Growth vs. debt balance gives SL “Neutral” outlook: FC

From left: First Capital Holdings Director-CEO Dilshan Wirasekara, First Capital Holdings Head of Research Dimantha Mathew, Commercial Bank of Ceylon Chief Financial Officer Nandika Buddhipala, Hatton National Bank COO Dilshan Rodrigo and Verite Research Director Deshal de Mel

• First Capital Research predicts 4.1% growth for 2020, 4.3% for 2021
• Highlights positives of stimulus, lower debt till 2Q, moderate inflation
• But warns of higher trade deficit, forex pressure, higher debt from 3Q onwards
• Economist says smaller stimulus would have been enough, predicts 7% deficit  
• Budget seen to be crucial, Govt. frontloading reforms needed
• Possible debt moratorium from China significant, India not so much   

By Uditha Jayasinghe

Sri Lanka will have to traverse a fine line in 2020 balancing higher growth, political stability, comparatively lower debt repayments till 2Q and moderate inflation with a high deficit and linked borrowing costs, weakening reserves and low liquidity, an official said last week.

First Capital Head of Research Dimantha Mathew told a packed audience in Colombo that the country could grow by as much as 4.1% this year with 2021 to grow at 4.3%. However, stronger growth is likely to come with multiple challenges, including a higher Budget deficit, possible downgrades from international rating agencies, and pressure on the rupee. 

First Capital Research projected that the Central Bank may have to tighten monetary policy in the second half of 2021, shifting from its current accommodative stance if the economy shows signs of overheating.    

“The exchange rate target of Rs. 188 to Rs. 190 is predicted for 2020 with stronger depreciation in 2H2020. With the potentially stable external environment, we expect the USD/LKR rate to stay stable in the 1H2020. As consumer demand accelerates towards 2H, we expect to witness a possible weakness in the currency,” Mathew said. Overall First Capital Research gave Sri Lanka’s Economic Outlook a “Neutral” evaluation.

“Following eased monetary policy measures we are already seeing a gradual improvement in consumer demand and credit. The heavy tax cuts and the lower interest rate regime is expected to boost consumption and investments improving GDP growth. However, the acceleration is likely to take place towards the 2H2020. Thereby, we expect growth to reach 4.1% during the year.”

While the stimulus package was largely welcomed it also throws up challenges for the Government to manage fiscal slippage, noted Verite Research Director Deshal de Mel who opined that a smaller boost may have been sufficient to turnaround growth.

“The logic behind it is that hopefully by reducing taxes on corporates and individuals you will then put cash in the hands of people to spend and still get investment from the corporate sector. The tricky part I think is that it is a significant cut and it is also had a time when cyclically there was space for consumption to recover because the economy had gone through a number of shocks. 

“Due to the constitutional crisis in 2018 and the Easter attacks in 2019 there was a fair amount of suppressed consumption that was ready to recover in the first place,” de Mel said.

“I think a smaller stimulus would have had the desired impact in terms of driving growth activity but the outcome now is a significantly larger stimulus. It is not going to be easy to avoid significant fiscal slippage because the space for managing or cutting expenditure is quite limited.”

De Mel warned that even though the Government has said it will manage fiscal slippage partly by cutting back on public expenditure, they would find it tough going as most spending cannot be deferred. As an example he drew attention to the point that in 2018 salaries, pensions and interest payments added up to just below Rs. 2 trillion, which was already below public revenue. 

In this context the Government was more likely to postpone or adjust its capital expenditure, perhaps moving more to Public-Private Partnerships and other models to ease pressure. De Mel predicted that even with such adjustments the Budget deficit is likely to exceed 7% and acknowledged it was necessary for the Government to push for reforms early in its term.

“I think the Budget will be important to see how the Government plans to manage the fiscal side. There are no easy answers.”

Though rupee debt repayments remain low in 2020, potentially high budget deficit is likely to be created with the hefty tax cuts. The high budget deficit is likely to push the rupee debt borrowing requirement also higher. Trade deficit may also grow wider towards 2H2020 amidst the possible rise in consumer demand possibly leading to a high level of consumer imports pressuring the foreign reserves and the rupee, First Capital Research said.

Predictably one of the biggest challenges will be maintaining sufficient reserves and funding debt repayment. The Central Bank estimates $ 4.8 billion in repayments for 2020. Since the successful Sovereign Bond issuance in June 2019, Sri Lanka’s foreign reserves have slowly depleted, but over the last three to four months the Central has managed to maintain it around the $ 7.5 billion mark. First Capital Research said the Government has announced plans to raise $ 1 billion via a Chinese loan but did not give details.

“We believe foreign reserves, though currently remains at comfortable levels above the minimum four months of imports, foreign repayments start to slowly accelerate especially in the 2H2020. We expect reserves to fall to about $ 7 billion by June 2020 due to the debt repayments despite the $ 1 billion Chinese loan. A large Foreign Loan or Sovereign Bond needs to be raised in order to maintain Reserves above the $ 7 billion mark,” Mathew said.

Responding to questions during the panel discussion Mathew noted that a moratorium from India is unlikely to reduce significant pressure from Sri Lanka but one from China would be significant as Sri Lanka has about $ 6 billion debt to China overall with annual payments tagged at about $ 600 million.

“If you look at the numbers our debt to India is about $ 1 billion. In the next few years we have to repay about $ 180 million to $ 270 million per annum to India. But what we owe to China is almost six times as much, so it would be very interesting to see China’s reaction. 

“We have somewhere close to $ 6 billion in loans to China and this year we have about $ 600 million to repay, which is a sizeable amount. So if China is looking at giving us a moratorium that would have a significantly positive impact towards Sri Lanka,” Mathew added.    

The year 2020 illustrates a notable reduction in repayments especially in 1Q2020 and 4Q2020. However, First Capital Research expects foreign payments in the range of $ 300-$ 350 million to exist on a monthly basis in the form of project loan repayments while 2Q and 3Q illustrates relatively high repayments with overall payments expected to rise in 2021 as well.

Pix by Ruwan Walpola