Sri lanka.
Core Views We have long cautioned that the political unassailability of
the ruling United People's Freedom Alliance greatly increases the risk
of governmentoverreach. Recent developments, such as the impeachment of
the country's chief justice, have only bolstered our view. More than two
and a half years after the EU decided to withdraw preferential tariff
benefits to Sri Lanka, it appears that the country's exporters are now
beginning to feel the economic squeeze. The ruling government's
inadequate progress on the human rights front suggests to us that these
privileges are unlikely to be reinstated any time soon. We do not see
the island's economic growth turning up until H213 at the very earliest,
implying that the ongoing slowdown will likely intensify in H113. We
are keeping to our 5.4% full-year real GDP growth forecast for 2013. The
island's economy is still feeling the pinch on multiple fronts, namely
high credit costs, the weak Sri Lankan rupee, and the fragile state of
developed markets. With price concerns gradually diminishing, we believe
that the primary focus of the Central Bank of Sri Lanka (CBSL)'s
policies over the coming 12 months will be economic growth. We are
projecting 100 basis points of additional easing in 2013, taking the
reverse repo rate to 8.50% by end-2013. Crucially, the CBSL's annual
road map signals further loosening of monetary policy in the months
ahead. Currency stability is likely to be the overriding theme for the
central bank following a fairly volatile 2012. The CBSL explicitly
expressed exchange rate stability as one of its policy priorities in its
annual road map for the year ahead, reiterating its willingness to
intervene. The government aims to narrow the fiscal deficit to 5.8% of
GDP by end-2013. We believe there will be nothing revolutionary about
how the government conducts its business this year, and that the amount
of fiscal consolidation will very likely be minimal at best. While the
country's overall business environment remains mediocre from a pan-Asian
perspective, we cannot ignore the rapid and dynamic changes taking
place in its regulatory framework, which indicate that its business
environment is making significant strides. This is likely to help to
sustain the country's foreign direct investment boom.
Major
Forecast Changes We have toned down our expectations for further rupee
strength and have set a conservative target of LKR126.00/US$ by end
2013, with the unit expected to average at LKR126.85/US$ for the year.
Key
Risks To Outlook Risks To Completion Of Sri Lanka-India CEPA: Potential
political stumbling blocks could stall the completion of the
Comprehensive Economic Partnership Agreement (CEPA). These include the
recurringconflict between Indian fishermen and the Sri Lankan navy, the
government's (perceived) lack of political reconciliation with the
country's Tamil minority, and the likelihood of rising domestic
protectionist sentiment at home. Upside Risks To Current Account
Deficit: Even though the country'sconcerted efforts at external
rebalancing have started to take hold, we highlight that the overall
process still faces a number of challenges. Risks include the potential
for adverse global commodity price movements (especially that of oil
prices), deeper weakness in the country's main export markets (the EU
and the US), and political instability in its key sources of remittance
inflows (the Middle East). Risks To Constructive Rupee Outlook:
Similarly, risks to our rupee outlook remain weighted to the downside,
with the most pertinent ones including a faster-than-expected economic
recovery in Sri Lanka, continued stubbornness in global oil prices and a
derailing of the expected bounce in global growth. Upside Risks To
Inflation And Policy Rate Outlook: We remain cognisant of the potential
for an improvement in global economic activity to elevate demand-driven
inflationary pressure in the island. Furthermore, domestic food
inflation could remain elevated for a long-than-expected period, as our
Commodities team expects global food inflation to pick up in H113.
Kurulla Research