Sri Lankan rupee seen recovering against US dollar : report
View(s):The Sri Lanka rupee (LKR) is expected to steadily gain versus the USD in the coming quarters as it recovers ground lost during the powerful upswing in USD-INR (Indian rupee – and broader EM FX vlatility) in the past four months, according to a research report by a global bank.
Expressing cautious optimism as the external outlook improves, Standard Chartered Bank (SCB) said in an Asia Regional Focus report released this week that the country’s current account deficit is on a steady downward path (forecast at 4.5 per cent of GDP in 2013).
The overall balance of payments is supported by heavy net inflows across the financial account, it said. “This pattern of current account deficits being more than offset by financial account inflows leaves the LKR vulnerable to short-lived market turbulence, but the inflows should be sufficient to put the LKR on a path of trend appreciation. Exporters should use any short-lived bounces in USD-LKR to raise their FX hedge ratios,” the report added.
SCB said Sri Lanka is set to consolidate its strong H1-2013 performance (average GDP growth of 6.4 per cent) in H2. “We maintain our full-year growth forecast of 6.5 per cent, despite the Central Bank (CB)’s more optimistic projection of 7.5 per cent premised on the global recovery in H2.
The growth uptick in Q2 was led by sustained momentum in the industrial sector and a recovery in the services sector. We are uncertain if this momentum will continue in H2, however, given moderating credit growth, weak budget revenues and low growth in non-oil imports. Given the improving external outlook, we are cautiously optimistic,” the report said.
SCB said policy rates will remain on hold at 7 per cent to give the CB more time to assess the impact of its policy-easing measures. The CB cut policy rates by 50bps in May and reduced the statutory reserve ratio (SRR) by 2ppt in July to 6 per cent; this has lowered short-term borrowing costs, and the trend is spreading to longer-term lending rates. “These developments are having the desired impact on credit growth – the latest data shows that private-sector credit growth was Rs. 28.5 billion in absolute terms in July, despite falling to its lowest pace this year (8.4 per cent y/y) due to base effects.
Healthy demand for exports looks likely to continue given brightening H2 growth prospects in the euro area and the US, Sri Lanka’s key export markets. This should contain the current account deficit to the SCB forecast of 4.5 per cent of GDP. While FDI inflows remain well below expectations at US$540 million in H1-2013, they rose 20 per cent y/y. Meanwhile, the capital account has received support from foreign debt capital inflows to the banking sector. On the capital account, an uptick in inflows via commercial bank issuance in 2013 has further cushioned the balance of payments.
“Inflation risks appear to have receded since H1-2013 amid favourable domestic and global supply conditions. Average inflation moderated to 6.2 per cent in Q3 from 6.8 per cent in Q2, largely due to base effects. Softer international commodity prices, improved domestic supply and favourable weather conditions are also containing inflation. We lower our 2013 inflation forecast to 7.3 per cent from 7.5 per cent due to the lower-than-expected Q2 reading. However, we expect some upward pressure on inflation in the coming months as domestic demand and private-sector investment pick up as a result of the central bank’s policy easing and lower interest rates. This should push Q4 growth to 6.8 per cent from an expected 6.6 per cent in Q3. We expect inflation to average 7.1 per cent in Q4-2013,” the SCB report added.
The global bank said on the fiscal front, weak tax revenues remain a key challenge. The mild pick-up in domestic activity expected in H2 may not generate enough tax revenue to achieve the authorities’ fiscal deficit target of 5.8 per cent of GDP. While the government is making progress on fiscal consolidation, its debt burden remains high at 79.2 per cent of GDP.
It said the government has borrowed Rs. 451 billion via T-bills and T-bonds in 2013 year-to-date, slightly higher than the budgeted Rs. 421 billion. “We think the government is unlikely to rely on further domestic market borrowing for the remainder of 2013. However, weak foreign demand is a concern,” the report said.
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