STORM CLOUDS IN THE NEW YEAR
Shiran Fernando provides an overview of the likely outcomes for the national economy in the new year
At the beginning of last year, the prospect of a somewhat stable and relatively positive macroeconomic performance was thought to be likely – numerous forecasters and commentators including myself said so. This was on the back of the Sri Lankan economy achieving its highest level of exports and foreign direct investment (FDI) inflows in 2017.
In the January 2018 edition of LMD, this column noted that “there is significant potential to build on the macro stability that has been achieved in 2017.” It was also a year for the economy to build up the necessary buffers to meet a challenging debt refinancing environment commencing in 2019. Therefore, the theme of building on stability with a medium-term buffer was emphasised.
Meanwhile, I also alluded to the need for reforms to have tangible benefits for the people of the country so that macroeconomic stability benefits not only policy makers and the private sector.
DIFFICULT YEAR To say that 2018 was a difficult year for the economy would be putting it mildly when considering the steep depreciation of the Sri Lankan Rupee. However, in most months in the first half of the year, there was macroeconomic stability.
Some of the more positive developments occurred at the beginning of the year when Sri Lanka signed a free trade agreement (FTA) with Singapore – its first FTA in over a decade. This was accompanied by trade remedy acts that would protect the economy from witnessing the dumping of products.
With global oil prices ticking up in the second half of 2017, Sri Lanka’s import bill came under pressure as well. This eventually led to the introduction of a market pricing formula as part of measures to reduce price controls.
CAPITAL CONCERNS The Central Bank of Sri Lanka (CBSL) raised US$ 2.5 billion in April 2018 to improve the country’s gross official reserves at that point. In the first eight months of the year, Sri Lanka was able to maintain its primary surplus and ensure that the fiscal deficit target was within range.
Over the same time period, the nation maintained a positive balance of payments, aided by the strength of FDI inflows in the first half of 2018.
But these positive developments were overshadowed by two factors in the main.
Firstly, the global financial market environment turned negative from April 2018 onwards amid capital outflows from emerging markets. From the last week of April to the third week of November, Sri Lanka recorded outflows of about Rs. 121 billion from its local bill and bond markets. Coupled with a stronger US Dollar, this resulted in depreciatory pressure on the rupee.
As a consequence, the rupee weakened by 14 percent against the dollar in the first 10 months of 2018. Sri Lanka was not alone in this respect as the likes of India and Indonesia also witnessed similar (if not higher) levels of depreciation in some periods.
Political uncertainty was the second factor that outweighed some of the positive developments and derailed macro stability. This was apparent from the start of the year following the local government elections in February. And uncertainty led to instability with the political events that have transpired since 26 October.
FUTURE EXPECTATIONS Political uncertainty will continue to play a part this year, given the prospect of elections. The focus on the economy however, should not be lost.
Over the course of this month, CBSL will have to refinance a one billion dollar sovereign bond – and four months later (in April), it will have to meet a debt obligation of 500 million dollars from another sovereign bond. Therefore, debt refinancing risks have never been as high for the Sri Lankan economy.
The recent rating downgrades by Moody’s Investors Service and Fitch Ratings, and uncertainty regarding the continuation of the IMF facility, will make it difficult for Sri Lanka to refinance its debt at favourable rates. Moreover, the economy will require favourable global financial conditions to ensure there’s an appetite for emerging market debt. Movements in global markets will continue to play a pivotal role in the direction of the rupee against the dollar.
Oil prices were extremely volatile last year, having peaked at around 80 dollars a barrel but slumping by more than 25 percent thereafter in a matter of weeks – the price of a barrel of Brent crude stood at slightly over 60 dollars on 17 December. A continuation of the pricing formula therefore, will be relevant to ensure that state owned institutions aren’t burdened with debt.
Sri Lanka’s growth outlook and performance so far have been below par. GDP growth has been under four percent for six consecutive quarters up to the first half of 2018.
With the outlook for reforms to drive growth in 2019 seeming rather dull, the consumption boost often associated with election cycles is expected to prop up growth – albeit unsustainably – in the near term.