Economy on stronger footing; weighed down by high budget deficit, inflation risk concerns

Economy on stronger footing; weighed down by high budget deficit, inflation risk concerns
December 5, 2012, 8:00 pm
The Island

Less than a week after the release of a global report highlighting Sri Lanka’s economic prospects for next year (see The Island Financial Review Friday November 30), Standard Chartered Bank yesterday (05) released a more detailed report on the domestic economy. It said the economy was on a stronger footing, but raised concerns over inflation and the already high fiscal deficit.

"We expect 7.2% growth in 2013 (slightly lower than the budget estimate of 7.5%), supported by a pick-up in investment, strong remittance inflows, and steady growth in the construction and tourism sectors. Weak demand from Sri Lanka’s key export markets, the EU and the US, is likely to persist, but overall demand should pick up in 2013 as the global recovery gathers momentum. The finance minister highlighted that exporters’ margins have deteriorated due to weak global demand but that exporters had benefited from exchange rate flexibility. Export earnings, at an estimated USD 9.5bn for 2012, are modest (c.6% lower than in 2011) but have exceeded expectations despite the downturn in Sri Lanka’s export markets," Standard Chartered Bank economists Ms. Samantha Amerasinghe and Nagaraj Kulkarni said in the latest report.

"The trade balance is likely to remain in deficit as demand for investment goods increases to support growth. However, we expect an improvement in the current account (to 4.5% of GDP in 2013 from an estimated 6.1% in 2012) as exports recover, supported by robust remittance inflows and tourism receipts. The balance of payments should remain in surplus, but there is substantial risk from higher oil prices (oil accounts for c.25% of Sri Lanka’s total imports), which could exacerbate the fiscal position."

"The high fiscal deficit and the risk of higher inflation due to the possible escalation of food prices are key concerns. The deficit has been under strain due to lower-than-expected tax revenues and higher debt interest payments. The increase in non-interest expenditure on wages and welfare spending has also contributed to fiscal slippage. For 2012, the government maintains that it will achieve its 6.2% deficit target, but we think it will be closer to 7% of GDP. Headline CPI inflation is likely to inch higher in Q4-2012 due to upward revisions of administered prices of fuel (and electricity) and supply-side constraints (Cyclone Nilam damaged crops in the northeast in early November). However, we expect inflation to moderate by Q2-2013 due to improved domestic supply and buffer stocks of rice, while the government’s prudent wage policy should suppress near-term wage demand pressures. We think this will provide the central bank with sufficient flexibility to cut policy rates by 25bps in Q1-2013. In 2013, the policy focus is likely to shift to supporting growth," the report said.

Standard Chartered Bank says balancing the budget would be a tough act.

"The 2013 budget remains development-oriented while maintaining the government’s fiscal consolidation stance. The government projects ambitious revenue growth of 19.2% (versus a 12.8% increase for 2012), and plans to increase expenditure by 15.9%. We note that while the expected pick-up in revenue growth in 2013 (to 14.7% from 14.2% of GDP in 2012) is insignificant, expenditure – at 20.5% of GDP – is unchanged.

"The government expects tax revenue growth of 22.9%, while non-tax revenue is projected to fall by 6.1%. Tax collection is expected to increase versus 2012 levels, at 13% of GDP. The government plans to increase infrastructure spending by 20.2% and expenditure on education and health by 28.4%, and to boost subsidy spending by LKR 35.9bn (though, as a percentage of total expenditure, it will remain flat at 15%). Interest costs, at LKR 444.8bn, remain the largest recurrent expenditure item, increasing by 12.9% versus 2012, but are flat as a percentage of total expenditure, at c.25%.

"For 2013, the government continues to focus on development and remains resolute in its efforts to tackle the twin deficits – trade and fiscal. The overall thrust of the 2013 budget is poverty alleviation and food security, but there is a strong emphasis on import substitution (in industries such as sugar, dairy, and livestock and fisheries), enhancing export competitiveness (tea, rubber, coconut and spices), and on sectors defined as key drivers of economic growth and new sectors such as IT and business process outsourcing (BPO). Import levies on dairy products, canned fish and milk powder have been increased to protect domestic industries."

Sri Lanka expects BOP surplus of US$ 380mn in 2012
December 5, 2012, 8:01 pm
The Island

LBO: Sri Lanka is expecting a ‘balance of payments’ surplus of 380 million US dollars in 2012 the latest Central Bank projection said, down from a 1.25 billion US dollar projection in May.

For 2013 the Central Bank is projecting a BOP surplus of 780 million US dollars, according to a presentation made by Central Bank Governor Nivard Cabraal to executives of Sri Lanka’s finance companies Monday.

A so-called BOP surplus roughly corresponds to an increase in Central Bank’s foreign reserves adjusted for items such as valuation changes.

Foreign reserves can increase steeply if there are reserves are captured and locked by a sell down of Central Bank’s Treasury bill stock preventing the converted rupee proceeds from being spent, either directly by the recipients or others through credit.

Foreign reserves fall rapidly in the Central Bank prints money by purchasing large volumes of Treasury bills either to finance a deficit budget or to continuously sterilize foreign exchange sales.

During the last balance of payments crisis, the Central Bank held Treasury bill stock rose from almost zero to around 240 billion rupees.

In the absence of a sell down of T-bills reserves will increase by the equivalent increase in domestic reserve money or interest earnings on forex reserves and any International Monetary Fund receipts which occur outside the domestic monetary system.

The Central Bank’s Treasury bill stock has been roughly stable at around 200 to 220 billion rupees from May until the first week of December and credit growth has been positive.

A balance of payments surplus is a legacy term dating back to the gold standard era when gold accumulated as a domestic asset in country when credit growth was low.

In modern paper fiat money systems, where gold is insignificant all inflows go out either as transactions by people, the government or reserve investments by the Central Bank and the balance of payments balance almost exactly.

But Central Bank monetary movements are considered ‘below the line’ and labeled as a balance of payments ‘surplus’, though the money has already moved out of the country usually to be invested in gilts of reserve currency countries.

The Central Bank is projecting a deficit in the current account of the balance of payments to narrow to 5.1 percent of gross domestic product in 2012 from 7.6 percent in 2011.

In May the Central Bank expected the current account to narrow to 3.8 percent of GDP, in 2012 despite projections of large inflows through the capital account.

A large surplus in the capital account (not counting IMF inflows) however generates a roughly equal deficit in the current account if bank credit is positive and there is no sell down of Central Bank held Treasury bills.

In 2013, the Central Bank is projecting the current account of the balance of payments to narrow to 3.6 percent of GDP.