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Sri Lanka Country Risk Report Q3 2016

  • May 2016
  • -
  • Business Monitor International
  • -
  • 43 pages

Core Views The Sri Lankan economy is likely to face multiple headwinds over the near term arising from a volatile agricultural sector, a poor consumer outlook, as well as rising risks of a balance of payments crisis. However, the industrial sector is likely to recover over the coming quarters on the back of a more stable political climate. As such, we forecast Sri Lanka's economy to grow at 4.8% in 2016, marking a stabilisation of growth from 2015. The Sri Lankan government will have to agree to austerity measures imposed by the IMF in order to secure a USD1.5bn bailout as the country faces risks of a balance of payments crisis. Under the conditions of the bailout, the government will likely have to reduce its budget deficit to 5.4% of GDP by end-2016. In addition, the CBSL will be forced to raise interest rates and devalue the currency in order to build a foreign reserves buffer.

However, we believe that the government will face difficulty in making short-term adjustments to its budget due to political gridlock and high interest costs. The election of President Maithripala Sirisena in January 2015 and the UNP's victory in the August general election have been positive for socio-political and economic reforms in Sri Lanka. However, we note that the loose coalition arrangement (which is made up of two parties from opposite ends of the political spectrum) is highly susceptible to political gridlock, and will be a risk to the policymaking process in the country. At the same time, there is also a possibility that the Joint Opposition could gain traction due to defections from the Unity Government. Accordingly, we have dialled back the Short- Tem Political Risk Index Score to 71.5, from 72.3 previously. Major Forecast Changes The rupee will likely face further downside pressure over the coming months due to persistent capital outflows and the requirement to build up a foreign reserves buffer under the IMF's guidance. This informs our expectation for the unit to weaken to LKR155.00/USD by end-2016, versus our previous forecast of LKR152.00/USD. Nevertheless, the currency will likely stabilise and average LKR156.10/ USD in 2017 as investor confidence gradually recovers. The Central Bank of Sri Lanka (CBSL) will likely adopt a more aggressive monetary tightening stance in order to slow credit and money supply growth. In addition, higher interest rates are also necessary for the CBSL to build up a foreign reserves buffer (in line with IMF demands). As such, we expect the central bank to hike its benchmark deposit and lending facility rates by 50 basis points to 7.00% and 8.50%, respectively, in H216.

