2019 growth was revised downwards from 1.6% YoY to 1.5% YoY during the quarter. The continued adverse impact of the Easter Sunday attacks was evident in the services sector, which recorded a growth of 2.8% YoY (compared with the 2-year average of 3.9%). However, we perceive the improvement from the lowest second quarter growth of 1.5% recorded in 2Q 2019, as a positive. Looking ahead, we expect the economy to recover from the slowdown in 2H 2019, particularly in the services sector owing to 1) the 100bps policy rate cut implemented by the Central Bank so far 2) improved sentiment following the Presidential elections, 3) stimulus package introduced in November and 4) public sector salary hike expected in January 2020.

    Central Bank maintains rates in-line with our expectations

    Key policy rates were left unchanged in December, in-line with our expectations, following the 50bps cut in August. The loose monetary policy stance taken so far this year, combined with liquidity injections from a lower SRR have resulted in 1) weekly AWPLR declining by ~183bps YTD and 2) bond yields shaving off ~240bps YTD (~263bps in November). Meanwhile, average overnight repo rates were marginally down from 7.53% in October to 7.50% in December, while overnight excess liquidity averaged at LKR 21bn so far in December, up ~62.4% MoM.

    Currency ends 2019 in-line with our forecast; looks to depreciate in 2020

    The average USD/LKR recorded a 0.4% MoM depreciation in December (as at 27th December), breaking its 2-month appreciating trend. The YTD appreciation now stands at 0.8%, with the currency ending the month at an average of USD/LKR 181.20, in-line with our forecast of USD/LKR 181.00 for the year. Looking ahead, we expect the marginal appreciation of the currency recorded in 2019 to reverse as a result of 1) higher import demand, 2) increased credit growth, 3) soft inflows into USD denominated bonds and 4) equities markets adding pressure to the currency.