ICRA Lanka projects economic recovery in 2H

• Rating agency joins Tundra Fonder in forecasting lower for longer on interest rates 
• Says inflation will remain subdued as less pressure on aggregate demand 
• Confides that government will meet its foreign currency debt obligations 

Early indications have shown that the Sri Lankan economy is on course to some recovery in the ongoing quarter with lower borrowing costs and benign prices continuing through the year as the country is going to a crucial poll to decide who could be better equipped to accelerate the momentum and lift people’s economic wellbeing. 

ICRA Lanka, which closely monitors the proxy indicators for economic activities such as electricity consumption, cement consumption and port services, said its forecasting models indicated the Sri Lankan economy to have grown by 0.2 percent in the first quarter before contracting by 6.9 percent in the second quarter due to coronavirus. 

But ICRA Lanka said its projections showed economy recording better performance in 3Q and 4Q. 

As lockdowns eased Sri Lanka’s Purchasing Managers Index for both manufacturing and services—a proxy for the level of economic activity—shot up in June while the companies said they see a stronger than expected recovery in consumer demand towards end of the second quarter.

John Keells Holdings, Sri Lanka’s largest conglomerate said its multiple sectors had reached near pre-pandemic levels by July barring the leisure sector. 

Meanwhile, the rating agency also expected the current substantially lower interest rates to remain through the year as the new Monetary Board remains mostly dovish and doesn’t seem to be shy to take unprecedented measures to support the pandemic beset economy. The Monetary Board in July slashed key policy rates by 100 basis points bringing the total cut in the benchmark rates to 250 basis points, which resulted in market interest rates plunge to the lowest levels in the recent history. This gave a strong indication to the markets that the Monetary Board stands ready to support credit markets. 

This is in line with the recent commentary by Tundra Fonder, a frontier market fund, which made similar forecast, as central banks world over could become more cautious in changing track given the scale and magnitude of the economic shock thrown in by the pandemic. 

This provides a degree of certainty to markets as businesses, and consumers could plan ahead with their cost of capital or loan installment, remaining somewhat static at least for the short term.

However, ICRA Lanka, a part of Moody’s Investors Service, does not expect, “an appreciable expansion in credit as the recessionary currents flow strong at the moment”. 
Yet, in a sign that there is a stronger appetite for credit in the economy, Sri Lanka’s private sector credit decline in May caused by the pandemic showed some deceleration in June as people forwarded more applications for loans. 

Meanwhile, the rating agency also forecast the country’s prices to remain benign due to the fall in aggregate demand. 

Low taxes and lower interest rates entwined with stronger agriculture output could dampen the price pressure, specially on food. 

Meanwhile, ICRA Lanka confided that Sri Lanka will meet its foreign currency obligations by rolling over some of the debt or through bilateral arrangements, which are being negotiated or already in place. 

But it said meeting the US$ 1.0 billion sovereign bond retirement could pose some challenge. ICRA Lanka expects the Sri Lankan rupee to be around Rs.187 against the US dollar by the year-end although there is a strong possibility for depreciation if imports pick up. 

“Given the slightly stronger rupee in terms of REER that prevailed as of end 1H 2020, the CBSL may tolerate further depreciation leading to reserve accumulation,” ICRA Lanka added.