“In a world of two speeds, Sri Lanka remains resilient”

Describing that the world was at present running in two speeds with risks, a top regional economist last week declared that Sri Lanka remained resilient though beset with several challenges.

“Growth for Sri Lanka will hold up relatively well in 2011 but the country needs to watch out for inflation,” HSBC Chief Economist for India and ASEAN Leif Lybecker Eskesen told a breakfast forum organised by the bank in Colombo on Friday.

He said that growth for the country was being supported by the unlocking of new productive capacity, positive domestic sentiments, solid income growth and continued reconstruction efforts post-war.

“In 2012, growth is set to ease in response to slower export growth and a possible shift to a less accommodative monetary policy stance. Capacity constraints may also be tightening, which could raise core inflation,” Eskesen said.

“A further weakening of global economic conditions pose downside risks to the growth outlook and could spill over to the economy through the trade, finance, and confidence channels,” he cautioned.



“Headline inflation has eased, but core pressures are simmering,” Eskesen opined, adding that CPI inflation was decelerating on a sequential basis following improved food supply output partially recovering from the flood-related damages early in the year.

“Moreover, the recent stabilisation in international commodities prices and a strong rupee has helped ease headline inflation. Core inflation has also eased a bit, but with domestic capacity utilisation running high and demand growth strong under easy policy settings, demand-led inflation pressures should continue to linger. This is despite the improvements on the supply side of the economy,” the HSBC economist pointed out.

Though noting that Sri Lanka wasn’t nearly as export-driven as peer countries in Asia, Ekesen said: “The momentum in exports has eased due to a slowdown in key export markets in the West. This trend will likely continue as global economic prospects have weakened considerably in recent months.”

Global economic headwinds, apart from impacting exports, will also have a bearing on capital flows, he added. “But we expect that growth will still hold up relatively well although some moderation is expected in 2012,” Ekesen added.

“The loose monetary policy settings,” he pointed out, “have spurred credit growth and growth more generally in the economy, but the Central Bank should stand ready to stem underlying inflation pressures.”

Fiscal consolidation, according to him, is set to continue, which should help support macroeconomic stability. “However, it may prove difficult to meet this year’s deficit target (of 6.8% of GDP),” Eskesen added.

“Tax cuts could leave revenue collections short of target, despite tax broadening measures and strong growth. This could leave the deficit a notch higher than planned (HSBC 7.1% of GDP), leaving the fiscal stance a little less tight,” the HSBC economist opined.

Focusing on the external front, he described the current global situation as “a world of two speeds with risks tilted to the downside”.

Commenting on Asia’s prospects, he said growth in the region was moderating, but the redeemer was solid domestic demand providing a cushion.

The HSBC economist identified advance country debt woes was a key risk along with high oil prices and Japan-related supply disruptions as well as a probable global double-dip recession. In this context he said inflation was a concern overall but weakening of the global economy was easing upward pressures.

However, Eskesen cautioned that there was no need to panic as yet. Favourable labour markets should support consumption and Asian investments are also expected to remain well-supported.

According to him, Asian exports face headwinds, although intraregional trade will provide some cushion.

Monetary conditions have not tightened much of late… partly reflecting that policy rates, in real terms, are near record lows. In fact, policy rates still far from where they need to be to tame inflation. Policy rates are, consequently, expected to go up, but the weaker global economy has pushed back the tightening cycle. Fiscal policy also remains more supportive than pre-crisis and also needs be normalised, with the speed depending on global developments.

Moreover, there is scope for further exchange rate appreciation when the global economy regains its footing as expected in our baseline. More targeted measures may also be needed next year. Policy priorities, however, could change if downside risks materialise, he said.

“If we get a more severe global economic downturn than currently anticipated, there will be a need to consider easing both fiscal and monetary policies,” he added.

Noting that there was room to ease policies, he emphasised: “There is less room to loosen macroeconomic policies than at the time of the 2008/09 global financial crisis.”

He also said within Asia core inflation pressures were still prevalent as credit growth had been rapid in a number of Asian countries in recent years.

“Monetary policy settings are already very accommodative in many Asian countries, with some central banks having barely begun policy normalisation following the significant easing in 2009,” he said.

“There is fiscal space to loosen, but in some cases a high level of debt limits the scope to some extent,” he said.

Commenting on the exchange rates, he said that should also be allowed to respond to market forces to help cushion the impact on growth.