Political tensions in the latter part of 2018 slowed the momentum of Sri Lanka’s economy, weakening gains made earlier in the year. Nevertheless, political stabilisation and advances in the export and tourism sectors are expected to drive robust growth over the coming year.
Citing policy differences, on October 26 President Maithripala Sirisena rescinded the mandate of Prime Minister Ranil Wickremesinghe to lead the government, despite the latter seemingly still having the backing of a majority of parliamentary deputies.
Though Prime Minister Wickremesinghe was reinstated on December 16 following a ruling in his favour by the Supreme Court, the constitutional crisis created something of a political vacuum that weakened business sentiment and impacted already slowing growth.
The economy grew at a rate of 3.3% year-on-year (y-o-y) for the first nine months of 2018, with the rate of expansion easing in the latter part of the year. GDP increased by 2.9% y-o-y in the third quarter, down on the 3.6% and 3.4% recorded for quarter two and the first quarter, respectively.
The Central Bank of Sri Lanka (CBSL) cited the constitutional crisis as a major contributing factor to the slowdown, although the bank has predicted a rebound in growth for 2019 as improved political stability eases risk.
This optimistic outlook is supported by the IMF which, in a report published in October, forecast a growth rate of 4.3% for 2019, rising to 5% by 2023.
See also: The Report – Sri Lanka 2018
Monetary policy keeps Sri Lankan inflation in check
Though economic expansion slowed in the second half of the year, at its last meeting on December 27 the monetary policy committee of the CBSL decided to leave its key benchmark rates unchanged, while flagging the need for broader structural reforms to provide economic stimulus.
The bank maintained its deposit facility rate and standing lending facility rate at 8% and 9%, respectively, citing the objective of keeping inflation at mid-single digit levels.
The central bank’s policy appears to be having the intended effect: inflation was contained both in the capital of Colombo and the wider economy, despite fluctuations in the rupee, which closed the year having depreciated 19% against the dollar, pushing up import costs.
The national inflation rate – as a 12-month moving average – stood at 2.7% in November, down from 7.5% in the same month of 2017. Meanwhile, the rate for Colombo was 4.3% in December, down from 6.6% over the previous year.
Consumer inflation is forecast to remain relatively subdued in 2019, with the central bank predicting pricing increases of below 5% in the coming year, with the index to stabilise to a range of 4% to 6% over the medium term, according to a statement issued in December.
However, the rupee is expected to stabilise in the first half of 2019, according to Dilshan Wirasekara, group CEO of First Capital Holdings, a Sri Lankan capital markets firm.
“Low foreign currency reserve positions, high foreign debt payments and foreign outflows from the debt and equity capital markets could further weaken the Sri Lankan rupee during the first half of 2019,” he told OBG.
“However, the current political stability and an improved outlook for emerging markets due to a slower pace of policy tightening by the US Federal Reserve will bolster the economic environment, and as the government and CBSL boost reserves by raising new debt via foreign currency swaps, Sri Lanka development bonds and bilateral loans the rupee will begin to stabilise. As investor confidence improves and the IMF facility gets back on track, there will likely be more interest in international sovereign bonds in the second half of 2019.”
Sri Lankan political impasse spills over into international ratings
The constitutional crisis also impacted international business confidence, with the three leading agencies all downgrading the country’s sovereign ratings.
Moody’s, Fitch and S&P all revised their assessments of Sri Lanka, with the latter two lowering their sovereign rating from B+ to B in early December, following Moody’s lead in late November.
All three cited heightened political uncertainty as a driver for the downgrade, though all maintained their “stable” outlook for the economy.
Record-breaking export gains, but rising trade deficit
Despite the political tensions, key elements of the economy continued to expand at a strong rate.
While exports fell short of the $17.4bn target set at the beginning of the year, the $17bn of outbound shipments did set a new record, according to data issued by the Export Development Board.
Exports rose 15% last year, eclipsing the previous record set in 2017 of $11.4bn. A similar rate of increase would put exports close to the $20bn objective identified by the government for 2019.
Among the categories that performed strongly across the year was the food, tobacco and beverages sector, which increased 17.7% to the end of October. Other top performers were textiles and garments, and tea, which both rose 5.3%, according to the CBSL.
However, despite the increase in exports Sri Lanka’s trade deficit widened in 2018, expanding to $8.8bn by the end of October. Among the leading outlays were crude and processed oil products, which accounted for $3.4bn for the first 10 months of the year.
Tourism and foreign direct investment (FDI) to grow in 2019
While falling short of the targeted 2.5m arrivals, Sri Lanka’s tourism sector continued to make a major contribution to foreign currency earnings in 2018, with the 2.3m visitors – up 10.3% on 2017 – generating an estimated $3.5bn.
Furthermore, these figures are forecast to rise in 2019, with the Ministry of Tourism projecting revenue of $5bn on the back of 4m overseas arrivals.
The reforms to the Land Restrictions on Alienation Act that went into effect in April 2018, which allow foreign entities to purchase freehold land in Sri Lanka if the entity is listed on the Colombo Stock Exchange (CSE), will also boost the economy in 2019 by encouraging greater FDI.
According to Wirasekara this will help fund infrastructure developments and improve the country’s capital markets.
“These changes to the law will provide a helping hand to the government as it secures successful foreign investments for the Port City development and planned divestiture of non-strategic commercial entities via the CSE, while increasing the market capitalisation and the liquidity of the capital market,” he told OBG.