UBS issues warning on Lankan economy

Monday, 2 April 2012 00:38 - - {{hitsCtrl.values.hits}}

Top investment bank UBS has issued a warning on Sri Lankan economy lowering the 2012 growth rate to 6% and suggesting a degree of overheating in addition to hinting interest rates going up, further pressure on exchange rate, interest rate and Budget deficit.

The report exposes some of the mistakes made in the recent past with regard to economic management as well resultant challenges the country has to deal with in 2012 and beyond.

“Sri Lanka is going through a modest episode of overheating,” UBS Securities Asia said in its research analysis on Sri Lanka released last week, adding that the economy appears to have over-expanded.

“We expect interest rates in Sri Lanka to go up another 150-200bp to reflect the much wider external gap and higher headline inflation in prospect. The domestic economy is already softer, but further weakness appears likely as higher rates depress spending and the current red-hot credit growth slows down. Overall we look for real GDP growth to slow to around 6% in 2012 from a number likely to be close to 8% in 2011,” UBS said.

UBS’s view is that Budget deficit target of 5.2% for 2012 may have to be re-set as the economy cools off tax buoyancy will be tested.

“While this is not a fiscal or balance of payments crisis for investors financial markets could be in for a bumpy time while the economy adjusts to the higher inflation lower growth mix,” UBS added.

“Many still believe that Sri Lanka has managed to attain a new higher 8% trend growth. We disagree," UBS opined whilst noting Sri Lanka is ill-equipped to run the kind of imbalances it experienced recently.

“As with other economies we do not envisage a sharp arresting seizure of economic activity (as happened in 2009 post Lehman’s bankruptcy), but a more moderate one. However, the key to escape from this slump (as in other places) will not be policy stimulation,” UBS pointed out.

“Sri Lanka cannot afford much in that department. Instead recovery will ride on: (i) global growth and export trends (which should look up from June quarter onwards and; (ii) the ability of the local private sector to stage a rapid profits recovery following interest rate hikes and a fuller translation of higher fuels costs – lagged,” UBS added.

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