Midyear Economic Update - 2021 August - ICRA Lanka
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Midyear
Economic
Update
2021
August
Midyear Economic Update
2021
AugustEconomy at a glance for 1H 2021 Economy relapses amid the third wave Highlights First quarter recorded a modest economic growth (4.2%) but the rapid escalation of the third wave of COVID infections stalled the momentum telling us that the pandemic will continue to cast a longer shadow over the economy. Our nowcasting models indicate that Sri Lanka’s GDP may have grown at around 4.1% in 2Q. Improving economic activities post relaxation of the lockdown brought the wages on an upward track on the back of growth in services and industries wages. Headline Inflation started to climb up in 1H as a result of uptick in non-food inflation. Following the fuel price hike in June, inflation made the biggest jump since the beginning of the pandemic last year. Supply shocks caused food inflation to remain high at double digits before moderating to upper single digit levels in 2Q. The CBSL maintained a dovish stance in monetary policy throughout 1H. The money market rates remained broadly steady and subdued in 1Q. Treasury yields edged up. Retail lending rates further declined. Improved mobility after the relaxation of lockdown measures together with the April new year festive season elevated consumer spending and retail trade activities boosting willingness to lend among lending institutions to drive private credit. However, the gloomy outlook that followed immediately in the wake of the rising third wave of infections eroded the optimism. In April rupee abruptly appreciated for a short duration only to spring back and remained around 200 for the rest of the quarter in what appears to be an attempt to use moral suasion to prevent rupee from depreciating. Consequently, the liquidity in the interbank forex market dwindled giving way for black market to thrive. Monthly merchandise exports during the first five months of 2021 outperformed its corresponding year-ago levels by 33.3%. Imports went up by 26% mainly due to increasing commodity prices. With the deterioration in terms-of- trade, Sri Lanka was unable to achieve a material improvement in the trade deficit. Remittances managed to perform consistently well above the last year levels (+18.2% in 5M 2021). However, tourism receipts (-97%) remained at dismal levels under current international travel restrictions. Throughout 1H Sri Lanka struggled to preserve or improve its reserve position while the country’s import cover was on a downward trajectory (5.7 months in January to 4.6 in May). Following sovereign rating downgrades by multiple agencies towards the end of 2020, the yields on SLISBs were on the rise mostly during 1H apart from few occasions where markets responded to positive news. Government revenue stagnated in 4M 2021 growing only by 0.8% despite modest recovery in GDP in 1Q. As a result of elevated expenditure level together with stagnant revenue, the fiscal deficit has further expanded (+15.1%). The deficit was primarily financed through domestic borrowings in the form of treasury bonds and bills. This has brought the total stock of debt over LKR 16 Tn by the end of April 2021.
Economic forecasts for 2021/2H Indicator Unit 2019 2020 2021* GDP (real) LKR Bn 9,883 9,531 9,858 GDP (nominal) LKR Bn 15,013 14,973 16,262 GDP (growth) % 2.3 -3.6 3.4 Government revenue LKR Bn 1,899 1,373 1,487 Government revenue, % of GDP % 12.6 9.2 9.1 Government expenditure LKR Bn 3,338 3,041 3,221 Government expenditure, % of GDP % 22.3 20.3 19.8 Fiscal balance LKR Bn -1,439 -1,668 -1,734 Fiscal balance, % of GDP % -9.6 -11.1 -10.7 Government debt LKR Bn 13,032 15,117 17,043 Government debt, % of GDP % 86.8 101.1 104.8 Exports USD Bn 11.9 10.0 12.3 Exports, % of GDP % 23.1 16.5 16.7 Imports USD Bn 19.9 16.1 20.3 Imports, % of GDP % 29.2 22.9 27.5 Trade balance USD Bn -8.0 -6.0 -8.0 Trade balance, % of GDP % -9.5 -7.5 -10.9 Current account balance USD Bn -1.8 -1.1 -1.4 Current account balance, % of GDP % -2.2 -1.3 -1.9 Exchange rate LKR/USD 178.8 185.5 200 - 220** Gross official reserves, year end USD Bn 7.6 5.7 3.9 AWCMR % 7.45 4.45 4.60 - 5.10** T-bill yield (3M) % 7.51 4.69 5.10 - 5.30** T-bill yield (12M) % 8.45 5.05 5.20 - 5.40** AWPR % 9.74 5.81 5.50 - 6.60** SLFR, year end % 7 4.50 4.50 SDFR, year end % 8 5.50 5.50 Inflation rate, CCPI (2013=100) % 4.3 4.6 5 - 6** Note: *ICRA Lanka Research projections, **Average for 2H 2021
Contents Performance in 1H 2020 ............................................... 1 Interest Rates .................................................................1 External Sector .............................................................5 Fiscal Sector .................................................................. 9 Prices & Wages............................................................ 11 Equities .......................................................................... 13 Financial Sector.......................................................... 14 Commodities ................................................................ 17 Real Sector................................................................... 19 Outlook for 2H 2021 .................................................... 22 Global Outlook ............................................................ 22 GDP ................................................................................ 23 External Sector .......................................................... 23 Fiscal Sector ............................................................... 25 Interest Rates ............................................................. 26 Inflation......................................................................... 26 Rating Actions .............................................................. 27
Midyear Economic Update | 2021
Performance in 1H 2020
Interest Rates
Short-term Rates
Figure 1: Treasury bill yield (3M) and money market rates
7.00%
The money market rates
6.50% remained broadly steady
and subdued in 1Q.
6.00%
5.50%
5.00%
4.50%
4.00%
AWCMR SDF SLF T-bill yield (3M) ARR
Notes: AWCMR- Average Weighted Call Money Rate, SDFR- Standing Deposit Facility
Rate, SLFR- Standing Lending Facility Rate, T-bill yields are for the secondary market,
ARR – simple average of daily repo rates
Source: CBSL
The CBSL maintained a dovish stance in monetary policy throughout 1H 2021. During
this period the CBSL did not conduct any auction based open market operations and
Money market
resorted to changing its stock of treasuries to influence the money supply. The money rates
market rates remained broadly steady and subdued in 1Q. Liquidity averaged LKR
159.9 Bn a day in 1Q down from 192.4 the quarter before. Occasionally, the market
liquidity fluctuated owing to the CBSL’s intervention in the forex market.
In 2Q the liquidity level further declined averaging LKR 113 Bn a day pushing call and
repo rates up by about 16 bps. Consequently, call and repo market volumes jumped to Liquidity
the highest levels seen since the beginning of the pandemic. Despite having witnessed
the largest surplus liquidity in the money markets in recent times, a considerable amount
of funds has been borrowed via the SLF facility since mid-March.
T-bills, the treasury’s preferred mode of financing the fiscal deficit now, saw yields
soaring with the relaxation/lifting of caps imposed. The cost of imposing these T-bill yields
distortionary caps was sloppy auctions with significantly low offer-to-acceptance ratios.
