First Capital paints gloomy outlook for economy

• Predicts sharp depreciation of rupee; spike in interest rates towards 2Q
• Expects complete reversal of current monetary policy stance; forecasts policy rate hikes in 3Q and 4Q
• Doubts govt.’s ability to continue with restrictions on non-essential imports any longer
• Forecasts 3.2% GDP growth in 2021, an upgrade from previous forecast of 2.8%

In what could be the gloomiest forecast issued by an independent research body so far, First Capital Research (FCR) this week said the sharp depreciation of the rupee against the US dollar, followed by a spike in interest rates — beginning from as early as the second quarter of 2021 — could send Sri Lanka’s economy reeling as the country scrambles to find growth. 

The FCR team, parsing the data on the Sri Lankan economy, even went on to predict a complete reversal in the course of the monetary policy, with the Monetary Board resorting to two potential policy rate hikes in the third and fourth quarters and the rupee to shed its value by as much as 12 percent to end between Rs.205 and Rs.215 by 
end-2021. 

“With the weak foreign currency reserve position, high foreign currency debt repayments and possible spike in consumer demand triggering higher imports are likely to result in a steep depreciation in 2021,” FCR wrote in their Strategy Report for 2021, released this week.

They are of the view that the government may not be able to continue with the restrictions on non-essential imports any longer and the expected increase in the credit to the private sector would put pressure on the currency and thereby the interest rates, as such moneys would fuel consumer imports. 

However, those who oppose the conventional economic wisdom, particularly with the new ground realities stemming from the COVID-19 pandemic, maintain a more positive view on the country’s 
economic prospects.

As they point out, cost of money is at an all-time low in Sri Lanka and all over the world and the central banks are trying to rekindle inflation even at trillions of dollars worth of stimulus money. The world has now come to a point where ‘inflation-free growth’ is becoming a possibility. 

In Sri Lanka’s case, the country is undergoing a new-found domestic manufacturing boom, with a renaissance in small businesses and entrepreneurship adding more muscle to the output, of which a major section is aimed at selling outside the country—exports.While these could at least partly make up for certain non-essential imports, which remain barred for the time being, the policy of the government appears to be to reopen markets for imports gradually, with the improvement in foreign inflows, specially the merchandise and services exports, which are showing notable progress.

In their report released under the theme ‘The second leg of ‘W’; Bumpy Road to recovery’, FCR pointed out that Sri Lanka has been undergoing a recovery in the shape of ‘W’, after the growth spurt seen during the July-September quarter lost steam in the October-December quarter, due to the second wave of COVID-19. 

Albeit with its dourest outlook for the currency and interest rate, FCR forecasted a 3.2 percent growth in gross domestic product in 2021, an upgrade from 
2.8 percent.