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The Sri Lankan Flag

The Sri Lanka flag is considered one of the world's oldest, dating back to 162 BC. The lion represents Sinhalese ethnicity, the strength of the nation, and bravery; the sword demonstrates the sovereignty of the nation; the four bo leaves – symbolising Buddhism and its influence on the country – stand for the four virtues of kindness, friendliness, happiness, and equanimity; orange signifies Sri Lankan Tamils, green Sri Lankan Moors, and maroon the Sinhalese majority; yellow denotes other ethnic groups

SriLanka flag

Sri Lanka: At a glance

Structure of the economy

In the decades since Sri Lanka gained independence from the British Empire, the economy has become highly diversified, with rapid growth in manufacturing (26% of GDP) and services (59% of GDP), alongside the traditional agricultural base (8% of GDP). Following crucial liberation reforms in 1977, Sri Lanka registered rapid periods of economic growth; by international standards, its long-term average growth has not been too far behind East Asian contemporaries. That said, structural progress has been repeatedly disrupted by incomplete reforms, political unrest and war. Sri Lanka has been hit hard by the pandemic, with key sectors in construction, tourism and transport severely disrupted. While Sri Lanka narrowly avoided default last year, the situation has been further complicated by the decision to reject IMF support in favour of loans from China.

Economic Outlook

Following the sharp contraction in the wake of the pandemic, Sri Lankan growth is expected to bounce back this year, underpinned by a rebound in domestic demand and strong export momentum. However, Sri Lanka is likely to lag the global recovery; IMF forecasts GDP growth at just 4% in 2021 and 4.1% in 2022. Sri Lanka faces considerable headwinds, and its key economy sectors – construction and tourism – are likely to be vulnerable to ongoing vaccination shortages and stubborn COVID infection waves.

Monetary policy

The Central Bank of Sri Lanka (CBSL) significantly contributed to the crisis response by undertaking considerable monetary policy easing via interest rate cuts and liquidity. It also introduced capital controls to limit destabilising currency pressure and, at the July meeting, left rates unchanged at 5.5%. While inflation has increased to 5.2%, it remains within the 4 to 6% target band and expectations remain well anchored; the CBSL remains committed to maintaining the current accommodative monetary policy stance to support the sustained revival of the economy amid the renewed challenges posed by the third wave of the pandemic.

Fiscal policy

The fiscal backdrop in Sri Lanka remains precarious. Even before the pandemic, the debt profile was skyrocketing, and debt as a percentage of GDP could reach an eye popping 105% this year. The situation has been further complicated by the decision to reject support from the IMF. The China Development bank has stepped into the void providing a $500m concessional loan, while the People’s Bank of China has rolled out a $1.5 bn standing facility. The debt repayment crunch is a multi-year issue and arrangements must be made to roll the debt at a reasonable cost over the long term. Sri Lanka avoided default once again this month by transferring funds from its FX reserves to cover the $1bn bond repayment due. Looking forward, the relationship with - and influence from - China remain under scrutiny, especially if Sri Lanka remains unable to raise dollars.

Political background

The political situation in Sri Lanka is concerning. The President and recently elected Prime Minister belong to the Rajapaksas family, which is known for their nepotism, authoritarian style of governance and support of Chinese influence on the island. The pace of the country towards an authoritarian rule is accelerating and must be taken into consideration when considering investments in Sri Lankan markets. This month President Gotabaya Rajapaksa tightened his grip on power by appointing his younger brother, Basil Rajapaksa as finance minister; he was sworn in by Prime Minister Mahinda Rajapaksa, also his older brother.

Sri Lanka is in a state of distress. From a bottom up standpoint, it is expected to rebound this year, although the recovery is likely to lag both global and regional peers. Likewise, the recovery faces further downside risks as vaccination shortfalls and recurring pandemic reinfection waves become apparent. Likewise, the fiscal situation is extremely concerning. The debt profile continues to deteriorate, with Sri Lanka living to a large extent hand to mouth, as it faces an ongoing debt repayment crunch. The political situation is also concerning as the Rajapaksas family tightens its grip on power and the country drifts towards authoritarian rule.  

From a structural perspective, as noted in our Roadmap for Q3 and Beyond , we believe that the current backdrop is complicated for emerging markets, however, in our view, there are selective alpha opportunities. Why? As noted under our investment theme – Sticky Inflation, Structural Headwinds  – we stick to our longstanding view that recent price pressures are transitory. As such, we believe that the Fed will introduce a controlled normalisation of monetary policy under the AIT framework, which will encourage selective carry positions. While selective carry is likely to be a feature of the second half of this year, we believe that the domestic uncertainties are too large in Sri Lanka and there are much better candidates that fit the bill. 

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Sources

1. United Nations
2. IMF
3. The World Bank
Olympics data: Olympiandatabase.com
All other data is ESLJ, 2021.

Disclosure

None of the contents of this document should be understood as constituting research on investment matters, or as a recommendations, advice or suggestions, implicit or explicit, with respect to an investment strategy involving the financial instruments discussed, or the issuers of the financial instruments, nor as a solicitation or offer, nor as consulting on investment matters, of a legal, fiscal, or other nature. All the companies of the Intesa Sanpaolo Group, its administrators, representatives, or employees, decline any responsibility (fault-based or otherwise) deriving from indirect damages potentially caused by the use of this communication or its contents, or in any case deriving in relation to this document, nor may they be consequently held liable for any of the above. The information provided and the opinions contained in this document are based on sources considered reliable and in good faith. However no declaration or guarantee is offered by Eurizon SLJ Capital Limited, explicitly or implicitly, on the accuracy, exhaustiveness and correctness of the information, and there is no guarantee that results, or any other future events, will be compatible with the opinions, forecasts, or estimates contained herein.

Views accurate as at the time of publication. Opinions expressed by the authors are their own and do not necessarily reflect those of Eurizon SLJ Capital Limited, Eurizon Capital SGR or the Intesa Sanpaolo Group.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

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