Sri Lanka's economic growth driven by gains in exports and tourism sector

On October 26, 2018 President Maithripala Sirisena rescinded the mandate of Prime Minister Ranil Wickremesinghe to lead the government. Although the Prime Minister Wickremesinghe was reinstated on December 16, the constitutional crisis weakened business sentiment and impacted already slowing growth. The economy grew by 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 3.4% and 3.6% recorded for the first and second 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.

Monetary Policy

Though economic expansion slowed in the second half of 2018, the CBSL left its key benchmark rates unchanged, 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 midsingle-digit levels. The central bank’s policy appears to be having the intended effect: inflation was contained, despite the fluctuations in the rupee, which closed the year having depreciated by some 19% against the US dollar, pushing up import costs.

The national inflation rate stood at 2.1% in December 2018, down from 7.7% in the same month of 2017. Meanwhile, the rate for Colombo was 4.3% in December, down from 6.6% the previous year. Consumer inflation is forecast to remain subdued in 2019. The CBSL predicts price increases of below 5%, and the index is expected to stabilise to a range of 4% to 6% in the medium term.

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 rupee,” he told OBG. “However, current political stability and an improved outlook for emerging markets 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.”

Exports

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. Exports rose 15% in 2018, 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 was the food, tobacco and beverages sector, which increased by 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.

Legal Changes

The reforms to the Land ( Restrictions on Alienation) Act, which came into effect in April 2018, enable foreign entities to purchase freehold land in Sri Lanka if the entity is listed on the Colombo Stock Exchange (CSE). Additionally, this measure will help boost the economy by encouraging greater levels of foreign direct investment. “These changes will provide a helping hand as the government secures foreign investment for the Port City development and planned divestiture of non-strategic commercial entities via the CSE, while also increasing the market capitalisation and the liquidity of the capital market,” Wirasekara told OBG.