In addition, the CBSL ramped up average quantity of treasuries offered in a single
auction to compensate for poor offer-to-acceptance ratio. In numerous instances, the
CBSL stepped in to purchase the unsold treasuries from primary auctions causing
Page | 1Midyear Economic Update | 2021
liquidity spikes which were sometimes offset by selling forex in the open market or selling
down of treasuries in the secondary market. In this setting, the CBSL’s stock of treasury
holdings grew 26.7% in 1H. In the secondary market T-bill volumes were at record levels
throughout the reference period.
Long-term Rates
Figure 2: Yield curve of treasuries
8.50%
The shorter end of the
8.00% yield curve remained by
7.50% and large flat while the
7.00% belly and the tail of the
curve steepened
6.50%
overtime.
6.00%
5.50%
5.00%
4.50%
3M
6M
1Y
< 2Y
< 3Y
< 5Y
< 6Y
< 8Y
< 10Y
< 15Y
< 20Y
< 30Y
2Q 2020 3Q 2020 4Q 2020 1Q 2021 2Q 2021
Notes: Yields are based on the weekly averages that prevailed at the last week of the month,
Shorter-end – less than 2Y, mid/intermediate tenor – 2 to 10Y, longer tenor – above 10Y
Source: CBSL
Policy rate cut in July last year shifted the yield curve down in 3Q 2020. Thereafter,
yields began to rise with rising inflation expectation due to gradual normalization of Bond yields
economic activity. The shorter end of the curve remained by and large flat while the belly
and the tail of the curve steepened overtime. Market showed appetite for fresh bond
issues throughout 1H barring the April auctions. Secondary market also posted record
turnover.
Figure 3: Secondary market T-bill yields and AWPR
9.00%
8.00% Note: AWPR – Average
7.00%
Weighted Prime Rate is
calculated based on the
6.00% submissions made by the
commercial banks to the
5.00%
CBSL on the rates offered
4.00% to customers who borrowed
more than LKR 10 Mn for
4-Jun-21
14-Aug-20
6-Nov-20
20-Nov-20
1-Jan-21
9-Apr-21
18-Jun-21
23-Apr-21
7-May-21
21-May-21
15-Jan-21
29-Jan-21
28-Aug-20
11-Sep-20
25-Sep-20
4-Dec-20
18-Dec-20
9-Oct-20
23-Oct-20
12-Feb-21
26-Feb-21
12-Mar-21
26-Mar-21
3-Jul-20
17-Jul-20
31-Jul-20
less than three months.
Source: CBSL
T-bill (3m) AWPR
Page | 2Midyear Economic Update | 2021
Retail lending rates further declined (AWNLR by 506 bps and AWLR by 395 bps in 5M Lending rates
2021). Nevertheless, AWPR whilst being volatile, bounced back to the level that
prevailed at the beginning of the year towards the tail end of 2Q. The spread between
AWPR and 3M T-bills, which has historically remained above 200 bps, is currently
narrowed to about 70 bps.
Credit
Figure 4: Credit demand and supply
Credit growth, M2B (Y/Y) Credit supply survey
70% 100
80
60%
60
50%
40
Index Value 20
40%
0
30%
-20
20% -40
-60
10%
-80
0% -100
Jul-19
Jul-20
Sep-19
Nov-19
May-20
Nov-20
May-21
Jan-20
Mar-20
Sep-20
Jan-21
Mar-21
3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q
2019 2019 2020 2020 2020 2020 2021 2021*
Private Government Willingness to Lend Demand for Loans
Notes: Indices in the credit supply survey are calculated as ‘Diffusion Indices’, that take values between -100 and 100, by
weighting responses of the licensed banks using exposure of each bank to Total Gross Loan Portfolio of the banking
sector. Index value > 0 means an increase; Index value < 0: decrease; Index value = 0: unchanged, *2Q 2021 outlook
Source: CBSL
Improved mobility after the relaxation of lockdown measures together with the April new
year festive season elevated consumer spending and retail trade activities boosting
Credit growth
willingness to lend among lending institutions to drive private credit. However, the
gloomy outlook that followed immediately in the wake of the rising third wave of
infections eroded the optimism. Concurrently, since the beginning of the pandemic the
government has been borrowing extensively from the banking system.
Given the current historically low interest rate setting, there was a strong interest
among institutional investors on good quality corporate debt instruments. A 6M Corporate debt
commercial paper issued by an A-rated entity fetched around 150 bps spread over market
AWPR while that of a BBB-rated entity fetched around 300 - 400 bps. According to
ICRA Lanka estimates roughly LKR 130 Bn debt instruments have been rated
between 2Q 2020 to 2Q 2021 period and 1Q 2021 marks the highest amount of
debt rated in a single quarter for the last five years.
Page | 3Midyear Economic Update | 2021
International Rates
Figure 5: International lending rates
0.70%
Eurodollar rates LIBOR
0.60% USD and SOFR
continued to move
0.50%
down as markets were
0.40% flushed with US dollars
0.30%
due to the Fed’s dovish
policies.
0.20%
0.10%
0.00%
Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21
LIBOR USD (6m) SOFR (6m)
Notes: The SOFR Averages are compounded averages of the SOFR over rolling 180-
calendar day periods.
Source: New York Federal Reserve and global-rates.com
Expedited COVID vaccine rollout in the US brought infection and death rates lower Fed policy and
helping to normalize economic activities. The US treasury yields started to move up over
inflation fears due to Fed’s inflation overshoot target. The Fed made several Eurodollar rates
reassurances that it would continue with the ongoing QE programme to calm the
markets. In June the markets were rattled when the Fed announced that they are
forecasting rate hikes in 2023 – a move which the Fed initially said would not initiate until
at least 2024. Meanwhile, Eurodollar rates LIBOR USD and SOFR continued to move
down as markets were flushed with US dollars due to the Fed’s dovish policies.
The CBSL held three SLDB auctions in 1H 2021 which collectively offered USD 1,050
SLDBs
Mn. With the crippling state of the country’s external sector situation, the CBSL
managed to collect only USD 774.3 Mn from the auctions of which about USD 700 Mn
were utilised to rollover a maturing SLDB tranche in May. The CBSL has not offered any
floating rate notes (which were tied to 6M LIBOR USD earlier) so far this year and
average yields during auctions remained elevated.
Read ICRA Lanka report on the LIBOR 2021 Transition is a bigger deal than you
might think…Is Sri Lanka ready?
Read ICRA Lanka report: Low interest rates. Who are the winners and losers?
Page | 4Midyear Economic Update | 2021
Figure 6: SLISB quarter end yields
28%
The yields on SLISBs
26%
24% were on the rise mostly
22% during 1H 2021 apart
20% from a few occasions
18% where markets
16% responded to positive
14%
news.
