Macroeconomic concerns heightened during the month, with the increase in scheduled power cuts following low fuel imports. The fuel shortage was reflected in the supply chain and factories, with productivity and supply chains negatively impacted owing to the fuel shortage and power cuts. While economic activity remained in positive territory in March albeit remaining relatively flat, we expect this trend to slow down further. This momentum was reflected in primary data indicators like the PMI, which was down 6.2 index points. Meanwhile inflationary concerns continued, with headline inflation reaching 15.1% YoY in February ahead of the currency correction. With reserves at USD 2.3bn in February, we see heightened pressure on the government to prioritise essential imports given the urgent need for higher fuel import volumes. We revise our growth forecast to a contraction of 2.0% - 3.0% YoY in 2022 owing to the higher than expected impact from the forex shortage and lower than forecasted growth in 4Q 2021. While we perceive the announcement of IMF talks a key positive at this juncture, we emphasise that the economic reform plan to be announced in April to the IMF is crucial to address the current headwinds facing the country.
IMF talks a clear positive; potential debt restructuring a high probability
Following President Rajapaksa’s talks with the IMF’s Asia Pacific director led delegation during the month, the government announced its stance of seeking IMF support for managing its upcoming debt obligations. The decision to commence discussions for a possible debt restructuring comes as foreign reserves declined to USD 2.3bn in February (which includes a USD 1.5bn Yuan swap). Its noteworthy that the government has already initiated some debt restructuring related to bilateral debt (payment extension to India, SWAP extension with Bangladesh, etc.). However, restructuring of the International Sovereign Bonds (ISB) – which is the most visible external foreign-currency denominated debt – remains a complicated process.
Central Bank announced a correction to the USD/LKR to ease macro pressure
In-line with our views expressed of a likely currency devaluation in 1Q 2022, the Central Bank (CBSL) announced that forex transactions would take place at no more than USD/LKR 230.00 (approx. 13.0% depreciation), from USD/LKR 203.00 before. Following the floating of the currency, the indicative spot rate has reached USD/LKR 295.00. We note that following this announcement, parallel market rates have surged to more than USD/LKR 400.00 as a result of rising speculation and demand for Dollars.
2021 GDP growth comes in at 3.7% YoY; multiple headwinds dampen 2022 momentum
Data released by the Department of Census and Statistics shows that the Sri Lankan economy grew 3.7% YoY in 2021, following the 3.6% YoY contraction recorded in 2020. This came in lower than our forecast of 4.0% YoY owing to the slower than anticipated growth in the Industrial and Agri sector during 4Q 2021. Looking ahead, with the Dollar shortage leading to extended power cuts and fuel shortages, lower chemical fertilizer availability, low fiscal space to support consumers will impact momentum in the near term. With rising inflationary pressure, we expect real household income to face significant pressure, leading to low spending capacity.