Macro Analysis /
Sri Lanka

Sri Lanka macro analysis: Fundamentals hold steady; economy steers towards consumer-led recovery

    Lakshini Fernando
    Asia Securities
    19 July 2019
    Published by
    • While policy and political uncertainty continued into 2019, the impact of the Easter Sunday attacks added a considerable drag on an already subdued growth environment. Amidst this backdrop, the Central Bank (CB) implemented a loose monetary stance to help revive economic growth.
    • Meanwhile, the fiscal deficit widened during the 4M CY19 amidst low revenue collections owing to a slowdown in the economy. On the positive side, 1) the LKR continued to appreciate, largely correcting the sharp depreciation recorded during end 2018, 2) reserves remain strong, covering over 5 months of imports, 3) low import demand has helped maintain the trade balance and 4) the CB has continued to increase buffer reserves to meet upcoming payments. 
    • Looking ahead, we expect the overall macro fundamentals to remain steady going towards 2020. We expect GDP growth of 2.5% YoY in CY19E and improve to 3.8% in CY20E on the back of a consumer led recovery. We forecast the LKR/USD at 179.00 and reserves to cover ~5.2 months of imports for CY19E.

    Consumer demand to pick up in 2020; credit demand by end 2019

    We expect consumer led growth to pick up in 2020 given more populist policies in the 2019 budget. We acknowledge that the consumer demand pick-up has been slower than anticipated, but, expect the positive impact of 1) the LKR 2,500 public sector salary wage hike, 2) an extension to a special drawing facility for pensioners and 3) concessions through the Samurdhi welfare scheme to materialize in 2H CY19 and 1H CY20. Meanwhile, one of our main concern lies on the slow credit growth environment. We forecast private sector credit growth to end 2019 at 5.5%-6.0% YoY as a result of lackluster loan demand. With market rates trending downwards, we expect credit demand by corporates, mainly in the industries sector to pick up during the latter months of 2019, once further clarity on Presidential Elections, and the candidates emerges.

    Prolonged drought threatens agri recovery

    We note that there are preliminary signs of a prolonged drought prevailing in the Southern, Northern and Eastern provinces. Our channel checks indicate that there is no serious threat to paddy crops in the near-term. However, there is an impact on coconut cultivation, which we expect to have a negative impact on inflation in the next 3-4 months. In the event of any delays in expected rainfall (which is expected by end August), a prolonged drought could have a significant impact to most cultivations which have somewhat recovered from 2 years of below-average harvests. Furthermore, with reservoir levels at significantly low levels, we expect low hydropower generation to result in higher oil imports which will negatively impact the trade balance.

    Reserves stack up well to ease repayment pressure

    Factoring in the expected inflows from the planned third ISB issuance in 2019 (of at least USD 2.0bn), USD 585mn from the Hambantota port lease agreement, and slow import demand, we revise our reserves estimate from USD 8.7bn to USD 9.0bn for 2019, covering 5.2 months of imports. Our estimate comes in below the CB’s USD 9.5bn target on the back of an estimated USD 1.6bn loss in anticipated tourism earnings for 2019 (ASEC estimates) and USD 700mn loss in FDI inflows for 2019 (BOI estimates).