First Capital optimistic of economic rebound from 3Q despite risks

• Commodity price slump, import controls to bode positively with current account 
• Budget deficit estimated to expand to 9% to 10% of GDP 
• Expects govt. to resort to bilateral funding as international capital markets run dry 
• Domestic borrowings to surge from 3Q for deficit financing, putting pressure on rates 

First Capital Research expects the Sri Lankan economy to rebound starting from 3Q20 onwards  and hit 2.4 percent growth for the full year if it can be re-opened gradually from the end of April provided the government’s strict guidelines on social distancing prove successful with near zero new COVID-19 cases reported by mid April. 

According to the research house, although the outlook on the Gross Domestic Product (GDP) appears grim than at the beginning of the year, they subscribed to the scenario of ending lockdowns and gradually returning to normalcy from end April as their base case scenario, with evidence proving strict lockdowns have been successful than delayed full lockdowns. 

“Some countries like Sri Lanka and Myanmar have gone beyond a lockdown action in to a complete shutdown by means of curfew with only a few selected essential services working at an early stage of the spread. 

This has proved to be successful so far. But we are yet to see the end of it”, the research firm stated. 

“Countries such as Europe and USA which delayed lockdown action have seen a massive surge in the spread of the disease and subsequent escalation of deaths”, it added. 

In other two scenarios used in their model, one forecasting a 3-4 months of hunkering down required by steady increase in the COVID-19 cases pointing to 0.2 percent contraction in the economy and worst case projecting 6 - 8 months shutdown with 2nd and 3rd waves of spread of the contagion resulting in business bankruptcies pointed to a much steeper 4.8 percent contraction in the economy.

Speaking on similar lines to that of First Capital, the Central Bank Governor, Professor W.D. Lakshman last week said he still hopes the economy to register 3.0 percent growth for 2020, down from 4.0 to 4.5 percent levels projected before the crisis. 

He also expects the immediate dangers to dissipate in about two months allowing the return to gradual normalcy from May. 

In any case, Sri Lanka is expected to record its worst second quarter this year after many years.

 Typically the second quarter growth comes muted due to New Year holidays in Sri Lanka. 

“The only thing that favours Sri Lanka is that, Q2 is usually Sri Lanka’s’ worst quarter in any given year due to the April new year holidays”, stated First Capital projecting a near zero growth in 2Q. 

Meanwhile contrary to common notion, First Capital said that they believe Sri Lanka’s current account could be positively impacted given Sri Lanka’s net 
importer status. 

“Heavy dip in imports is likely to be led by the global price dip in oil and the usage dip in Sri Lanka. In addition, significant dip in consumer items such as vehicles and imported F&B items are likely to push imports lower. With a possible dip in apparel exports, a significant dip in raw material imports may also contribute towards lower imports,” they said.  They estimate the dip in imports to outweigh the dip in exports and will remain for sometime in tourism, apparel and 
worker remittance. 

“We have seen this happening during the global recessions in 2001 and 2008 as well. Therefore we expect a similar pattern during this crisis as well which could favour Sri Lanka’s current account,” said Dimantha Mathews, the author of the report and the Head of Research for Investments in Fixed Income and Equity. 

However there are risks in areas of debt re-financing and budget deficit financing, First Capital said.  They estimate a budget deficit of 9 to 10 percent of GDP for 2020, higher than their original estimate of 7 percent. 

As 3Q and 4Q will pose higher risks for Sri Lanka in repaying sovereign bond and budget deficit financing, First Capital expects the government would focus on bilateral loans such as the one similar to the Chinese loan as liquidity in international markets could be dry for some time. 

“The current global situation poses a significant risk to our economy with the inability to raise funds in the international markets amidst the current volatility and the lack of interest in emerging and frontier bond markets. Therefore, Sri Lanka may have to focus on bilateral loans, similar to the recent Chinese loan.  As the government will have to lean more on the domestic market for deficit financing, Fitch expected rupee borrowing requirement to significantly increase towards 3Q and 4Q which will in turn put pressure on the interest rates from the 2H20.