12%
10%
Maturity Date
2Q 2020 2Q 2021
Source: CBSL
Following sovereign rating downgrades by multiple agencies towards the end of 2020,
the yields on SLISBs were on the rise mostly during 1H 2021 apart from few occasions Sovereign bonds
where markets responded to positive news – most notably confirmation of USD 1.5 Bn
swap with China in March and signing of USD 500 Mn Foreign Currency Term Financing
Facility (FCTFF) in April. The pressure on yields was most felt in the near-dated
maturities amid worries over Sri Lanka’s challenging external sector situation. In June
the CBSL lifted the ban preventing banks from buying SLISBs to make SLISBs more
liquid.
External Sector
Figure 7: External trade (USD Mn)
2,500
During 5M 2021,
2,000 exports and imports
rose 33% and 26% Y/Y
1,500 respectively while the
trade deficit worsened
1,000 by USD 562 Mn.
500
-
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Trade Deficit (2021) Exports (2020) Exports (2021)
Imports (2020) Imports (2021)
Source: CBSL
Page | 5Midyear Economic Update | 2021
Monthly merchandise exports during the first five months of 2021 outperformed its
corresponding year-ago levels three months in a row while managing to maintain Exports
exports at around USD 1 Bn a month helped by faster recovery in key export
destinations (i.e., US, UK, and Europe). For the said period, on year-on-year basis
exports grew 33.3% and the increase was mainly attributable to the growth in garments
(+34%), rubber products (+50.8%) and tea (+15.3%).
Imports shot up by 26% despite having import controls on account of increase in prices
of intermediate goods, especially fuel (+51.9%), textiles (+32%), chemical products
Imports
(47.3%), and base metals (+88.4%). Furthermore, there is a notable increase in
machinery and equipment (+30%) imports.
With the deterioration in terms-of-trade, Sri Lanka was unable to achieve a material
improvement in the trade deficit. In this context, the trade deficit worsened by USD 562 Trade balance
Mn to USD 3,663 Mn during 5M 2020 vis-à-vis 2021.
Figure 8: Remittances (USD Mn)
800
Remittances managed
700 to perform
600 consistently well
500
above the last year
levels (+18.2% in 5M
400
2021).
300
200
100
-
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov
2021 2020
Source: CBSL
Remittances managed to perform consistently well above the last year levels (+18.2% in Remittances and
5M 2021). This is in spite of a significant number of returnees particularly from Middle
Eastern countries. The increase is attributable to increased remittances from Sri tourism
Lankans living in developed countries to Special Deposit Accounts with higher interest
rate. However, tourism receipts (-97%) remained at dismal levels under current
international travel restrictions.
Page | 6Midyear Economic Update | 2021
Figure 9: Net foreign purchase of equities and treasuries (LKR Mn)
15,000
10,000 Foreigners sold USD
5,000 119 Mn in equities and
0 USD 14 Mn in
-5,000 treasuries during 5M
-10,000 2021.
-15,000
-20,000
-25,000
-30,000
-35,000
Jul-20
Apr-21
Jun-21
Aug-20
Nov-20
Dec-20
Jan-21
May-21
Sep-20
Feb-21
Mar-21
Oct-20
Equity Treasury
Source: CSE, CBSL
Notwithstanding the boom in CSE in January 2021, foreign investors showed very little
appetite in Sri Lankan equities. Foreigners were consistently on the sell-side and in Inflows to capital
aggregate accounted for USD 119 Mn net outflow in the first five months of the year. In account
this respect, treasury instruments fared marginally better with a net inflow of USD 14 Mn
during the same period. Successive rating downgrades and surging US treasury yields
have narrowed the interest rate differential making Sri Lankan treasuries less attractive
for foreign investors. Foreign direct investments (FDIs) have also suffered a major blow,
totaling only USD 198 Mn in 5M 2021.
Figure 10: Interbank spot market for forex
205 80
200 70 The Sri Lankan rupee
faced a high degree of
Spot rate (LKR/USD)
60
Volume (Mn USD)
195
50 volatility in 1H. The
190
40 liquidity in the
185 interbank spot market
30
180 declined in 2Q.
20
175 10
170 0
28-Aug-20
14-Aug-20
6-Nov-20
20-Nov-20
1-Jan-21
26-Feb-21
9-Apr-21
23-Apr-21
4-Jun-21
18-Jun-21
7-May-21
21-May-21
11-Sep-20
25-Sep-20
4-Dec-20
18-Dec-20
15-Jan-21
29-Jan-21
12-Feb-21
12-Mar-21
26-Mar-21
9-Oct-20
23-Oct-20
3-Jul-20
17-Jul-20
31-Jul-20
Spot exchange rate Average daily volume
Source: CBSL
Page | 7Midyear Economic Update | 2021
Sri Lankan rupee faced a high degree of selling pressure in January 2021 with the uptick
in US treasury yields. In this context, the CBSL temporarily suspended forward contracts
Exchange rate
and extended the restriction on outward remittances on capital transactions. In addition, and spot market
direct intervention by the CBSL added more liquidity to the domestic forex market to
ease the pressure. In February, rupee was broadly stable with better forex inflows but
rupee came under pressure again in March amid a spike in imports. In April rupee
abruptly appreciated for a short duration only to spring back and remained around 200
for the rest of the quarter in what appears to be an attempt to use moral suasion to
prevent rupee from depreciating. Consequently, the liquidity in the interbank forex
market dwindled giving way for black market to thrive. Sri Lankan rupee’s Real Effective
Exchange Rate (REER)1 index slid to 82.51 in May making it the most undervalued
instance on record since 2010.
Figure 11: Interbank forward market for forex
205 70
With the suspension of
60
200 forward contracts by
Forward rate (LKR/USD)
50 the CBSL in January,
Volume (Mn USD)
195
liquidity in the forward
40
190
market moderated
30 with the exception of
185 March.
20
180 10
175 0
20-Nov-20
21-May-21
9-Apr-21
23-Apr-21
6-Nov-20
1-Jan-21
7-May-21
4-Jun-21
18-Jun-21
14-Aug-20
28-Aug-20
11-Sep-20
25-Sep-20
4-Dec-20
18-Dec-20
15-Jan-21
29-Jan-21
12-Feb-21
26-Feb-21
12-Mar-21
26-Mar-21
3-Jul-20
17-Jul-20
31-Jul-20
9-Oct-20
23-Oct-20
Forward exchange rate (1M) Average daily volume
Source: CBSL
Forward premiums were inverted for most part of 1H 2021 as a result of narrower LKR –
USD interest rate differential. With the suspension of forward contracts by the CBSL in Forward market
January, liquidity in the forward market moderated with the exception of March where
demand for forward contracts grew on the back of a spike in imports (imports rose 26%
in March from April). By the end of 1H outstanding forward volume contracted by 40%
compared to the year open.
1
A rising REER typically means that a country’s goods are becoming more expensive to foreign counterparts, and
therefore less competitive (i.e., stronger rupee), relative to its trading partners while a declining REER indicates the
opposite.
Page | 8Midyear Economic Update | 2021
Figure 12: Gross official reserves (USD Mn)
8,000
7,000 Throughout 1H Sri
Lanka struggled to
6,000
preserve or improve
5,000 its reserve position
while the country’s
4,000
import cover was on a
3,000 downward trajectory.
