Macro Analysis /
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Sri Lanka: Macro Roundup - April 2022

  • Political and economic uncertainties heighten as interim govt yet to be appointed

  • IMF talks conclude; fiscal consolidation key towards funding package

  • Government bill yields shift up as Central Bank hikes rates by 700bps

Lakshini Fernando
Asia Securities
4 May 2022
Published by

In one of the most volatile months seen in recent history, economic and political stability was tested in April ‘22. This also came on the back of the resignation of the entire Cabinet of Ministers, together with the Central Bank Governor. The newly appointed MPs and Governor have a steep task ahead to get the economy to a sustainable level, with initial talks with the IMF concluding during the month. Meanwhile, the impact of the prolonged fuel shortage was visible on the supply chain and factories, with productivity and supply chains negatively impacted owing to the power cuts. While economic activity remained in positive territory in March albeit remaining relatively flat, we expect a further slowdown in this trend going forward. Meanwhile inflationary pressure continued, with headline inflation reaching 29.8% YoY in April as fuel prices increased over 130%. Following the IMF talks, we expect faster fiscal tightening policy measures to be announced. We maintain our GDP forecast of a contraction of 2.0% - 3.0% YoY in 2022. While we perceive the announcement of debt restructuring a key positive at this juncture, we emphasise that the economic reform plan and a stronger political backdrop is key to mitigating the economic impact.

Political and economic uncertainties heighten as interim govt yet to be appointed

April commenced with ongoing protests, calling for the ministers and President Rajapaksa to step down. While this resulted in a mass resignation of the Cabinet, President Rajapaksa and Prime Minister Mahinda Rajapaksa remained in their posts. While a new cabinet was appointed following weeks of uncertainty, a no-confidence motion brought by the Opposition remains a crucial factor. A number of political parties have rejected the proposal of an interim Government which is favored by the President. The opposition was successful in taking firm steps towards abolishing the 20th Amendment which will revoke the Executive powers of the President.

IMF talks conclude; fiscal consolidation key towards funding package

While the Government’s request for a Rapid Financing Instrument (RFI) did not get approval from the IMF, discussions for a funding program progressed during the month in Washington. Following the conclusion of the meetings, our view is that the IMF would require further policy tightening measures, especially on the fiscal front to be announced prior to further discussions. The Governor expects a staff level agreement to be finalised in 2-months, ahead of our expectations. In our view, any further political uncertainties will disrupt the progress of any IMF discussions. Barring any further deterioration on the political front, we expect the IMF to announce a program in 2H 2022.

Government bill yields shift up as Central Bank hikes rates by 700bps

The upward shift in rates continued its upward trend following the sharp increase in key policy rates. As such, 1-year Government bond yields reached 24.09% by month end from 12.28% at end March. 3-month yields also moved upwards, currently at 23.53%. Looking ahead, given the lack of forex inflows amidst higher domestic refinancing needs, we expect this trend to continue. This has been evident in the recent weeks, with the longer-term government bond yields increasing during the month. The latest auctions reflect the Central Bank’s preference for short tenure debt, with the 3-month bond issuances making up for most of the acceptance volumes.