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Central Bank of Sri Lanka
Sri Lanka’s growth is expected to contract by 1.7% in 2020 before rebounding to an optimistic 5% next year, the Central Bank said yesterday, but the monetary authority warned a recovery was dependent on strong reforms, including better fiscal management, strong exports and increased investment.
The latest projections were published in a Central Bank report titled ‘Recent Economic Developments: Highlights of 2020 and Prospects for 2021’. Despite the strong impact of COVID-19 on economic expansion this year, the Central Bank has remained staunchly optimistic, initially projecting the economy would grow by 1.5% before shifting to a neutral stance.
However, this new report indicates the Central Bank has deviated from its position maintained since mid-2020 and even without 2Q data, acknowledged Sri Lanka’s economy will shrink. Nonetheless the Central Bank’s projection is still far more optimistic than similar projections made by the International Monetary Fund (IMF) and Asian Development Bank (ADB), which estimate growth to reduce by 5.5%-6% in 2020.
According to the Central Bank, Sri Lanka’s trade gap will shrink to 6.6% helped by restrictions on imports but hints at this being reversed next year with the gap to rise to 8.2%. The current account balance is also projected to record minus 1.5% before changing to minus 2.4% in 2021.
Private sector credit growth will grow only by 6% in 2020 but is expected to fare much better in 2021 at 13.9%. Board money growth will decline from 20.6% to 15% in 2021 and inflation will likely remain anchored at mid-single digit levels.
“The achievement of the projected medium-term macroeconomic path is contingent upon implementing the identified reforms in the period ahead. Along with the establishment of a stable Government, the COVID-19 outbreak has created an opportunity to review macroeconomic policies and set appropriate policy priorities and long-term development goals for the country,” the report said.
The Government’s drive to support and encourage domestic production to reach self-sufficiency in identified goods is likely to play a crucial role in Sri Lanka’s economic transformation. However, the maintenance of quality standards of domestically-produced goods and ensuring availability at a reasonable price are vital to derive intended benefits in the medium to long term, the report added.
“Adequate investment in innovation and research and development (R&D), and the promotion of export-oriented FDI are needed to improve efficiency and enhance productivity, particularly in the SME sector. As envisaged high growth necessitates improved access to international markets, trade negotiations with existing and new partner economies must continue.”
Reforms in relation to labour, land and financial markets were also seen as essential. “Beyond the near-term economic hardships caused by the pandemic, long-term growth and macroeconomic stability remain key priorities that Sri Lanka must balance in its march towards shared prosperity.”
The Sri Lankan economy is expected to rebound in 2021 as evidenced by the fast recovery of activity since the relaxation of the lockdown in May 2020, although a resurgence of COVID-19 cases, as observed in October, could affect the momentum to some extent.
The large-scale policy support provided by the Central Bank and the Government is expected to facilitate a fast recovery of economic activity in the near term, while growth-oriented policies of the Government are expected to sustain the recovery over the medium term.
“In 2020, the economy is projected to contract by 1.7%, reflecting the impact of the pandemic-induced fallout, particularly in the second quarter of the year. The lagged effect of extensive fiscal and monetary policy stimuli provided thus far, along with improved investor confidence due to the restoration of political stability and the implementation of the growth-oriented policy agenda of the Government, would support sustainable and equitable growth in the period ahead.”
The report noted that in spite of disruptions to economic activity in the near term, the pandemic also created a window of opportunity for the Government to introduce pro-growth policies with increased emphasis on domestic agricultural and industrial production.
Essential infrastructure development projects are expected to be implemented with the unveiling of the National Budget for 2021, thereby increasing regional connectivity and the productive capacity of the economy. Education and skill development policies are also being reoriented towards a knowledge-based growth promotion strategy.
“Despite the heightened vulnerabilities amidst the COVID-19 pandemic, Sri Lanka’s external sector is expected to show resilience over the medium term with appropriate policies implemented without delay. With the recovery in global demand and the policy drive to improve domestic production and support exports, a sizeable increase in earnings from exports is envisaged in the medium term. Expenditure on imports could rise in 2021, compared to substantially low levels in 2020.”
The normalisation of oil prices and the rise in demand for intermediate and investment goods, due to the expected expansion of domestic production and exports, are expected to influence the level of expenditure on imports in the period ahead. Accordingly, the trade deficit, which is expected to decline substantially in 2020, is projected to improve over the medium term after an initial adjustment in 2021.
Despite the setback in the tourism industry, the surplus in the services account is expected to improve steadily over the medium term, supported by the envisaged recovery of the tourism industry as the pandemic fears fade away in the period ahead.
Moreover, the growth in transport services and IT/BPO is also expected to support the expected improvement in services exports. Meanwhile, workers’ remittances are projected to grow, albeit slowly, over the medium term.
Consequently, the external current account deficit, which is expected to narrow to 1.5% of GDP in 2020, is projected to increase to 2.4% of GDP in 2021 and decline gradually to 1.2% of GDP by 2025. The moderation of financial flows amidst the COVID-19 pandemic is expected to affect the financial account of the BOP in the near term.
However, with positive investor sentiments following the restoration of political stability and the expected recovery in the global economy, an increase in FDI inflows and foreign investment to the CSE and the Government securities market is expected over the medium term. Foreign investment flows are expected, particularly on account of the Colombo Port City and the Hambantota Industrial Zone project.
The Central Bank is expected to maintain adequate levels of foreign reserves over the medium term, while maintaining a flexible and competitive exchange rate. The Government is expected to take appropriate measures to ensure the sustainability of Sri Lanka’s external debt, through short-term measures to secure adequate financing and through longer-term reforms to ensure a sustained increase in merchandise and services exports, while enhancing non debt creating inflows in the form of FDI, the report added.
“Following the inevitable expansion in the fiscal deficit and debt levels in 2020, performance of the fiscal sector is projected to improve over the medium term, supported by the envisaged recovery of economic activity. The medium-term fiscal strategy of the Government, which is to be announced with the presentation of the national budget in mid-November 2020, is expected to include measures to strengthen the fiscal consolidation path through tax policy reforms, further rationalising recurrent expenditure, and improving the efficiency of capital expenditure.”
Meanwhile, measures to promote domestic production in several earmarked areas and to improve the performance of State-Owned Enterprises (SOEs) are expected to support activity, while providing more avenues of revenue for the Government in the period ahead.
The large volumes of credit obtained by the public sector are expected to cause the growth of broad money (M2b) to accelerate in the near term. The growth of broad money is projected to stabilise at around 12.5% in the medium term, mainly driven by the expansion in credit extended to the private sector.
Inflation is expected to be maintained within the desired range of 4%-6% over the medium term. Headline inflation, as measured by the year-on-year change in the Colombo Consumer Price Index (CCPI), is envisaged to be maintained broadly around mid-single-digit levels in the period ahead. Inflation could reach the upper level of this range in 2022 and 2023 with the expected rebound in aggregate demand, reflecting the lagged impact of the fiscal and monetary stimuli and expected normalisation of petroleum prices globally.
On the supply side, the Government’s efforts to achieve self-sufficiency in certain agricultural products are expected to stabilise domestic food inflation in the period ahead.
“The Central Bank stands ready to implement appropriate policy measures to arrest any build-up of unwarranted inflationary pressures arising from the demand side, while the Government’s commitment to addressing transitory supply side pressures and managing the fiscal balances along the envisaged path also remains crucial in ensuring low and stable inflation and sustained economic growth over the medium term.”