Table Of Contents

Sri Lanka Country Risk Report Q3 2016
Executive Summary 5
Core Views5
Major Forecast Changes5
Key Risks5
Chapter 1:Economic Outlook 7
SWOT Analysis 7
BMI Economic Risk Index 7
Economic Growth Outlook 8
Stable Growth Outlook Amid Multiple Headwinds8
Sri Lanka's industrial sector is likely to recover over the course of the year on the back of a stable political climate However, we expect
the broader economy to face multiple headwinds stemming from a volatile agricultural sector, a weak consumption growth outlook, poor
government finances and rising risks of a BoP crisis As such, we forecast Sri Lanka's real GDP growth to remain stable at 48% in
GDP By Expenditure Outlook 9
TABLE: GDP GROWTH FORECASTS9
TABLE: PRIVATE CONSUMPTION FORECASTS9
TABLE: GOVERNMENT CONSUMPTION FORECASTS10
TABLE: FIXED INVESTMENT FORECASTS10
TABLE: NET EXPORTS FORECASTS10
Fiscal And Public Debt Outlook 10
Teetering On The Brink Of A BoP Crisis Again10
Sri Lanka will have to agree to austerity measures laid down by the IMF in order to secure a bailout under the 36-month EFF program
as the country continues to face risks of a balance of payments crisis Under the terms of the bailout, the government would have to
narrow its fiscal deficit to 54% of GDP by end-2016, versus an official estimate of 72% in 2015 The central bank will also be forced
to hike interest rates further and devalue its currency That said, we believe that the government will find it difficult to make short-term
adjustments to its spending due to political gridlock and high interest repayment costs
Structural Fiscal Position 12
TABLE: MAIN REVENUE AND EXPENDITURE 13
External Trade And Investment Outlook 13
LKR: Further Weakness Ahead Before Stabilising13
We have downgraded our forecast for the Sri Lankan rupee, and expect the unit to weaken further to LKR15500/USD by end-2016
(versus our previous forecast of LKR15200/USD) due to persistent capital outflows, as well as the need for the central bank to build
up a foreign reserves buffer (under IMF guidance) Nevertheless, we expect the currency to stabilise in 2017 as the IMF bailout loan
facility will likely instill confidence among other international financial aid agencies and investors, informing our forecast for the rupee to
average LKR15616/USD for 2017
TABLE: BMI CURRENCY FORECAST 14
Structural External Position 15
TABLE: MAIN EXPORT AND IMPORT PARTNERS 15
TABLE: MAIN EXPORTS AND IMPORTS 15
TABLE: CAPITAL and FINANCIAL ACCOUNT BALANCE 15
Monetary Policy 16
Rate Hikes Likely Under IMF Guidance16
We expect the CBSL to be forced to devalue the rupee and hike interest rates in line with IMF demands to build up a foreign reserves
buffer, as the country seeks a bailout loan from the international aid agency More aggressive monetary tightening measures will likely
be required to slow credit and money supply growth As such, we expect CBSL to hike its benchmark deposit and lending facility rates
by 50bps to 700% and 850%, respectively, in H216
Monetary Policy Framework 17
Chapter 2: 10-Year Forecast 19
The Sri Lankan Economy To 2025 19
A Constructive Long-Term Outlook19
Sri Lanka's economy has grown strongly since the conclusion of the 26-year-long civil war in 2009, and we believe that the island is
well placed to sustain its economic growth momentum over the coming years Although the overheating remains an ongoing risk for the
economy, the reintegration of resources (particularly labour) into the formal economy and a deepening of financial markets bode well for
robust economic expansion over the medium term As such, we are expecting Sri Lanka's real GDP growth to average 58% over the
next 10 years
TABLE: LONG-TERM MACROECONOMIC FORECASTS19
Chapter 3: Political Outlook 21
SWOT Analysis 21
BMI Political Risk Index 21
Domestic Politics 22
Unity Government To Face Challenges In Policymaking22
Following the election of President Maithripala Sirisena in January 2015 and the UNP's victory in the August general election,
socio-political and economic reform momentum in Sri Lanka has started to gain traction However, we note that the grand coalition
arrangement (made up of two rival parties) is highly susceptible to political gridlock, and will continue to pose downside risk to the
policymaking process in the country Meanwhile, there is also a possibility that the Joint Opposition could become stronger due to
defections from the Unity Government As such, we have dialed back Sri Lanka's Short-Term Political Risk Index score to 715, from
723 previously
TABLE: POLITICAL OVERVIEW22
Long-Term Political Outlook 24
Major Challenges In Coming Decade24
Maithripala Sirisena's election to the presidency in January 2015 and the UNP's victory in the August 2015 general election will set Sri
Lanka on a path of increased political accountability over the coming decade, and greater economic reforms Sirisena's biggest political
challenge will be to reconcile the Tamil minority with the Sinhalese Buddhist majority However, this will not be easy, and tensions
between the two groups will persist for the foreseeable future
Chapter 4: Operational Risk 27
SWOT Analysis 27
Operational Risk Index 27
Operational Risk 28
TABLE: OPERATIONAL RISK 28
Economic Openness 29
TABLE: FREE TRADE AGREEMENTS 30
TABLE: FREE TRADE ZONES AND INVESTMENT INCENTIVES 32
Availability Of Labour 33
TABLE: ASIA - AVAILABILITY OF LABOUR RISK 34
TABLE: LABOUR FORCE EMPLOYMENT BY SECTOR ('000), 2009-2012 36
TABLE: TOP 10 SOURCE COUNTRIES FOR MIGRANT WORKERS 36
Chapter 5: BMI Global Macro Outlook 39
Global Macro Outlook 39
Tentative Stability,But New Risks Emerging39
TABLE: GLOBAL ASSUMPTIONS 39
TABLE: DEVELOPED STATES, REAL GDP GROWTH, % 40
TABLE: EMERGING MARKETS, REAL GDP GROWTH, % 41
TABLE: MACROECONOMIC DATA and FORECASTS 43

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