2,000
1,000
0
Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21
Source: CBSL
Throughout 1H Sri Lanka struggled to preserve or improve its reserve position while the
country’s import cover was on a downward trajectory (5.7 months in January to 4.6 in Reserve position
May). Several major forex obligations were settled in a span of four months (February
USD 400 Mn swap with Reserve Bank of India, March USD 500 Mn with Fed and USD
694 Mn SLDBs in May) while few key inflows (USD 1.5 Bn swap with Peoples Bank of
China in March, USD 500 Mn FCTFF in April, and USD 200 Mn swap with Bangladesh
Bank in June) helped to offset outflows. The CBSL absorbed forex through mandatory
conversion of dollar proceeds and remittances, swaps with commercial banks, SLDB
auctions, and open market purchases while providing liquidity when the currency was
under pressure in a few occasions.
Fiscal Sector
Table 1: Government revenue and expenditure (LKR Bn)
4M 2020 4M 2021 Change (%)
Revenue* 479 482 +0.8
Expenditure** 931 1,003 +7.7
Balance -452 -521 +15.1
Notes: *Revenue includes grants, **Expenditure includes net lending
Source: CBSL
Government revenue stagnated in 4M 2021 growing only by 0.8% despite modest
recovery in GDP in 1Q. The figure is not far off from ICRA Lanka’s previous projections. State revenue
Meagre growth in revenue is mainly on account of the fall in income tax and excise tax
revenues.
Page | 9Midyear Economic Update | 2021
Table 2: Performance of the government tax revenue – 4M 2021
Tax type Composition (% of the Y/Y Change (%)
total revenue)
Excise 23 -12.8
VAT 21 +32.4
Income tax 11.5 -32.1
PAL 11 +44.8
Import duty 7 +1.2
Cess 6 +110
SCL 4 -14.9
NBT 0.04 -87.2
Source: Ministry of Finance
The drop in income tax revenue was owing to the failure of the 2020 tax revisions to Performance of
bring about envisaged economic revival amid the pandemic2. However, in January this
year there is a marked improvement in capital gains tax income. tax revenue
Primary hit to the excise tax revenue in 2021 came from the restrictions imposed on
passenger motor vehicle imports. In addition, excise revenue from cigarettes and
petroleum have suffered, while revenue from liquor shot up by 46.5%.
The GoSL abolished Nation Building Tax (NBT) and Economic Service Charge (ESC) in
2020 cutting the total government revenue by about LKR 125 Bn annually. Furthermore,
the GoSL slashed Special Commodity Levy (SCL) and import duty on selected
commodities in October 2020 to quell mounting food prices thereby leading to nearly a
15% decline in SCL revenue.
With Sri Lanka’s main source market for imports, China embroiled in the COVID crisis,
imports plunged sharply (-21%) in 1H 2020 weakening revenues from import duty and
import based Value Added Tax (VAT), Port & Aviation Levy (PAL) and Cess. During 5M
2021 imports bounced back 20.8% more-or-less on par with pre-crisis level leading to a
substantial increase in income from aforementioned taxes from the previous year.
Improved mobility post lockdowns triggered higher consumer spending leading to
greater retail trade volumes in March and April compared to last year thereby helping to
boost VAT revenue quite significantly.
In contrast to government revenue, the expenditure grew by 7.7% in 4M 2021 – well
Government
over ICRA Lanka’s expectation – driven by stronger expansion in recurrent expenditure.
expenditure
Biggest contribution to the increase came from the interest payments which accounted
for 41.7% of the increase, followed by salaries and wages (28.1%), and pension
payments (16.2%). During the same period, capital expenditure grew only marginally
(+2.3%).
2
Income tax cuts were implemented in April 2020, which means the impact on the tax revenue would not be seen
until the 3Q 2020. Therefore, the income tax revenue in 4M 2020 is essentially a higher base based on the previous
tax regime to compare against the same period in 2021.
Page | 10Midyear Economic Update | 2021
Table 3: Outstanding government debt (LKR Bn)
2020 2021
Change (%)
End Dec End Apr
Domestic 9,065 9,710 7.1
Foreign 6,052 6,578 8.7
Total 15,117 16,288 7.7
Source: CBSL
As a result of elevated expenditure level together with stagnant revenue, the fiscal deficit
has further expanded (+15.1%). The deficit was primarily financed through domestic Government debt
borrowings in the form of treasury bonds and bills. This has brought the total stock of
debt over LKR 16 Tn by the end of April 2021.
Prices & Wages
Figure 13: CCPI and Wage Rate Index of the informal private sector (Y/Y)
8%
Improving economic
7% activities post
6% relaxation of the
lockdown brought the
5%
wages on an upward
4% track. Headline
3%
Inflation started to
climb up in 1H 2021 as
2%
a result of uptick in
1% non-food inflation.
0%
Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21
CCPI WRI
Notes: WRI (100=2012), CCPI (100=2013)
Source: CBSL
Improving economic activities post relaxation of the lockdown brought the wages on an
upward track on the back of growth in services and industries wages. However, the Wage growth
spike in wage growth in May is owing to the lower base that prevailed last year. Sri
Lanka’s unemployment reached a decade high in 2020 as a result of the pandemic.
Services sector employment broadly remained weak in 1H 2021, while that of the
manufacturing sector grew in 1Q.
Headline Inflation started to climb up in 1H 2021 as a result of uptick in non-food
inflation. Following the fuel price hike in June, inflation made the biggest jump since the Inflation
beginning of the pandemic last year. Supply shocks caused food inflation to remain high
at double digits before moderating to upper single digit levels in 2Q.
Page | 11Midyear Economic Update | 2021
Figure 14: Growth in Producer Price Index (Y/Y)
12%
PPI shows input
10%
prices of producers
8% escalating faster than
CCPI in 5M 2021.
6%
4%
2%
0%
Note: PPI (100 = 4Q 2013)
Source: DCS
PPI (Producer Price Index) shows input prices of producers escalating in 5M 2021. PPI
has been growing at a faster pace than the headline inflation (CCPI). In most of the Producer prices
months this year ending May, agricultural and manufacturing producers saw prices
escalating by double digits. Compared to last year, agricultural producers saw growth in
prices slowing down, while manufacturers experienced prices accelerating.
Figure 15: Property prices
150
Housing prices went
Index Value (100 = 2Q 2020)
140
up by over 16% from
130
the 2Q 2020 level
120 which is in stark
110 contrast to apartment
100 prices which only saw
about 3% increase.
90
80
2Q 2020 3Q 2020 4Q 2020 1Q 2021 2Q 2021
Houses Apartments Lands
Notes: Average price of a four-bedroom house, three-bedroom apartment, and one
perch land
Source: ICRA Lanka Research data based on Lankapropertyweb.com
Lower interest rates pushed the demand for housing loans up, resulting in housing
prices soaring by over 16% from the 2Q 2020 level which is in stark contrast to Real estate
apartment prices which only saw about 3% increase. Land prices experienced a sharp prices
rise in 2Q 2021 (+44%). Higher cost of construction triggered by the import controls
may also be keeping the resale house prices buoyant.
