Sri Lanka’s fundamentals strong, but country at decisive political juncture: First Capital

 From left: Head of Research First Capital Holdings Dimantha Mathew, Director of First Capital Holdings and Executive Director Verite Research Dr. Nishan De Mel and Director/ CEO First Capital Holdings Dilshan Wirasekara, seen during the Mid-Year Economic Outlook report launch 

- Pic by Chamila Karunarathne

By Charumini de Silva

First Capital Research on Wednesday declared that Sri Lanka’s fundamentals are strong, but the country was at a decisive political juncture, with the upcoming Presidential Election likely to ease uncertainty.

Releasing its Mid-Year Economic Outlook report, First Capital said expectations are for improvement in economic activity and GDP growth towards 4Q2019. “Election during 4Q2019 is likely to provide an added boost to the economy amidst island wide election campaigning,” the report said, adding 1H2020 growth was projected to show strong recovery. 

“With the election in 4Q2019, the pick-up in consumer demand may continue in 1H2020 in an accelerated manner, boosting GDP growth and consumer credit. We expect a significant recovery in GDP growth, supported by the lower interest rate environment,” First Capital Research noted. The launch of the Outlook report was followed by a panel discussion featuring First Capital Holdings Director and CEO Dilshan Wirasekara, Director and Verité Research Head Dr. Nishan De Mel, and First Capital Holdings Research Head Dimantha Mathew.

The Outlook report said the completion of the election cycle is likely to resolve political uncertainty on the local front, but predicted there would most probably be a hung Parliament.

“With the current electoral system, no single party is likely to obtain a majority to form a Government. A majority Government has been formed by a single party only on a couple of rare occasions in history, where there has been extreme popularity. In such a situation, similar to previous occasions, we are most likely to see multiple political parties getting together to form a Government. Though multi-party government usually leads to slow decision-making, we are most likely to see President, Government and Provincial Councils controlled by a single party, or a single party together with minority parties, which may provide some stability,” First Capital noted. 

The Outlook report also said a strong foreign reserve position would bring in stability, with a sharp drop in imports and planned $ 500 million fundraising via a Samurai BOND ahead of the election, in order to support next year’s foreign repayments.

“We believe foreign reserves are at a comfortable stage, with the foreign repayment cover improving to 2.1x for the 12 months (Jul’19 to Jun’20), suggesting the lowest foreign currency requirement in recent years. The new Samurai bond issue adds a further cushion to foreign reserves, as we expect reserves to be $ 8.0 billion towards 2019 year end, while maintaining above $ 7.0 billion by end of 1H2020,” First Capital added.

Noting that Bond repayments dip amidst the lower SLDBs and lack of Sovereign payments, it said the next 12 months, up to June 2020, illustrate a notable reduction in repayments, especially in 4Q2019 and 1Q2020. “However, we expect foreign payments in the range of $ 300-400 million to exist on a monthly basis, in the form of project loan repayments,” it said. 

However, First Capital said total debt payment for 2020 was at Rs. 2.4 trillion, with rollovers from the rest of the year 2019. “The debt to GDP as at 2018 was 83%, whereas we expect it to rise to 85% in 2019, while dipping from 2020 onwards, partly with the acceleration of GDP growth, comparatively lower debt repayments, and possible large FDIs led by the investments into Port City,” it noted. 

It also said that reversal of foreign flows and elections may improve liquidity during early 2020. “With the continuous foreign selling in the market, and CBSL reducing CBSL holdings, we believe that maintaining positive liquidity is likely to be a struggle during early 4Q2019. We believe the global trade war, political uncertainty, policy rate cut already given, and Government borrowing requirement to fund the budget deficit expansion amidst the shortage in revenue, may lead to liquidity in the market to be negative. This will lead to lending to remain high resulting in lower credit demand. 

“Following the Presidential Election towards 1Q2020, with the settling of the political uncertainty to a certain extent, we expect foreign inflow into our debt market, while the elections in the 4Q2019 may also improve liquidity supported by the rise in economic activity and growth.”

It was noted that private sector credit may remain low for the rest of 2019, with a full year growth forecast to be at 5%, but may pick up, with liquidity in 1Q2020 supported by possible inflows. “Amidst the negative liquidity situation, we expect a possible delay in the decline in lending rates, resulting in low credit growth during 2H2019 as well. Despite the Central Bank cutting policy rates by 50bps in August 2019, the lower liquidity position in the market may hamper decline in rates and boosting of credit.”

In 2020, First Capital expects credit to rise back to a moderate level. However, “we expect liquidity position to improve towards 1Q2020 amidst possible inflows. Thereby, we expect it to lead to a decline in rates and rise in private sector credit growth. We expect 2020 credit growth improve to 14% YoY,” it added.

First Capital also expects inflation to stay within the CBSL targeted range, with no real spikes. The heavy depreciation of the rupee during 2018 is unlikely to be a major threat to inflation, resulting from crash in the consumer demand. Consumer demand saw signs of picking up early in 2019, but immediately following the Easter Sunday attacks, again plunged to all-time low levels, supporting lower inflation levels, which is likely to benefit during 2H2019. “We have downgraded our inflation targets for 2H2019, but still show signs of a slow uptrend due to the currency impact in the comparative month. We do not expect any major threat to inflation during the 1H2020 as well, with inflation likely to hover in the range of 4.0-5.0%.”

First Capital said given internal and external challenges, the overall impact on Sri Lanka’s economy is Neutral. 

“The political environment is likely to be stable, possibly providing policy stability. Despite the slower outlook on the economic front, there is room for a certain amount of acceleration, coupled with possible support from the external front with foreign inflows, which makes the overall impact at a Neutral stage,” it said.