Amid tighter travel restrictions economic activity continued to slow down, albeit not to the extent seen in previous cycles. However, with the lockdowns ending from the 1st of October, we expect a faster recovery in momentum. Key leading indicators like the Business Confidence Index and the Index of Industrial Production (IIP) showed encouraging signals for 3Q 2021 growth momentum, with the IIP continuing its upward momentum. Meanwhile, fresh concerns on the inflationary impact stemming from the food basket re-emerged as initial signals of the impact from lower availability of chemical fertilizer during the Maha season emerged. This, combined with rising global commodity prices are key concerns on the inflationary front in the coming months. As such, we revise our inflation forecast to 7.0% - 8.0% YoY for 2021. Meanwhile the CB imposed tighter restrictions on imports as the Dollar liquidity shortage persisted. The month also saw the govt bond yield caps come off, a much needed positive to indicate a gradual end to money printing. We forecast the indicative spot rate at USD/LKR 210.00 – 215.00 in 2021, while we expect the bank conversion rates to reach USD/LKR 215.00 – 220.00. We forecast overall growth to reach 4.4% - 4.8% YoY, with economic activity picking up following the roll-out of the vaccine.
Central Bank implemented tighter import controls as Dollar shortage persists
The Central Bank imposed fresh restrictions on imports at the last monetary Board meeting held earlier this month. As such, the CB imposed a 100% non-interest bearing cash margin deposit for over 600 import product categories under “non-essential” goods. This replaces the 180-day advance Letters of Credit option available for importers earlier. This followed the break in the moral suasion USD/LKR conversion cap of 200.00 – 203.00 imposed earlier. Tighter restrictions came on the back of rising imports, where the value of these items for 7M 2021 amounted to USD 753mn compared with USD 871mn for the full year 2020. Against this backdrop, broad money growth recorded a 21.5% YoY increase in June.
Low base supports 2Q GDP growth; QoQ decline reflects dampened momentum
Data released by the Department of Census and Statistics shows that the Sri Lankan economy was impacted by the fresh travel restrictions imposed in April, with the economy contracting 9.4% QoQ in 2Q 2021. Supported by the low base, the economy recorded a 12.3% YoY growth for the quarter. The Services sector which accounts for over 50.0% of GDP expanded by 7.5% YoY (-7.6% QoQ), while the Industrial Sector grew 22.1% YoY (-23.7% QoQ). Meanwhile, agriculture was the only sector to record a positive QoQ growth of 0.8% (+8.1% YoY). Absolute numbers show that GDP has not recovered to pre-COVID levels yet, but we expect momentum to pick-up in 2H 2021 amidst a rapid vaccination drive and removal of travel restrictions.
Bank exchange rates remain at moral suasion level; Dollar shortage persists
Following the correction recorded last month, the monthly average USD/LKR spot rate reversed to USD/LKR 200.00 during the month, as such, the indicative spot rate recorded a 4.8% MoM appreciation (compared with an approx. 5.1% MoM depreciation recorded in August), reaching USD/LKR 199.98 by month end. The same trend was reflected in bank conversion rates as well, with the rate moving back to the moral suasion level of USD/LKR 200.00 – 203.00. Against this backdrop, our discussions indicate a significant shortage of Dollars in the market, with kerb market rates reaching USD/LKR 225.00 – 235.00 during the month.