Page | 12Midyear Economic Update | 2021
Equities
Figure 16: Share market performance – ASPI (M/M)
35%
30% January 2021 marks
25% the all-time high
20% performance of CSE
15% recording over 25%
10%
and 30% gains in the
5%
ASPI and the S&P20.
0%
-5%
-10%
-15%
-20%
Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21
Source: CSE
January 2021 marks the all-time high performance of CSE recording over 25% and 30%
gains in the ASPI and the S&P20. Domestic investors shored up their portfolios as Stock market
foreign sellers exited. Yet, investor optimism did not last long as CSE went through two
consecutive months of market correction wiping out over LKR 700 Bn from the market.
In the subsequent months market recovered somewhat, but overall PBV (price-to-book-
value) reverted to year open level. Transportation and diversified financials were among
the top performing sectors during 1H 2021.
Table 4: GICS sector performance- 1H 2021
Sector Index Points Gained
Transportation 3516
Diversified Financials 909
Materials 234
Food & Staples Retailing 172
Capital Goods 141
Household & Personal Products 83
Banks 49
Consumer Durables & Apparel 43
Real Estate 2
Food, Beverage & Tobacco -6
Telecommunication Services -11
Automobiles & Components -29
Consumer Services -38
Utilities -43
Retailing -60
Insurance -62
Energy -82
Commercial & Professional Services -84
Health Care Equipment & Services -193
Source: CSE
Page | 13Midyear Economic Update | 2021 Financial Sector Financial sector was recovering in 1Q 2021, but the escalation of corona infections in 2Q 2021 presented financial institutions with yet another quarter with a challenging Operational operating environment. ICRA Lanka observes that pandemic readiness of the financial environment institutions has improved markedly this time around and therefore the business continuity was comparatively better. Operating efficiency has also improved across banking and financial sectors on account of remote working arrangements and extensive use of online infrastructure to deliver services. In the current context, financial institutions are increasingly preferring asset backed and short-tenured lending thereby having a high concentration in safer assets in their Asset quality portfolios. As such there is an uptick in exposure to the housing and construction sector among banks and pawning among finance companies. A number of banks and non- bank financial institutions (NBFIs) in ICRA Lanka's rated pool demonstrated noteworthy improvement in non-performing assets (NPAs) by March 2021 and the impact of the 3rd wave on NPAs is expected to be moderate. Heavy investment in treasury securities have also contributed to improved asset quality and liquidity position among banks. However, in the absence of major swings in the interest rates, income received from capital gains by trading treasuries was rather low. During 1H 2021, ICRA Lanka changed the outlook from Negative to Stable for three NBFIs of which one of the entities received a rating upgrade. There have been no rating Rating actions changes in the banking sector. Banks Banks experienced relatively better growth in private credit in 1Q 2021 which moderated somewhat in 2Q. Meanwhile, state banks’ exposure to government credit Credit growth shows a substantial increase as the government’s funding requirement amplified with the pandemic. Demand for loans was growing but the willingness to lend among banks moderated in the face of the third wave. Funding profile of the banking sector has gone through some transformation lately. Cost of funding of banks further declined as witnessed by the rising CASA ratio. The growth in Funding profile time deposits also slowed down due to lackluster fixed deposit rates. In addition, the share of institutional deposits among licensed commercial banks (LCBs) has grown. Banks have been able to remain somewhat profitable as a result of higher net interest margins (NIMs) enabled by systemic interest rates. Adverse impact of import restrictions Revenue on banking sector’s fee income from letters of credit was somewhat offset by fee income from ATMs and online transactions. Banks continued to maintain a comfortable level of capital buffers stipulated by the regulatory authority. Quality of capital also remained favourable from a risk standpoint. Capital In addition, ICRA Lanka saw the state banks shoring up their capital bases by issuing hybrid debt instruments in the market. Two of the largest state banks issued rated Additional Tier 1 Capital bonds during the period. But higher liquidity levels built up overtime due to slowdown in credit was weighing down on the profitability of the sector. Page | 14
Midyear Economic Update | 2021 Banks occasionally faced difficulties with shortage of forex which became severe after the currency volatility in March. In addition, banks were seen operating very close to Forex desk their net open positions (NOPs) which hindered their foreign currency operations. NBFIs Under the sector consolidation roadmap of the CBSL, there were a number of mergers and acquisitions (M & A) in the NBFI. ICRA Lanka expects the number of the NBFIs to Sector reduce over the coming year and views this to be a positive development for the sector consolidation stability. Capital levels among NBFIs improved on account of shrinking loan portfolio and contraction of some high-risk products. With credit still recovering, NBFIs had to absorb Capital some revenue losses at the expense of liquidity. Asset quality deterioration is more acute among the NBFIs and relatively higher than banks due to inherent vulnerabilities of its clientele. However, there is a notable Asset quality improvement in asset quality in 1Q 2021 before moderating in 2Q. Wider NIMs have helped to improve the earnings of NBFIs. Contraction in the sector loan portfolio has improved earning indicators. Unlike the banks, NBFI earning profiles Earning profile are less diversified making them susceptible to shocks such as the current pandemic. But the collections have normalized since 2020 4Q mainly due to the performance of the vehicle leasing sector. Leasing portfolios of many NBFIs are expanding amid the booming secondhand vehicles market. while some NBFIs seemed to have exercised caution expecting an imminent price correction in case of a relaxation of import restrictions. Price appreciation in gold articles have encouraged the NBFIs to expand their pawning portfolio. Given the weaker economic outlook, some NBFIs have restricted their microfinance and SME lending portfolios. Page | 15
Midyear Economic Update | 2021
Figure 17: Financial sector key indicators (%)
Capital Adequacy Earnings
15 5
14 4
13 3
12 2
11
1
10
0
9
-1
8
-2
7
6 -3
1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q
2016 2017 2018 2019 2020 2021 2016 2017 2018 2019 2020 2021
Banks NBFIs Banks NBFIs
Asset Quality Liquidity
16 40
14 35
12 30
10 25
8 20
6 15
4 10
2 5
0 0
1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q 3Q 1Q
2016 2017 2018 2019 2020 2021 2016 2017 2018 2019 2020 2021
Banks NBFIs Banks NBFIs
Notes: Capital adequacy indicators; for banks- Tier 1 Capital Ratio, for finance/leasing companies – Core Capital to
Risk Weighted Assets, Earnings indicators; for banks- Return on Assets – before tax, for finance/leasing companies –
Return on Assets (Annualized), Asset quality indicators; for banks- Non-performing Loans to Total Loans and
Advances, for finance/leasing companies – Gross Non Performing Advances to Total Advances, Liquidity indicators; for
banks- Liquid Assets to Total Assets, for Finance/leasing - Regulatory Liquid Assets to Total Assets
NBFIs in above only include Licensed Finance Companies and Specialised Leasing
Companies Sector
Source: CBSL
Page | 16Midyear Economic Update | 2021
Commodities
Figure 18: Crude oil price (USD/bbl)
80
Demand for crude oil
70
recovered rapidly
60
stemming from global
50
growth prospects after
40
successful vaccine
30
rollouts in major
20
economies.
