ECONOMYNEXT – Sri Lanka’s economic slowdown which was caused by drought, floods, political uncertainty and the Easter Sunday terror attack is expected to bottom out in 2019, HSBC Global Research said in a recent report.
“Sri Lanka continues to grapple with various challenges, and a fall in tourism may add to the squeeze. Still the economy is likely to bottom this year, accelerating into 2020,” the report ‘Asian Economics: Keep on Truckin’’ said.
Sri Lanka’s economic growth slowed to 3.2 percent in 2018 from 3.4 percent a year earlier, and HSBC forecasts growth will fall to 2.7 percent in 2019 and pick up to 3.2 percent in 2020.
Drought, floods, and a political crisis have curtailed growth. The Easter Sunday terror attacks and subsequent communal unrest will dampen growth prospects further.
“To begin with, we were not expecting a sharp acceleration in growth in 2019,” HSBC said.
Presidential elections are expected towards the end of this year followed by parliamentary elections.
“As election season kicks in, policy and political uncertainty weighs on economic activities. Investment activity tends to remain subdued, led by weak private participation. And the recent bombings and concerns over national security are likely to be a further drag on growth recovery.”
Weak sentiment
An HSBC survey of local business indicated a weak outlook for industry. Following the terror attacks in April, low tourism arrivals will drag services and other sectors allied to the tourism industry.
“It is important to note that it may take some time before the impact on tourism becomes clear. April, May, and June are months of low tourist arrivals," the HSBC report said.
“This seasonality needs to be kept in mind while reading tourist arrivals data over the next few months. It is only by July/August that we will get to know if there are signs of major weakness in this sector," it said.
Experience in other countries shows that the impact of a severe security incident tends to fade over time, possibly within a year, HSBC said.
“The off-peak season may also provide a breather to ensure that travel advisories to Sri Lanka are removed”.
Credit Growth
Falling credit growth is a cause for concern.
“A combination of the cuts in policy rates, better transmission into lower lending rates, and improved liquidity will go a long way, in our view, to lifting growth,” HSBC said.
The Central Bank’s measures to bring down lending rates to reverse a credit slowdown and stimulate the economy will take time to show results.
In May the Central Bank cut policy rates by 50 basis points and the Statutory Reserve Ratio was reduced twice, in November 2018 and the following February. It also capped ceiling in bank deposit rates to force a reduction in lending rates.
“The transmission to lower lending rates is likely to happen slowly, as the deposit base takes time to reprice,” HSBC said.
“These steps, in our view, are well timed and are likely to get transmitted into lower lending rates by early 2020, which is just about the time when election-related uncertainties begin to fade”.
The bank said that despite the recent cut in policy rates, Sri Lanka’s real interest rate were still above many emerging economies. HSBC is forecasting another 50 basis-point policy rate cut in 2020.
“Having said that, it is important for the central bank to be mindful of the risks on the horizon,” the bank cautioned.
“It has to tread carefully in managing the risks around debt repayment, currency volatility, quality of credit growth, and the slower pace of fiscal consolidation”.
With Sri Lanka soon entering an elections cycles, efforts to reduce lending rates could be undermined by fiscal slippages.
Risks
Sri Lanka’s debt repayment schedule for 2020 is estimated at 3.7 billion US dollars and the country runs a twin-deficit of around 8 percent of GDP.
“Although the IMF’s fifth review of the Extended Fund Facility (EFF) was recently announced, it’s extremely important for Sri Lanka to continue undertaking structural reforms under the IMF umbrella as these reviews underscore market confidence in the country’s commitment towards reforms.
“Also, presidential elections are scheduled in 4Q19 and general election in 2Q20, with risks of the latter being brought forward.
“Under this backdrop, if there is increased fiscal spending, it could result in higher inflation, and curtail policy rate cuts,” the HSBC report said. (COLOMBO, 11 July 2019)
