Sri Lanka’s domestic financial conditions have eased substantially with banking system liquidity remaining in surplus, says First Capital Research in their monthly Policy Expectation August 2020 report released last week.
“Banks have abundant liquidity, following CBSL infusing ample liquidity into the banking system via increased CBSL holdings (Money Printing). However, the outlook for credit seems lacklustre given the uncertainty surrounding pandemic,” the report adds.
Recovery of manufacturing activities continued in August 2020 (Index Value 57.9) as reflected by PMI Manufacturing, benefitting from the normalization of business activities in the country.
PMI Services continued to expand for the 3rd consecutive month with the index reaching 56 in August 2020. Additionally, the Index of Industrial Production (IIP) for July 2020 increased to 111.1 from 92.8 in June 2020. Political stability after the General Election and a slow return to normalcy was depicted in LMD-Nielsen Business Confidence Index (BCI) during Jun-Sep 2020 reflecting an improvement to 123 from 96.
Domestic economic activities, which were adversely affected by the COVID-19 pandemic, are expected to recover in the 4Q of 2020, thus not requiring further relaxation in policies.
Private sector credit also rebounded in August 2020 by Rs 78.3 billion, for the first time since April 2020 reflecting the fact that both businesses and individuals are accelerating their economic activities to make up for the lost opportunities during the lockdowns period.
First Capital Research estimates that Sri Lanka’s GDP would see its steepest contraction in history of -5.8% in 2020 following the unexpected contraction in 1Q GDP growth of -1.6%.
Amidst the lack of demand for credit, import restrictions, and the slowness in the recovery of consumer demand, GDP growth is expected to turn positive only by 4Q of 2020. Accordingly, GDP growth can be considered as a major factor favouring the further policy easing at the upcoming review.
The pandemic led disruption has had a lasting impact on the income of individuals with businesses being shut and either lay-offs or pay cuts experienced by salaried professionals. The lower disposable income in the hands of consumers will have a bearing on the demand for consumption with discretionary spending being either deferred or cancelled for a period of time.
“However, higher credit growth and consumer demand can be aggravated through further policy easing.”
First Capital Research expects Sri Lanka’s budget deficit in 2020 to reach 10% of GDP. Generally, the fiscal deficit is funded via domestic and foreign sources of borrowing.
“Lack of FDI and limited foreign borrowing options in the current period may push the Govt. to borrow predominantly from the domestic market. A decline in domestic interest rates in response to the aggressive monetary easing delivered the required support to soften the pandemic impact on the economy. Thereby, maintaining a low-interest-rate environment or further reducing the interest rate to benefit the Government’s finances.”
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