Economy relapsing amid 3rd wave, warns ICRA Lanka

• Downgrades 2021 GDP growth projection to 3.4%
• Says terms of trade will continue to deteriorate
• Predicts relatively higher inflation level in 2H
• Expect fiscal deficit to improve to 10.7% of GDP while debt stock will further increase to 104.8% of GDP

The ongoing third wave will weaken the economy further, ICRA Sri Lanka warned yesterday, prompting the rating agency to downgrade 2021 GDP growth projection to 3.4%. 

In its midyear economic update, ICRA Lanka Ltd. said expedited vaccine rollouts in many major economies had enhanced global growth outlook for 2H 2021. 

“Sri Lanka, which was earlier expected to be a laggard, is now among the countries with the fastest vaccination rates in the world. 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. In this context, we slightly downgrade our initial 2021 GDP projection to 3.4%,” said ICRA Lanka, a subsidiary of ICRA Ltd. of India and international credit rating agency, Moody’s Investors Service as ultimate parent. 

The economy contracted by 3.6% last year as against a 2.3% growth.

ICRA Lanka said monthly exports may consistently stay over and above $ 1 billion for the remainder of 2021 beginning from June to bring total exports to $ 12.3 billion by the year end but the troubles in the external sector would be far from over. 

It said Sri Lanka’s terms of trade would continue to deteriorate despite having import restrictions due to rising commodity prices. “We expect the trade deficit to widen to $ 8 billion, current account balance to reach $ 1.4 billion, and gross official reserves would fall to $ 3.8 billion by the end of 2021,” it added. 

ICRA Lanka also expects State revenues to weaken to 9.1% of the GDP in 2021 from 9.2% in 2020 amid the current subdued domestic economic situation. However, it said the Government may observe gradual normalisation of revenues in 4Q 2021. 

“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 while the debt stock will further increase to 104.8% of the GDP,” ICRA Lanka said. 

ICRA Lanka views 2H to have a relatively higher inflation level than 1H due to a number of reasons: (1) vaccination rollout is expected to add a boost to the consumer spending; (2) rising commodity prices; (3) scarcity of goods rendered by the import restrictions and speculative element that comes with it; (4) weaker rupee which makes imported 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,” it noted.

Due to external sector vulnerability, potential acceleration in credit, and expected rise in inflation, ICRA Lanka does not believe the CBSL has scope for a further easing of the policy rates in 2H. 

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 lending rates in the medium-term. ICRA Lanka said T-bills may potentially move up by another 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,” it added.