Recession of -1.9% most probable for SL: ICRA Lanka

• Three possible outcomes outlined for 2020
• Best would see 0.6% contraction and worst -3.3%
• Even -1.9% would see economic shock of Rs. 0.9 t, Budget deficit of 7.8%
• Agriculture expected to be least affected, industry and services to struggle
• Tourism, despite current tough times, likely to recover fastest

ICRA Lanka yesterday outlined three possible economic outcomes for Sri Lanka from COVID-19, with the most optimistic projecting a recession of -0.6%, a medium -1.9%, or an extreme scenario of -3.3% in 2020.

The report titled, “Economic Impact of COVID-19 in Sri Lanka” also compared how the country’s economy recovered after three previous crises, namely the 2001 Central Bank bombing, the 2008 international financial crisis, and the 2019 Easter Sunday bombings.

The organisation, which is a subsidiary of Moody’s Investor Service, said in the most probable scenario of a 1.9% contraction, the shock to the economy will see a loss of Rs. 0.9 trillion, a Budget deficit of 7.8%, revenue losses of Rs. 181 billion, and unemployment climbing to 9.8%. Nonetheless, the economy is expected to rebound in the first quarter of 2021.

In the worst situation, the shock would be Rs. 1.1 trillion, Budget deficit would be 8.1%, and revenue losses Rs. 211 billion. If the recession is as bad as -3.3%, the country could see unemployment increase to 10.5%.

In the best case scenario, ICRA Lanka projects the recession will only be -0.6%, economic losses will be limited to Rs. 0.7 trillion, and the Budget deficit 7.5%. But even in this most optimistic of forecasts, unemployment would rise to 8.2%, nearly double that of the pre-virus time.

“The expected blow to the revenue collection and heavy fiscal stimuli will come with a hefty price tag. The budget deficit will widen close to 8% of the GDP,” the report said.

“With companies already moving forward with salary cuts, as the crisis deepens, the unemployment could rise to upper single digits. In the more severe case, the unemployment rate can accelerate to the levels before the late 90’s, where Sri Lanka used to have double digit unemployment rate.”

The domestic demand may remain subdued for the remainder of the year amidst weakening demand, and therefore inflation is expected to be in the range of 4-7%.

The impact of COVID-19 on the agriculture sector will be minimal, as the sector is quite resilient to the external shocks, and also usually receives significant Government support due to the high number of people it employs. Most of the impact will be felt in the services and industry sectors, as these sectors are more open to external shocks.

“Industry sector is comprised of a sizable segment of manufacturing. This segment is the most vulnerable to global economic fallout due to (1) increase in input prices due to deteriorating foreign exchange rate (2) drop in export demand as source markets will be in turmoil for foreseeable future. Due to this reason the industry sector is likely to experience a deeper shock with a longer recovery.”

 In contrast, in 2019, following the Easter Sunday attacks, the industry sector recovered much quickly.

The shocks in the services sector will mainly be felt in tourism and retail/wholesale trade industries, which are substantially large sectors of the economy.

“Tourism has come to a near standstill as key source markets are currently in lockdown. In addition, exchange rate depreciation and import restrictions may affect the supply lines of retail and wholesale trade. But the sector may recover sooner than the industry sector if the travel restrictions are relaxed,” the report added.

The growth disruption due to COVID-19 is expected to be driven by three factors: (1) demand shock, (2) supply shock, and (3) export shock. Demand shock results initially from temporary drop in demand from the confinement and then from loss of real incomes of consumers once the recession is in motion. The supply shock also initially results from the confinement.

Thereafter, input scarcity could lead to a drop in supply. The key export markets are also battling the COVID-19 crisis and those economies are set to take a blow. In the process, they may cut down on imports, which could lead to a dip in the export demand.

Considering all the relevant up-to-date information, ICRA Lanka sees three outcomes for Sri Lankan economy. These scenarios depend on how the global and the domestic situation evolves in next few months and ICRA Lanka continues to monitor the situation and may revise the prediction when more information is available.

Scenario 1: In ICRA Lanka’s most optimistic modelling, the virus is assumed to have been contained within 2 months from mid-March. Here the overall impact is moderate, and the economy bounces back strongly on the back of strong global rebound to return to pre-crisis level by end of the year.

Scenario 2: This is the most probable scenario for Sri Lanka in ICRA Lanka’s opinion. It is also the most conservative estimate and acts as the base case for the remainder of the report. In this scenario, global recovery is moderate and the overall impact on the Sri Lankan economy would be high. As per this, Sri Lanka will return to pre-crisis level by Q1 of 2021.

Scenario 3: If Sri Lanka could not contain the virus within 2 months amidst a muted/moderate global rebound, this scenario can occur. Here the initial shock will sustain or decline slowly overtime through a better part of 2021 as well. The overall impact on the economy can be devastating.