Macro Analysis /
Global

Sri Lanka: Macro SL - Sentiment improves following swap & UNHRC finalisation

  • UNHRC resolution concludes; we reiterate our view of low trade implications

  • CB finalises USD 1.5bn currency swap agreement; a much needed positive to sentiment

  • Short end of the yield curve records steep downward trend as investor sentiment improves

Asia Securities
31 March 2021
Published byAsia Securities

March saw the conclusion of the 46th regular session of the UNHRC, where the resolution around Sri Lanka’s Human Rights violations was passed. We reiterate our view that hard sanctions on Sri Lanka at this point are minimal. Meanwhile, the finalisation of the USD 1.5bn swap agreement with China was a much needed boost to investor sentiment. Following the news, yields on the short end of the ISB curve plunged, indicating greater confidence in the international market of the Government honoring its debt obligations. However, lower USD liquidity continued to add pressure on the currency in March, with the spot rate recording a 2.1% MoM depreciation, reaching USD/LKR 196.76 (as of 29th Mar), while the monthly average was USD/LKR 198.17. Looking ahead, we forecast the currency at USD/LKR 203.00 – 205.00 for 2021, depreciating by 8.9% YoY. We expect overall GDP growth to reach 5.2% YoY in 2021, with economic activity picking up amidst the roll-out of the vaccine.

UNHRC resolution concludes; we reiterate our view of low trade implications

The month-long discussions around assessing Sri Lanka’s human rights conditions concluded during the month. Majority of countries supported a resolution to call on the Government to improve its commitment to human rights. We maintain our view that the probability of hard sanctions on Sri Lanka are minimal at this point. The likelihood of a continuation of travel bans on individuals (as currently by the US on Sri Lanka’s army chief) and soft sanctions (if at all) could take place in the near term. The key positive is that the resolution does not direct to instituting action in international criminal court in the near term.

CB finalises USD 1.5bn currency swap agreement; a much needed positive to sentiment

The State Minister for Capital Markets and Money, Nivard Cabraal announced that the government has reached an agreement on the USD 1.5bn currency swap with China during the month. Following the news, yields on the short end of the International Sovereign Bond (ISB) curve plunged in response, indicating greater confidence in the international market of the Government honoring its debt obligations. The USD 1.5bn swap is a much-needed boost for the reserves position which stood at USD 4.6bn by end February. As such, if the government decides to draw down the swap, we expect the reserves position to reach ~USD 5.8 - USD 6.0bn by end March (taking into account interest payments due during the month). According to State Minister Cabraal, the USD 1.5bn will likely be kept as a buffer to help strengthen reserves at this point.

Short end of the yield curve records steep downward trend as investor sentiment improves

Following the news of the USD 1.5bn swap finalisation, the short end of the Sovereign curve plunged, as concerns of the country’s near-term debt repayment ability eased. At the end of March, yields on the 2021 ISB declined to 15.74% (on the 29th of March), down 15.98pp since December 2020. We re-iterate our view that we do not see a near term concern in terms of the 2021 repayment at this point. In our view, the longer-term refinancing concerns continue to be a pain point for SL Sovereign bonds, amidst no clear fiscal framework currently in place. While the 2021 budget offered clarity into this area of concern to some extent, our main concern is on the government’s fiscal constraint.