10
0
Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21
Brent WTI
Source: Bloomberg quoted in CBSL
Demand for crude oil recovered rapidly stemming from global growth prospects after
successful vaccine rollouts in major economies. The supply quota agreements in place Crude oil
by the OPEC+ countries inflated the prices even further pushing beyond the pre-crisis
levels. As a result, global Brent crude oil prices have risen by around 50% (USD 50 –
75/bbl) during the first 6 months of 2021.
Figure 19: Auction prices of commercial crops
Tea Rubber Coconut
3.50 600 64
3.40 63
500
3.30 63
3.20 400 62
USD/Kg
LKR/nut
3.10 62
LKR
300
3.00 61
2.90 200 61
2.80 100 60
2.70 60
0
2.60 59
7-Jan-21
8-Apr-21
4-Jun-21
25-Jun-21
6-May-21
29-Jan-21
25-Feb-21
18-Mar-21
59
29-Jan
19-Feb
17-Apr
30-Apr
7-Jan
11-Mar
21-May
1-Jul
10-Jun
Notes: Tea prices for all elevations, rubber prices for LATEX Crepe 4X
Sources: Forbes & Walker, RRISL, CDA
Tea prices failed to maintain momentum for the most part in the first half of 2021.
However, prices surged briefly in April, as a result of bulk buying due to potential supply Tea
restrictions in India amidst surging COVID cases. With many major tea producers
gradually restoring their operations global supply soared bringing prices down.
Page | 17Midyear Economic Update | 2021
Rubber prices which remained relatively subdued last year bounced back in the first few Natural rubber
months on the back of growing industrial demand. Soaring crude oil prices and supply
constraints also helped sustain the prices.
Weekly coconut auctions, which had been suspended since September last year,
resumed in May. Auction prices continued to fall likely as a result of drop in nut quality Coconut
due to adverse weather conditions that prevailed towards 4Q 2020.
Figure 20: Metal price index (2016=100)
250
Gold remained flat
200
while growing global
industrial activities
150
prompted base metal
prices to remain
100
buoyant throughout
the year.
50
0
Jul-20 Aug-20 Sep-20 Oct-20 Nov-20 Dec-20 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21
Base Metals Precious Metals
Notes: Base metals index includes Aluminum, Cobalt, Copper, Iron Ore, Molybdenum, Nickel,
Tin, Uranium, and Zinc, precious metals index includes Gold, Silver, Palladium, and Platinum
Source: IMF
During the first quarter of 2021, gold prices continued to decline. During this period high
treasury yields and bullish equity markets drove investors away from gold. However, as Gold
inflation fears loomed, investors stacked up their portfolios with gold.
Growing global industrial activities prompted base metal prices to remain buoyant
throughout the year. Base metal prices reached their 10-year peaks towards the end of Base metals
the first quarter as a result of stockpiling by large manufacturers fearing potential supply
bottleneck from India. However, prices moderated to a certain degree towards the end
of the second quarter due to the intervention by the Chinese regulators to curb
speculative buying.
Read ICRA Lanka’s report: Commodity price deflation is over! What next for Sri
Lanka?
Page | 18Midyear Economic Update | 2021
Real Sector
Agriculture
Table 5: Output growth of key agriculture sectors - 2021 (Y/Y)
Month Tea (%) Rubber (%) Coconut (%) Fisheries (%)
Jan 5 12.7 -1.9 -17
Feb 22.9 6.7 0.3 -17.2
Mar 110 23.7 25.7 38.5
Apr 42.1 24 17.4 23.5
May 7.0 6.6 10.1 N/A
Source: CBSL
Agriculture sector saw a relatively healthy output level in the first half of 2021 compared
Though key
to year-ago level. The official GDP data show the sector rebounding by 6.1% (Q/Q) in
1Q after experiencing a contraction of 6.1% last year. Key commercial crops, especially commercial crops had
tea (47.6%), vegetables (19.7%) and fruits (11.7%) made a noteworthy contribution to a robust first quarter,
the growth in overall sector output. However, marine fishing and aquaculture recorded we expect 2Q sector
yet another disappointing quarter by contracting 16% (Q/Q) in 1Q. performance to be
more-or-less mixed.
Though key commercial crops had a robust first quarter, we expect 2Q sector
performance to be more-or-less mixed as the country went into an island-wide lockdown
in the face of rising third wave of Corona infections impeding the entire agricultural value
chain. In addition, we believe fisheries subsector output may have plummeted sharply as
it was badly affected by the X-Press Pearly disaster [1].
Industries
Table 6: Growth in selected industrial activity indicators - 2021 (Y/Y)
Month Total Industrial Cement Ship Container Cargo
electricity electricity consumption traffic handling handling
usage usage (%) (%) (%) (%) (%)
(%)
Jan -4.1 2.9 -10 2.6 -3 -1.5
Feb -5 1.5 5.8 -17.5 -3.4 -1.2
Mar 13.3 N/A 13.7 -2.8 3.7 4.1
Apr N/A N/A 171.2 19.9 36.4 49.7
May N/A N/A N/A 3.4 19 27.7
Source: CBSL
Industrial sector grew by 5.5% in 1Q 2021, recovering from 7.9% contraction in 1Q
2020. Most subsectors expanded but the recovery was uneven, with contribution to the
output growth mainly coming from manufacturing of food & beverages (28% of the
change in output), textile & apparel (22.7%), and construction sectors (13.7%).
Petroleum refining recorded a sharpest drop in production among all subsectors (-
44.3%, Y/Y).
Page | 19Midyear Economic Update | 2021
Figure 21: Industrial production level indicators
PMI - Manufacturing IIP (2015=100)
20 140
15
120
10
5 100
0 80
-5
-10 60
-15 40
-20
20
-25
-30 0
Jul-20
May-20
Jun-20
Jun-21
Apr-20
Nov-20
Apr-21
May-21
Jan-20
Aug-20
Dec-20
Feb-20
Mar-20
Sep-20
Jan-21
Feb-21
Mar-21
Oct-20
Jul-20
Jun-20
Apr-20
May-20
Sep-20
Nov-20
Apr-21
Dec-20
May-21
Jan-20
Aug-20
Feb-20
Mar-20
Jan-21
Feb-21
Mar-21
Oct-20
Notes: Purchasing Managers Index (PMI) - negative values indicate the sector is generally contracting on a month-on-
month basis while positive values indicate the sector is expanding. The strength of contraction or expansion is manifested
by the magnitude of the figure. Index value > 0 means an increase; Index value < 0: decrease; Index value = 0:
unchanged. IIP is Index of Industrial Production
Source: DCS
Industrial production suffered another blow with the advent of the third COVID wave in
the 2Q. The PMI index shows manufacturing sector contracting in April and May before
making a marginal recovery in June. Manufacturing activities generally drop in April due
to New Year holidays. It is evident from the IIP data that the contraction is smaller than
that of 1Q 2021. The delays in industrial input supplies were persistent as the shipping
traffic level continued to remain below the pre-crisis level.
