Govt.’s policy framework triggers ‘W-shaped’ recovery instead ‘V-shaped’: First Capital

• Says economy may experience currency spike followed by interest rate spike
• Substantial BOP deficit projected due to lack of FDI and borrowing options
• Expects govt. to raise US$ 5bn this year against US$ 6bn external debt commitments
• Expects credit to pick earlier than expected while accelerating in 4Q2020

The policy direction set out by the government would lead to another economic shock, preventing a ‘V-shaped’ recovery as anticipated and triggering a ‘W-shaped’ recovery path instead, a leading equity research house based in Colombo said.

“Considering the heavy CBSL holding volume and inevitable relaxation of import restrictions, economy may showcase a currency spike followed by an interest rate spike resulting in another shock to the economy which may prevent a V-shaped recovery while inducing a W-shaped one for the recovery process,” said First Capital Research (FCR) in its mid-year review report.

FCR noted that as the nation’s GDP growth would record the steepest contraction at -5.8 percent for 2020, 

 the GDP growth may continue to struggle though the economy is projected to grow at 2.8 percent in 2021.

“Amidst the lack of demand for credit, import restrictions and the slowness in recovery in consumer demand may result in GDP growth turning positive only by 4Q2020 while the unexpected contraction in 1Q2020 further hampered prospects of a lower contraction in GDP,” justified FCR.

With regard to the country’s balance of payment (BOP) position, witnessed is an overall trade contraction and extended import restrictions in place to improve the current account to a marginal surplus. However, the deficit is expected to expand back, closer to US$ 1 billion in 2021 once restrictions are lifted, it said. 

The research house added that lack of foreign direct investment (FDI) and limited borrowing options may result in a substantial BOP deficit in 2020 and in the wake of 2021, foreign debt raising becomes critical and is likely to be a major challenge.

FCR said it expects the government to raise about US$ 5.0 billion in 2020 compared to US$ 6.0 billion for foreign currency repayments. The government has already raised or secured US$ 2.4 billion during the first seven months of 2020.

The research house further pointed out that dollar maturities are on an upward trajectory from 4Q2020 onwards amidst the sovereign bond maturities. 

“Difficulty in raising external long-term funding is likely to cause some stress to the system. Rise in Rupee Bond maturities coupled with large budget deficit funding requirements adds on to the pressure,” it said.

FCR also said hefty liquidity surplus and back-to-back policy rate cuts may trigger credit from 4Q2020 onwards. 

Acknowledging that high liquidity, consecutive policy rate cuts and the subsequent reduced lending rate caps have resulted in a steep decline in lending rates, FCR said it expects credit to pick earlier than expected while accelerating in 4Q2020 and beyond. 

It added that stronger credit growth during 1H2021 is expected further supported by possible relaxation of import restrictions.