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he global banking giant HSBC has put Sri Lanka back in its good books over her accelerated macro-economic growth driven by supportive monetary policy and rise in exports, booming tourism, construction and manufacturing sectors and the perking up of capital market.

However just five months ago the same bank was skeptical about Sri Lanka’s outlook due to budget and current account deficits as well as concerns about the investment and business climate.

This phenomenon is evident from the low level of corporate earnings, despite higher economic growth which are well below 2006/07 levels

The visiting HSBC research staff that witnessed the mass scale constructions taking place then concluded that the looks could be deceiving and went on to say the country was losing her sparkle.

However, changing its perspective, HSBC last week said Sri Lanka was now their favourite frontier market in Asia.  

“However, overall we feel that Sri Lanka is a country where the health of the banking system is improving, infrastructure is getting better and a stable, pro-development government is helping to lower the cost of doing business to a level that is very competitive compared with that of peers,” HSBC said in its regular equities research report titled ‘The Flying Dutchman’.

According to government statistics, Sri Lanka’s economy grew at 7.6 percent in 1Q14 accelerating from 6.1 percent a year ago and the trade gap continued to narrow in April by 17.7 percent to US $ 682. 2 million amid weak domestic credit.

Meanwhile, the business sentiment, though still not great, has inched higher in the past few months, as measured by the LMD-Nielsen business confidence index, HSBC said.

The banking giant largely attributed Sri Lanka’s growth to tourism, real estate and port related infrastructure which they believe should help turn Sri Lanka into a major logistics hub.     

HSBC largely attributed SL’s growth to tourism, real estate and port related infrastructure which they believe should help turn SL into a major logistics hub

Nevertheless HSBC said it had concerns about the quality of growth especially because domestic demand is yet to pick up, and the very limited
private sector investment in infrastructure projects.

In Sri Lanka, the private sector has been crowded out due to the state sector dominance in almost all major development projects.

This phenomenon is evident from the low level of corporate earnings—despite higher economic growth—which are well below 2006/07 levels.

“There are also doubts about the returns on big government projects, funded mostly by large foreign loans, which puts pressure on the nation’s finances,” the report noted.

Poor consumer spending Despite the lending rates now at multi-year lows and benign inflation, Sri Lankans don’t appear to have felt the need to rev up their consumption. This phenomenon has in fact troubled economists in recent times but HSBC said that the raising indirect taxes had impacted consumer spending negatively. “The government has done a good job in bringing down the deficit, but this has come at the expense of a decline in consumer spending. Raising indirect taxes (eg, VAT) to improve revenues hit consumers’ pocket, and currency depreciation in late 2012 and the removal of electricity subsidies have not helped either,” the report noted. According to research firm Nielsen, the sales volume of fast-moving consumer goods (FMCG) had contracted for seven quarters in a row. However, there are signs that volumes started to pick up in late 2013. “We believe FMCG sales have bottomed and should expand in 2014. New salary increases and improvements in business and consumer sentiments should drive consumption growth, provided the currency remains supportive,” they noted.