Services
Figure 22: PMI deviation from point of neutrality (Index points)
15
10 Services sector
performance in 1H is
5
mixed. We believe the
0
pandemic impact on the
-5 sector output is less
-10 severe this year.
-15
-20
-25
Source: DCS
Page | 20Midyear Economic Update | 2021 Services sector GDP recorded a modest recovery (3%, Q/Q) in 1Q 2021. Largest contribution to the gain in production came from the financial services (48.7% of the change in output) followed by wholesale and retail trade (25.3%) and real estate activities (14.1%). Despite hotels reopening for domestic tourism, with very limited foreign travelers coming to the country, the leisure and tourism sector contracted by 31.9% (Q/Q). According to the PMI index, the sector contracted for the first two months of 2Q with most impact felt in May before recovering marginally in June. We believe the pandemic impact on the sector output is less severe this year compared to the corresponding period of last year. Peak impact of the pandemic fell in the second quarter of last year. Over the course of GDP growth in the last few months, the economy has developed some resilience to withstand COVID induced disturbances. According to our nowcasting models GDP in 2Q may have grown 2Q 2021 at around 4.1%. Page | 21
Midyear Economic Update | 2021
Outlook for 2H 2021
Global Outlook
Expedited vaccine rollouts in many major economies have enhanced global growth
outlook for 2H 2021. The World Bank and IMF revised up their forecasts from 4% and Global GDP
5.5% to 5.6% and 6% respectively for 2021. Latest estimate from the WTO sees the
volume of world merchandise trade increasing by 8.0% in 2021 after having fallen 5.3%
in the previous year. Many agencies and experts opine that inflation is going to be
higher-than-expected, but the debate over whether it is transitory or not is still not
settled. In any case, major central banks in the world have not indicated an end to their
dovish outlook for the rest of the year.
There is little doubt that the global recovery is going to be even with less developed
countries struggling to access vaccines while combating significant stress to their
external sector. The IMF has cut the growth outlook for low-income countries by 40 bps.
Table 7: GDP growth forecasts for key trading partners – 2021 (%)
China India US UK Europe
8.1 9.5 7 7 4.6
Source: IMF
Economies of Sri Lanka’s key trading partners are expected to recover in 2021. The IMF Trading partners’
upgraded growth projections for the US (+0.6 pps) and UK (+1.7 pps) but downgraded
the same for India (-3.0 pps) and China (-0.3 pps) in its July economic update. economies
Table 8: Vaccination progress – Sri Lanka vs. key trading partners
Sri Lanka China India US UK Europe
Received at 37 43 25 57 69 48
least one shot
(%)
Fully 9 16 7 49 55 38
vaccinated
(%)
Target From early By late By late By late By late By late
vaccination 2023 2022 2022 2021 2021 2021
coverage onwards
Note: Vaccination data as of 27th July 2021, Target for achieving 60-70% of the respective
adult population fully vaccinated as of end April 2021
Sources: Our World in Data [2], John Hopkins University [3], KFF [4], Economist
Intelligence Unit [5]
Page | 22Midyear Economic Update | 2021
Speedy vaccination is the key to global recovery. At the time of writing this report, the Vaccination
world population that is fully vaccinated stands at 14.1% while 27.6% of the world
population has received at least one dose of a COVID-19 vaccine [2]. Developed progress
countries are enroute to meeting target vaccination coverage sooner than the April
forecasts, while emerging economies such as China and India are battling to keep up
with the vaccination rates because of the sheer size of their populations. Meanwhile, Sri
Lanka which was earlier expected to be a laggard, is now among the countries with the
fastest vaccination rates in the world. Sri Lanka has set an ambitious target to vaccinate
its entire population by end 2021/early 2022 [6].
GDP
Table 9: GDP growth 2021
1Q* 2Q** 3Q*** 4Q*** Overall
GDP growth (%) 4.2 4.1 2.6 3.0 3.4
Notes: * Actual ** Nowcasted ***Forecasted, Source: ICRA Lanka Research
Previously ICRA Lanka forecasted Sri Lankan economy to grow by 3.6% in 2021. In light
of recently released official 1Q GDP data and ICRA Lanka’s estimates for the rest of the
Economic growth
quarters for 2021 we downgrade our initial projection to 3.4% assuming there will be no in 2021
major shocks in 3Q and 4Q.
Sri Lanka’s growth in the medium-term is expected to hover around 4%. Structural
weaknesses, external sector vulnerability, and absence of substantial real investments
makes it difficult for the country to achieve a satisfactory growth level. We expect COVID
Growth in
induced shocks to last through 2H while their magnitude diminishes relatively faster over medium term
the next few quarters. Thus, the economy will operate with excess capacity during this
time.
ICRA Lanka believes abrupt banning of chemical fertilizers and weedicides and
indiscriminate introduction of organic fertilizer could do serious damage to the output Fertilizer ban
level of the agricultural sector. The adoption of organic fertilizer should be done in
phases spread across an adequate time span to avoid disruption to agricultural output.
External Sector
Table 10: External sector forecasts (USD Bn)
5M 2021* 2021
Exports 4.7 12.3
Imports 8.4 20.3
Trade balance -3.6 -8.0
Remittances 2.8 6.7
Net inflow to treasuries and equities -0.1 -0.2
FDIs 0.2 0.5
Current account balance -1.1 -1.4
Gross official reserves 4.0 3.9
Notes: * Actual Source: ICRA Lanka Research
Page | 23Midyear Economic Update | 2021
Sri Lanka’s key export destinations –US (USD 2.7 Bn exports in 2020), Europe (USD 2.8
Bn) and the UK (USD 956 Mn) – are expected to have a stronger second half this year. Exports
Thus, monthly exports may consistently stay over and above USD 1 Bn for the
remainder of 2021 beginning from June to bring total exports to USD 12.3 Bn by the
year end.
According to a global survey conducted by UNWTO, the majority of the respondents Tourism
(56%) in Asia/Pacific believe it would take another three or more years for tourism to
return to pre-pandemic levels in their respective countries [7]. Before the COVID crisis,
Sri Lanka’s tourism brought about USD 300-400 in forex revenue on average per
month. If Sri Lanka can meet its target for vaccination coverage, then there is a glimmer
of hope that tourism may resume. But when the country will be open for tourism remains
uncertain.
Sri Lanka now has a more diversified source of foreign currency remittances across
many continents helping to bring sizable forex inflow to the country. Remittances are Remittances
expected to have a robust 2nd half contributing about USD 6.7 Bn in net forex inflows to
the country in 2021.
