South Asia to remain fastest growing region: ADB

• In latest outlook report predicts SL will grow by 4.1% 
• Overall SA to expand by 9.5%, largely on India’s performance 
• Agriculture to grow by 3.7%, inflation to be 4.5%
• Growth largely dependent on Govt. spending 
• Pandemic, extreme weather and debt remain downside risks 

The Asian Development Bank (ADB) yesterday said South Asia was likely to hang on to its fast growth despite fresh outbreaks of COVID-19, with 9.5% overall economic expansion and Sri Lanka projected to grow by 4.1% this year. 

South Asia will have developing Asia’s fastest growth this year after suffering the region’s sharpest contraction in 2020. Aggregate output is forecast to expand by 9.5% in 2021, with growth tapering to 6.6% in 2022, the ADB said in its flagship Outlook report. 

South Asia’s largely reflects the performance of India, which will rebound from an 8% contraction in fiscal year 2020 and grow by 11% and 7% in this and the following fiscal year.

 A stimulus-fuelled surge in the US – India’s largest export market – will support the revival, but a severe second COVID-19 wave is threatening the recovery. 

Economic activity in Afghanistan, Nepal, and Pakistan will also rise as tight containment restrictions are lifted, with buoyant remittances stimulating growth in Nepal and Pakistan. Sri Lanka’s challenging macroeconomic situation will likely moderate growth in 2022 but is forecast to grow at 4.1% in 2021. However, this is lower than Government projections of 5.5%-6%. 

Growth recovery is dependent on an expansive budget and stronger global demand with a marked rebound expected in the major advanced economies, as well as from a base effect following contraction in 2020. 

“Growth is projected to slow somewhat to 3.6% in 2022. Building on growth momentum in Q3 and Q4 2020, the Purchasing Managers’ Index, a leading indicator of economic activity, moved strongly into expansionary territory above 50 in the three months to March 2021, with manufacturing above 60 and services in the high-50s,” the report said. 

Growth will benefit in the near term from increased private consumption as pent-up demand is released, and consumption and investment will benefit from low interest rates and ample liquidity. 

Progress on the Colombo Port City special economic zone is expected to foster Foreign Direct Investment, as does development in the Hambantota Industrial Zone. The Government’s reform priorities include deregulation to simplify governance structure, improvements to the Judiciary, Customs efficiency, financial sector regulation, and effective land use.

The strength of recovery in 2021 and 2022 will crucially depend, however, on the pace of vaccination in Sri Lanka and in key export and tourist markets. Sri Lanka plans to vaccinate nearly half of its population by the end of 2021. 

Growth by sector in 2021 will reflect base effects from 2020, with industry bouncing back by 4.8% from its steep contraction. 

Manufacturing growth will be fuelled by recovery in export markets, pent-up domestic demand, and import restrictions. Construction will benefit from a Government focus on public investment and resumed private sector projects. Services are forecast to grow by 4.2% on gradual recovery in tourism.

Agriculture expansion is projected at 3.7% in 2021 with planted area under rice and other crops in December 2020 greater than a year earlier.

The Government plans to increase public investment to 5.4% of GDP as part of its push for recovery in 2021. This increase will come from allocations for Government priorities in health and education, a 100,000 kilometre road program, water for all, rural development, and primary production in agriculture, plantations, fisheries, and energy. 

The Government projects a budget deficit at 8.8% of GDP in 2021. Given rigid recurrent expenditure, any revenue shortfall may require constraint on public investment to contain the deficit.

Domestic sources are expected to provide 94% of net deficit financing in 2021 as envisaged in the medium-term fiscal framework 2021-2025. This could push up interest rates as private sector demand for credit grows with economic recovery and perhaps crowd out some private borrowers. Low interest rates, deficit financing, pressure on the rupee, and import restrictions may push up domestic prices. 

Inflation averaged 3.5% in the first three months of 2021, accelerating in March to 4.1% year on year. Strong agricultural growth and base effects from high food inflation in 2020 are expected to contain inflation at 4.5% in 2021, rising to 5.0% in 2022.

The current account deficit is expected to edge lower to 1.1% of GDP in 2021. Exports will grow as demand recovers in major export markets. Domestic demand recovery and higher oil prices will raise imports, but continued import restrictions are expected to limit import growth and contain the deficit. 

Remittance inflow increased by 13.2% in the first two months of 2021 and is forecast to increase from 2020 as economic activity picks up in host countries. Tourist arrivals, at only 9,629 in the first three months of 2021, are expected to gather momentum in the second half, when vaccinations are widespread.

Foreign reserves fell to $4.1 billion at the end of March 2021, and the rupee depreciated by 6.8% against the dollar in the first three months of 2021. To shore up reserves and squelch exchange rate volatility and speculation, the Central Bank imposed a three-month ban to mid-April on banks issuing foreign exchange forward contracts, and it required exporters to transfer proceeds to Sri Lanka within 180 days of shipment and convert 25% of them into local currency within two weeks of transfer, lowered in April to 10% within 30 days of transfer. 

Higher remittances were encouraged by providing an additional SLRs2 per dollar for converted remittances, and banks were required to sell 10% of remittance inflow to the central bank. To attract deposits from non-residents, a special depositary account introduced in April 2020 offers a higher interest rate.

Central Government external debt servicing in 2021–2025 will average slightly more than $ 4 billion each year. Foreign exchange requirements are higher when factoring in the external debt of the private sector and State-Owned Enterprises, as well as dollar-denominated Government development bonds. Non-debt creating capital inflows, support from bilateral partners, and the timely disbursement of committed project financing are expected to buttress foreign exchange reserves. 

The People’s Bank of China provided in March 2021 a standby three-year swap facility worth CNY 10 billion to be accessed if necessary. The next month, China Development Bank approved a $ 500 million second tranche from its $ 1.2 billion term financing facility, which will directly support reserves. A proposed International Monetary Fund allocation of special drawing rights would further cushion reserves.

“Risks to the forecast stem from uncertainty generated by the ongoing pandemic, in particular the impact of new strains and the pace of vaccination. Once forbearance measures under COVID-19 are lifted, higher nonperforming loans may constrain private sector credit growth, as may crowding-out effects under fiscal deficit monetisation, limiting growth in consumption and investment. Other risks to recovery prospects are fiscal and debt challenges, import restrictions, significant external financing requirements, underlying structural issues, and extreme weather.” 

After years of steady improvement, the poverty rate likely worsened in 2020 as the pandemic caused income losses, especially for informal and smaller enterprises and their employees. The Government has thus focused on strengthening education, healthcare, and rural development to preserve progress in human development achieved over many decades.

However, safeguarding this progress and advancing it through higher economic growth depends on Sri Lanka overcoming its fiscal and debt challenges.