What are Sri Lanka’s economic prospects in 2021?

2020 was a year of ultimate disruptions across a widest spectrum, that no expert saw coming: the virus and its devastating impact on lives, livelihoods, society and governments. 

Although 2021 remains uncertain, there are reasons for hope with the recent breakthroughs with the vaccines, the unprecedented level of fiscal and monetary stimulus, step-change in innovation and digitisation across sectors and a refreshed US administration and EU post Brexit. 

Many economists anticipate a mixed economic recovery for Sri Lanka in 2021. As the economy bounces back from the pandemic, the recovery may be patchy, as some local outbreaks and lockdowns will come and go throughout 2021. 

Locally and globally, there will be aggressive multilateral disputes over the distribution of vaccines. As the vaccines become available in quantity, the focus will shift to the task of distributing them. 

Vaccine diplomacy will be required to manage the distribution. The gap between the strong and weak will likely widen for countries, companies and individuals. 

Economy and business
It is anticipated that the economy would recover during 2021, with a projected growth of approx. 4.3 percent, on the back of the lower base in 2020. With such anticipated growth in the economy and the consequential increase in loan demand, interest rates are likely also to edge up next year, providing for better interest margins in the banking sector. 

However, the critical factor would be the ability of borrowers to service their loans post moratoria, which will determine the trend for NPAs and credit impairments in the industry. 

With the authorities remaining hopeful of combating the growth in COVID rates to much more manageable levels next year and with the expected growth in the economy, businesses would recover by mid-2021 and the loan recovery rates will be strong. 

The financial sector has been affected by the slowdown in the economy, resulting from the impact of the Easter Sunday attacks last year and the COVID pandemic since March this year. 

The NPA of the industry has increased over the last 12 months and credit costs have also risen significantly. These have also impacted loan growth and fee income-generating activities of banks. Loan growth, which was averaging between 15-20 percent, has dropped to a single digit and the fall in interest rates especially this year, has resulted in contracting margins. 

Despite the drop in profitability, the industry remains well regulated and resilient, since most banks have strong capital levels and have recorded modest returns  despite the challenges in the  environment. However, 2020 will end with a negative growth in the economy for the second time, post independence.

Public expectations
A well-planned initiative to roll out an effective vaccine for COVID-19 could be the catalyst to kick start the economy next year.  The Central Bank will need to watch their Monetary Policy closely, once the economy takes off, to curb the trends that can fuel a rise in inflation and exert pressure on our external reserves and forex rates. 
The rating downgrade of the sovereign will certainly make it more difficult and expensive for banks to obtain foreign funding in 2021. We need therefore to attract FDI and drive up export income to fill the savings-investment gap and enhance the investments in the country. Sri Lanka will have to stabilise the debt burden and post-COVID opportunities will emerge to restructure Sri Lanka debt. 

In the final analysis, given the significant debt overhang and the economic scarring from the lasting impact of COVID globally on the services sector, especially on Sri Lanka’s post-pandemic tourism, economic growth could be lower than that – possibly closer to 4 percent in the medium-to-longer term. 

Therefore, managing our external relations tactfully is a must, as there is a growing momentum among several leaders of the world’s biggest economies to diversify their sourcing, production and distribution to countries and allies with similar interests.

In addition, we need to skilfully manage the soft side of the economy, that will help us to fast-track our economic recovery.