ICRA Lanka expects the total import bill to reach USD 20.3 Bn in 2021. With gradual
normalization of industrial activities in China (USD 3.6 Bn imports in 2020), its industrial Imports
output is expected to go up steadily. India (USD 3.1 Bn) is also a critical source market
for industrial inputs for Sri Lanka. However, the current COVID situation in India has
derailed its recovery creating supply bottlenecks. In addition, Sri Lankan manufacturers
have been experiencing supplier delays since 2020 due to various logistical issues in the
global supply chain, and still there is no sign of improvement.
Impact of import restrictions on the exports sector is relatively moderate as the
government has accommodated some leniency for exporters in order to ensure Import
uninterrupted production. The burden of the restrictions has directly fallen on the
restrictions
consumers in a way of rising prices of imported items and is expected to have a stronger
contribution to inflation in 2H. To lessen the impact on the GDP, the government should
consider relaxing import restrictions by imposing it on a narrower range of products.
Table 11: Key commodity price predictions
Commodity Unit 2020 2021 Change (%)
Crude oil, average USD/bbl 41 72 75.6*
Tea, average USD/kg 2.70 2.50 -7.4
Coconut oil USD/mt 930 937 0.8
Rice, Thailand, 5% USD/mt 500 498 -0.4
Wheat, U.S., HRW USD/mt 205 207 1
Sugar, World USD/kg 0.28 0.34 21.4
Rubber, RSS3 USD/mt 1.73 2.25 30.1
DAP USD/mt 312 450 44.2
Phosphate rock USD/mt 75 90 20
Potassium Chloride USD/mt 220 205 6.8
TSP USD/mt 265 410 54.7 Sources: World Bank, *U.S.
Aluminum (LME spot) USD/mt 1,704 2,000 17.4 Energy Information
Copper (LME spot) USD/mt 6,181 8,500 37.5 Administration
Iron ore (China) USD/mt 108 135 25
Page | 24Midyear Economic Update | 2021
It will be challenging to curb expansion of Sri Lanka’s trade deficit especially in the midst
of faster-than-expected rise in commodity prices in the global markets. Fuel and base Trade deficit
metals alone contributed to 41.9% of the increase in imports in the first five months this
year. Crude oil (USD 2.5 Bn fuel imports in 2020) is forecasted to grow 60-80%. Main
base metals (USD 430.3 Mn) will see prices soaring by more than 15%. Over 20%
increase in price of sugar (USD 277.1) is forecasted for this year. Forecasted 7.4% fall
in tea (USD 1.2 Bn exports) price will be a blow to tea exporters, but the overall adverse
impact on country’s export revenue may be to some extent offset by the 30% increase
in rubber (USD 810.2 Mn rubber and rubber products exports) prices. Nonetheless, Sri
Lanka’s terms-of-trade will continue to deteriorate despite having import restrictions. We
expect the trade deficit to widen to USD 8 Bn by the end of 2021.
Inflows to the capital (financial) account will continue to be weak in 2H. As of the end
1H, total foreign ownership in equities and treasuries was LKR 29 Bn which roughly Capital inflows
translates to about USD 132 Mn. In this context, net outflows (i.e., primary income) from
treasuries and equities would also remain low and we expect the total net outflow to be
around USD 200 Mn in 2021. In light of improved global economic outlook, we revise up
expected FDIs in 2021 to USD 500 Mn.
Initially, ICRA Lanka expected a smaller current account surplus in 2021 due to import
compression. Rapid pace at which the prices of global commodities rebounded has Current account
overshot our expectations for the total import bill. Therefore, we expect the current
account balance to reach USD 1.4 Bn which is about 1.9% of the GDP.
Going forward, fluctuation in the trade deficit is likely to be the principal determinant of
the exchange rate assuming all export proceeds are converted to rupees. Currently, the
rupee is pegged to USD at 200 and has caused severe shortage of foreign currency in Exchange rate
the spot market among the banks. The Sri Lankan rupee has a strong tendency for
volatility clustering. We believe the current peg is unsustainable unless there is a
material improvement in forex inflows. Therefore, further depreciation of the currency is
likely.
At the end of 2020 total foreign currency obligations stood at USD 6.8 Bn. This includes Reserves
settlement of USD 1 Bn ISB maturing in July. We expect the GoSL to rollover about USD
1.5 Bn existing obligations, and borrow about USD 4.5 Bn via bilateral/multilateral
arrangements. As per ICRA Lanka’s projections, in this setting total gross official
reserves would fall to USD 3.8 Bn by the end of 2021.
Fiscal Sector
Table 12: Fiscal sector forecasts (LKR Bn)
2020* 2021
Revenue** 1,373 1,487
Expenditure*** 3,041 3,221
Balance -1,668 -1,734
Outstanding Debt 15,117 17,043
Notes: * Actual, **revenue includes grants, ***expenditure includes net lending
Source: ICRA Lanka Research
Page | 25Midyear Economic Update | 2021
ICRA Lanka revises its forecasts to reflect the impact of the third wave of infections on
the fiscal variables. Accordingly, we expect the revenues to weaken to 9.1% of the GDP Fiscal deficit and
in 2021 from 9.2% in 2020 amid the current subdued domestic economic situation. government debt
However, the GoSL may observe gradual normalization of revenues in 4Q 2021. The
expenditure will grow relatively slowly and will sit around 19.8% of the GDP. The overall
expenditure in absolute terms may expand at the expense of capital expenditure. In this
context we expect the fiscal deficit to improve to 10.7% of the GDP but the debt stock
will further increase to 104.8% of the GDP.
Interest Rates
Gradual recovery of the economy and rising inflation expectations is driving the treasury
yields higher which ICRA Lanka believes will resist downward adjustment of retail Policy rates,
lending rates in the medium-term. We feel, T-bills may potentially move up by another
money market
10-20 bps in 2H. Therefore, we expect the AWPR to fluctuate in a relatively broader
range between 5.50-to-6.50% for the rest of the year. Due to external sector rates, treasury
vulnerability, potential acceleration in credit, and expected rise in inflation, we do not yields, and
believe the CBSL has scope for a further easing of the policy rates in 2H. On the other
hand, the CBSL has emphasized its commitment to keep interest rates at single digits lending rates
[8]. Hence, it is very likely that the CBSL will maintain its current policy window through
2H. In this context, we may see moderate levels of liquidity in the money market
effectively driving overnight rates higher. Therefore, the average call rate for 2H may
range between 4.60 to 5.10%.
Inflation
ICRA Lanka views 2H to have a relatively higher inflation level than 1H due to number of ICRA Lanka views 2H to
reasons – (1) vaccination rollout is expected to add a boost to the consumer spending; have a relatively higher
(2) rising commodity prices; (3) scarcity of goods rendered by the import restrictions inflation due to a
and speculative element that comes with it; (4) weaker rupee which makes imported number of reasons.
goods even more expensive; and (5) vagaries of weather which results in supply shocks
to agricultural produce. Thus, we revise our CCPI (Y/Y) average inflation forecast to be
between 5-to-6% for 2H.
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