Given that the Sri Lankan economy is relatively small and open, the administration's balanced and pragmatic approach towards ethnic reconciliation on the island and foreign relations will be positive for growth over the medium-to-long term. However, we believe that there will be several key challenges which will inhibit progress over the near-term.
The Central Bank of Sri Lanka (CBSL) will likely keep its policy rates on hold over the coming months with a tightening bias in order to manage the cost of refinancing for public debt, ensure price stability, and down play the risk of a balance of payment crisis.
Major Forecast Changes
Despite a likely recovery in the industrial sector over the coming quarters, we expect the Sri Lankan economy to face mounting headwinds from a difficult global economic outlook, a high fiscal deficit, and rising risks of a BoP crisis. As such, we have downgraded Sri Lanka's real GDP growth forecast for 2016 to 6.3%, from 6.7% previously, representing a stabilisation of growth in the economy (with growth estimated to come in at 6.2% in 2015).
We are bearish on the Sri Lankan rupee and expect the currency to depreciate further to LKR152.00/USD by end-2016 (versus our previous forecast of LKR148.00/USD) due to persistent external headwinds, global economic uncertainties, rising inflationary pressure, and elevated levels of public indebtedness.
We are bearish on Sri Lanka's fixed income market in 2016 as the central bank could be forced to raise interest rates to prevent a balance of payments crisis. Meanwhile, due to higher budget expenditures and a less optimistic revenue growth outlook, we are now forecasting a budget deficit equivalent to 6.3% of GDP (up from our previous forecast of 5.8%), which will exert upside pressures on sovereign bond yields.
The CBSL could be forced to return to capital controls if the country once again sinks into a full-fledged balance of payments crisis, but this will likely be a method of last resort given that the central bank had refrained from doing so in the past despite moderate BOP shocks.
|Nominal GDP, USDbn||74.9||77.2||77.2||81.3|
|Real GDP growth, % y-o-y||7.4||6.2||6.3||6.4|
|Consumer price inflation, % y-o-y, eop||2.1||2.0||3.0||3.0|
|Exchange rate LKR/USD, eop||131.21||144.25||152.00||156.56|
|Budget balance, % of GDP||-6.0||-6.2||-6.4||-6.2|
|Current account balance, % of GDP||-2.7||-3.2||-3.8||-3.4|
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