Shiran Fernando analyses the role of sentiment in economic direction

As much as we focus on economic numbers and fundamentals, sentiment plays a major role in the direction of an economy. At the time of writing, most commentators, columnists, investors and friends with whom I spoke were pessimistic about the future of Sri Lanka’s economy. And I don’t blame them because there are many reasons for being negative.

THE COST OF LIVING With the weakening of our currency, increases in taxes and the impact of the drought, it is becoming increasingly difficult for the majority of the general public to make ends meet.

A part of the economic stabilisation process relies on slowing down consumption with policy makers indirectly asking us to tighten our belts. This inevitably creates discontent especially when we see some of the proposed spending being channelled towards the upkeep of members of parliament.

FOREIGN INTEREST The key yardstick of foreign direct investment (FDI), which often grabs our attention, has also been woefully low and not displayed signs of picking up in recent years. There’s been much attention and interest through forums organised by Sri Lanka or visits by foreign delegations but little of this has translated into FDIs on the ground.

CURRENCY VALUE Meanwhile, the value of our currency – which stood at Rs. 133 (against the US Dollar) a couple of years ago – has surpassed 150 rupees. This has caused much anxiety among the people with some expectations that the rupee could weaken further.

THE DEBT DILEMMA Our debt figure is the most popular number being flung around to explain the dire straits of the economy. While there are many misconceptions surrounding this sentiment, the main complaint is that we are ‘caught in a debt trap.’

EXPORT SHORTFALL Exports earnings have been inadequate in the light of an uptick in debt repayments and the lack of FDIs. Sri Lankan exports continue to rely on a handful of products that are ending up in a few markets. And it would seem that this ongoing issue isn’t being addressed by policy makers.

POLICY UNCERTAINTY And finally, the lack of policy clarity in Sri Lanka is one of the most important reasons for business sentiment to wane. There is widespread uncertainty about taxes and investment incentives, which is adding to the pressures of continuing to do ‘business as usual.’

The negative or low sentiment is justified but possibly overdone. The bias is weighted towards a negative framework and so less attention is paid to understanding some of the positive factors that are unfolding in tandem.

Here are some factors worth considering…

CYCLICAL PATTERNS We are only just past a two-year adjustment period for the Sri Lankan Rupee as well as interest rates. And these adjustments are expected to continue.

But we’ve been through these cycles over the last decade or so where conditions turned bad and then stabilised, following which we moved onto better times. The present scenario could be viewed as the stabilising leg with both monetary and fiscal tightening involved. If this proves to be successful, then stability can be achieved.

BORROWING COSTS The margin above the LIBOR rates for a one-year floating Sri Lanka Development Bond was down 1.8 percent in the 14 March issue compared to that of 23 March 2016. The 10-year Sri Lanka dollar bond, which was trading above eight percent late February last year, is now at mid-six percent levels.

FISCAL REBALANCE The Achilles’ heel of Sri Lanka’s economy has been fiscal imbalance in the past: we simply do not generate adequate revenue on an annual basis to cover expenses (recurrent expenditure), let alone meet the nation’s capital expenditure.

So increases in taxes and collections overall should help ease these concerns in the long term; and short-term pain should be viewed in the context of the long-term gains.

EXPECTATION GAP With the installation of the new administration came expectations in particular on the economic front. Though expectations were set, our perceptions of coalition politics and the optics around it weren’t properly understood. Many of the big-ticket reforms have faced several roadblocks; and as a result, the initial optimism has dwindled over the last two years.

The lesson to be learnt is that not all items on the wish list to turn this country around can be achieved.

A TURNAROUND But there are key low-hanging fruit that the government and policy makers can reach for in the next few years – including macro stability and policy certainty. If these can be achieved, the cycle could turn around and positive sentiment may emerge from the current lull.