Economic and political uncertainty remained elevated during the month. While this has resulted in further delays in an interim budget and corrective policy implementation, we note that these are now back on-tack. As such, we expect an interim budget by mid-July. We also note that following the appointment of legal and financial advisors, debt restructuring discussions are likely to be already underway. This follows Sri Lanka’s formal default in May. Meanwhile, the impact of the prolonged fuel shortage was visible on the supply chain and factories, with productivity and supply chains negatively impacted due to power interruptions. While economic activity has also declined, we revise our 2022 GDP expectations to a contraction of 4.5% - 5.5% YoY, from a 2.0% - 3.0% YoY contraction previously. Meanwhile inflationary pressure continued, with headline inflation reaching 29.8% YoY in April as fuel prices increased over 130%. This increased further in May, which is likely to push headline inflation further up. With our expectation of an electricity price hike combined with a worse-than-expected impact in the Yala season on the Agri sector, we revise our inflation forecast to 30.0% - 35.0% YoY from 18.0% earlier. We emphasise that the economic reform plan and a stronger political backdrop is key to mitigating the economic impact.
Primary data indicates slowdown in economy; we revise our GDP forecasts
Given the prolonged impact from 1) the fuel and power shortages, 2) probable global recession, 3) global commodity shortage, 4) impact from the chemical fertilizer ban and 5) rising interest rate environment, we revise our GDP growth forecasts for 2022. As such, we revise our forecast to a contraction of 4.5% YoY - 5.5% YoY from a contraction of 2.0% YoY - 3.0% YoY. We note that this will be revised down further from any prolonged impact from the above-mentioned factors. The slowdown was reflected in mobility data, which recorded a downward trend in footfall in May. The PMI too reflected this, recording a sharp contraction of 21.4 points MoM in April.
CBSL clamps down on open account imports; positive for Dollar liquidity but negative for food imports
The Central Bank took further measures to support Dollar inflows through official bank channels during the month. As such, effective 20th May, the use of Open accounts for imports were banned. This remains open for the export sector for any raw material imports. The Governor noted that out of the available Dollar inflows, priority will be given towards fuel and gas imports. While this is a positive to curb Dollar flows through unofficial channels, we note that Banks continue to face pressure to open LCs due to the lack of Dollar liquidity. Our recent conversations with industry experts reflect this trend, with Bank inability to service LCs for importers.
IMF staff level talks conclude; fiscal delays remain a concern
IMF staff level technical discussions completed during the month, with the IMF reaffirming its commitment to support Sri Lanka. However, the timing of a staff level agreement is likely to take a further 2-3 months given that 1) progress of debt restructuring discussions and 2) a concrete fiscal consolidation plan are key requirements for the finalisation of an agreement. The IMF has also noted the importance of “restoring fiscal sustainability while protecting the vulnerable and poor”.