It is evident that the current unprecedented scenario, faced both locally and globally, will impact the Sri Lankan economy through: 1) external supply and demand shocks and, 2) internal demand disruptions.
The key priority at this stage is curbing contagion of the disease. In this regard, we note that the government has taken a number of precautionary steps to mitigate the spread of the virus, starting with imposing curfew and swift measures to convert multiple hospitals and other buildings into quarantine centres and banning all arrivals temporarily. These proactive measures will assist a faster resumption in growth, compared to countries like Italy, which took almost two weeks into the first outbreak to take action. On this basis, we expect the containment of the virus by end-May, and a resumption of economic activity in c1.5 months.
Lockdown measures come at a cost
While the lockdown has undoubtedly helped curb the spread of Covid-19, this comes at an economic cost, mainly from demand disruptions. As such, for our analysis, we have
Looked at the impact on key sectors, taking the views from our sector analysts,
Accounted for policy initiatives taken from both the fiscal and monetary side, and
Evaluated the impact on the informal sector in Sri Lanka
We have used a triangulated top-down and bottom-up approaches to come at specific ranges of results, using 3 main scenarios. Scenario 1: containment of the virus by end-May (base case); Scenario 2: Quick resolution by end-April (best case) and; Scenario 3: a protracted recovery of 6-7 months (worst case).
Assuming Covid-19 spread in Sri Lanka will be contained by end-May, we calculate the following impact on 2020 GDP.
GDP impact in 2020
5.0% - 5.4% decline
4.0% - 4.5% decline
Fiscal stimulus is the correct news, but limited fiscal space a concern
The main concern here is the limited fiscal space available for the government to undertake further measures. We note that in 2019 the fiscal deficit increased to 6.5% of GDP, up from 5.3% in 2018 as a result of lower government revenue and higher expenditure. Outstanding government debt increased 8.3% YoY to LKR 13tn, with foreign debt accounting for 49.1% of total debt.
Amidst sweeping tax cuts in November 2019 and January 2020, we expected pressure on the fiscal deficit at the beginning of the year. Amidst the current slowdown, we expect further pressure with lower corporate taxes and lower direct taxes. Earlier during the month, the government took measures to finalise a USD 500mn 10-year loan from China Development Bank and has plans of extending this to a further USD 700mn in May. While we expect this to help the government’s funding stress, we expect possible funding from the IMF and the World Bank to help create some fiscal space for further support.
Download our full 27-page report on the impact of Covid-19 on Sri Lanka growth.