Strategy Note /
Sri Lanka

Sri Lanka's food and currency "emergency"

  • President Rajapaksa declared emergency powers to secure supply of food items at "fair" prices; another populist move

  • This includes the power to seize private sector inventories of food items like sugar and fix consumer prices

  • Global food prices are moderating but Sri Lanka faces very high currency risk; its cheap equities are for locals alone

Sri Lanka's food and currency "emergency"
Hasnain Malik
Hasnain Malik

Strategy & Head of Equity Research

Tellimer Research
1 September 2021
Published byTellimer Research

President Gotabaya Rajapaksa declared emergency powers to secure supply of food items at "fair" prices, from 31 August. This includes the power to seize private sector inventories of food items like sugar and rice, arrest suspected hoarders and fix consumer food prices.

After a year of very sharp increases, global food inflation has moderated in the past two months. Furthermore, Sri Lanka is not nearly as exposed to either a high proportion of household spend on food or to significant net imports of food as many other emerging markets.

Separately, the Covid vaccination rate increasing quickly, with a 16pp increase in the population that is fully vaccinated in the month of August alone, taking the total to 30%.

But this action is a reflection of the very high currency risk: the FX rate has already depreciated 7% ytd. A bailout from regional powers who see geopolitical value in Sri Lanka's deep-water ports, China and India, or a populist about-turn from the Rajapaksas (Gotabaya Rajapaksa and his brother Mahinda, the prime minister) to commit to the reforms required for an IMF deal, are likely needed to resolve this risk.

Sri Lanka equities (CSE All Share) are up 26% ytd. They appear cheap: 2021 forward PB for Sri Lanka MSCI IMI (where conglomerate John Keells is a 34% weight and Commercial Bank of Ceylon is 16%) is merely 0.6x, a 40% discount to the 5-year median, for 12.4% ROE.

However, this value is more appealing for local investors, rather than foreigners, who are at risk of trapped capital. For cheap value in small EM Asia, Indonesia, the Philippines and Pakistan look more appealing.

Sri Lanka food exposure and currency risk

The FX rate has depreciated 7% ytd and 13% since the start of 2019. There is increasing anecdotal evidence of repatriation difficulty for foreign institutional investors in local equities. Five facts about the current crisis:

  1. Food takes up 30% of total household spend in Sri Lanka (2018 data), in the middle of the range for EM (15% to 60%);

  2. Net food exports are normally close to zero (2015-19 annual average), again in the middle of the range for EM (-6% to +6%, as a percentage of GDP), while the overall current account deficit is 2.2% (average IMF forecast for 2021-22);

  3. FX reserves are below the red-flag three months of import cover threshold (2.8x), external debt (public and private) to GDP is 70% (with short-term debt of over 10% and equivalent to double FX reserves);

  4. Last reported inflation of 6.8% and a policy rate of 5% (standing deposit facility) imply a real interest rate of negative 1.8% (no carry-trade incentive here)

  5. Remittances are 8% of GDP and relatively healthy, compared with Covid-hit tourism, which is, in terms of direct contribution, 5% of GDP.

Related reading

Commodity food prices drop again but from a high level, August 2021

Sri Lanka tightens monetary policy, but more is needed (Curran), August 2021

Sri Lanka: Rajapaksas like it's 2010, August 2020

Emerging-Frontier Equity Monthly – August: Taper, Covid, Afghanistan, August 2021