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Sri Lanka Country Risk Report Q4 2016

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

Core Views

The Sri Lankan economy is likely to face multiple headwinds overthe near term arising from a volatile agricultural sector, a poor consumeroutlook, as well as rising risks of a balance of payments crisis.However, the industrial sector is likely to recover over the comingquarters on the back of a more stable political climate. As such, weforecast Sri Lanka's economy to grow at 5.2% in 2016, marking animprovement in growth from 2015.The Sri Lankan government will have to agree to austerity measuresimposed by the IMF under the conditions of a USD1.5bn bailout asthe country faces risks of a balance of payments crisis. Under theconditions of the bailout, the government will likely have to reduceits budget deficit to 5.4% of GDP by end-2016. In addition, theCentral Bank of Sri Lanka (CBSL) will be forced to raise interestrates and devalue the currency in order to build a foreign reservesbuffer. However, we believe that the government will face difficulty inmaking short-term adjustments to its budget due to political gridlockand high interest costs.The election of President Maithripala Sirisena in January 2015 andthe United National Party's victory in the August general electionhave been positive for socio-political and economic reforms in SriLanka. However, we note that the loose coalition arrangement(which is made up of two parties from opposite ends of the politicalspectrum) is highly susceptible to political gridlock, and will be a riskto the policymaking process in the country. At the same time, thereis also a possibility that the Joint Opposition could gain traction dueto defections from the Unity Government. Accordingly, we havedialled back the Short-Tem Political Risk Index Score to 71.5, from72.3 previously.

Major Forecast Changes
The CBSL will likely pursue further monetary tightening stance inorder to slow credit and money supply growth. In addition, higherinterest rates are also necessary for the CBSL to build up a foreignreserves buffer (in line with IMF demands). As such, we expect thecentral bank to hike its benchmark deposit and lending facility ratesby 50 basis points to 7.50% and 9.00%, respectively, by the end of2016.

Table Of Contents

Sri Lanka Country Risk Report Q4 2016
Executive Summary.. 5
Core Views...5
Major Forecast Changes.5
Key Risks.5
Chapter 1: Economic Outlook.. 7
SWOT Analysis... 7
BMI Economic Risk Index.. 7
Economic Growth Outlook 8
Strong Industrial Sector Growth To Support Economy...8
We expect Sri Lanka's industrial sector growth to remain robust over the coming quarters on the back of a more stable political and
macroeconomic environment and a softening of the government's stance towards Chinese investment. Accordingly, we have revised
our expectations for Sri Lanka's real GDP growth to come in at 5.2% in 2016, up from 4.8% previously, before accelerating to 5.4% in
2017. That said, we believe that the broader economy will continue to face multiple growth headwinds over the coming quarters amid
more fiscal and monetary tightening measures.
GDP By Expenditure Outlook 9
TABLE: GDP GROWTH FORECASTS..9
TABLE: PRIVATE CONSUMPTION FORECASTS9
TABLE: GOVERNMENT CONSUMPTION FORECASTS...10
TABLE: FIXED INVESTMENT FORECASTS..10
TABLE: NET EXPORTS FORECASTS10
Fiscal Policy And Public Debt Outlook.. 10
IMF Loan Paves Way For Deeper Structural Reforms...10
The USD1.5bn IMF loan to Sri Lanka will help stave off an external crisis, and encourage greater fiscal discipline through its strict
budgetary conditions. However, we believe that the pace of deficit reduction will continue to be constrained by high spending pressures
and potential political disagreements. We therefore maintain our 5.9% budget deficit forecast for 2016, implying that Sri Lanka will miss
the 5.4% target associated with the IMF loan. The country will make steady progress over subsequent years in improving its public
finances.
Structural Fiscal Position 12
TABLE: MAIN REVENUE AND EXPENDITURE.12
TABLE: FISCAL AND PUBLIC DEBT FORECASTS...12
External Trade And Investment Outlook 13
External Performance To Improve Despite Agricultural Slowdown.13
We believe that Sri Lanka's external sector will show gradual improvement in 2016, following a modest improvement in April's balance
of payments data. In particular, we expect robust tourism spending and manufactured export growth to contribute to a shrinking current
account deficit. This trajectory would be in line with our current account deficit forecast of 1.6% of GDP at the end of 2016, shrinking
from 2.4% in 2015. Meanwhile, FDI is likely to recover as foreign investor sentiment stabilises following the approval of an IMF loan in
April.
Outlook On External Position.. 15
TABLE: MAIN EXPORT AND IMPORT PARTNERS...15
TABLE: CURRENT ACCOUNT BALANCE FORECASTS...15
TABLE: MAIN EXPORTS AND IMPORTS...16
TABLE: CAPITAL and FINANCIAL ACCOUNT BALANCE.16
Monetary Policy 16
Scope For Further Monetary Tightening.16
We believe that the CBSL's decision to hike its benchmark SLF rate from 8.00% to 8.50% signals the new governor's hawkish stance
towards combating inflation. Addressing the country's rising inflation rate is also a crucial tenet of the country's pledge to improve its
external finances following the approval of an IMF loan in May. We therefore have revised our forecast upwards in expectation of a
further 50bps worth of hikes before the end of 2016. Stable demand conditions meanwhile suggest that growth remain relatively robust
despite future rate hikes.
Monetary Policy Framework 17
TABLE: MONETARY POLICY FORECASTS..18
Currency Forecast 18
LKR To Face Continued Downward Pressure Despite Stabilisation18
We believe that the LKR faces substantial downward pressures in the near term as weak external finances and high inflation pressures
reflect overheating in Sri Lanka's economy. Despite signs of stabilisation seen in July, we maintain our forecast that the rupee will
weaken to LKR155.16/USD at the end of 2016. Over the long term, we expect stabilisation of the rupee at an average of LKR156.16/
USD in 2017, due to tightening fiscal and monetary policy conditions and a wider rebalancing effort from consumption to savings in both
public and private sectors.
TABLE: BMI CURRENCY FORECAST19
Chapter 2: 10-Year Forecast... 21
The Sri Lankan Economy To 2025.. 21
A Constructive Long-Term Outlook.21
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 5.8% over the
next 10 years.
TABLE: LONG-TERM MACROECONOMIC FORECASTS.21
Chapter 3: Political Outlook... 23
SWOT Analysis. 23
BMI Political Risk Index... 23
Domestic Politics. 24
Full Ethnic Reconciliation Remains A Distant Prospect...24
We believe that Sri Lanka's reforms to internal security legislation and judicial inquiries into war crimes will only proceed slowly due to
divisions within the coalition government. At the same time, limited public engagement has allowed social frictions to persist between
communities on opposing sides of the former conflict. Nevertheless, Sri Lanka's gradual progress in other aspects of reconciliation, such
as demilitarising ex-conflict areas and searching for missing persons, will improve its ties with the West and expand access to foreign
investments and development aid.
TABLE: POLITICAL OVERVIEW.24
Long-Term Political Outlook... 26
Major Challenges In Coming Decade..26
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, as well as 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... 29
SWOT Analysis. 29
Operational Risk Index 29
Operational Risk... 30
TABLE: OPERATIONAL RISK.30
Market Size And Utilities.. 31
TABLE: ASIA - MARKET SIZE AND UTILITIES RISK32
Labour Costs 35
TABLE: REGULATIONS GOVERNING FLEXIBILITY OF WORKFORCE...36
Chapter 5: BMI Global Macro Outlook... 39
Global Macro Outlook.. 39
Brexit To Hit Global Growth.39
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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