1

QUICK TAKE | Outlook 2016 – Global & Sri Lanka Economy Reading Time: 5 Min.

GLOBAL

Outlook § Slowdown in China and associated spillovers on emerging markets (especially Asia) § Tricky adjustment to a higher interest rate environment (need to watch pace of US Fed rate) § Weaknesses in key EMs - Russia and Brazil both now in recession § Impact of low commodity prices mixed - exporters adversely affected and purchasing power falls;

importers gaining from low import bill § High outflows from emerging markets - 2015 was first time in 27 years that EMs saw net outflows of

capital. In Q3 2015 investors pulled out US$ 52 bn from EM equity and bonds

SRI LANKA

Growth Outlook 5.5% Analysis § 2016 growth will have to come from the investment side as consumption-led growth has little headroom

more to grow; as borrowing rates edge up, import demand narrows alongside a depreciating rupee. Agriculture would contribute to H1 GDP growth as good harvest is predicted

§ Although Q4 2015 data are not out yet, we believe that Q4 would have grown at around 6.3-6.5%, giving the full year 2015 at just above 5%.

§ Recent growth was driven by handful of sectors - Financial services, wholesale & retail trade, personal services, construction, transport and warehousing. All are non-export, domestic economy, and nearly all (except construction) are services.

2

§ These cannot sustain high growth over the medium-term - Small domestic market + these sectors do not promote productivity improvements and economic dynamism

Inflation Outlook 4.5-5.0% Analysis § Core inflation has begun edging up; LKR depreciation will drive higher import prices

§ Continued low oil prices (topping $40/barrel at most) will continue to help; full benefit not enjoyed due to lack of pricing formula

§ Food prices unlikely to see sharp rises in H1 Budget Deficit Outlook 6.5% Analysis § Above GoSL forecast of 5.9%; but government strategy can be to postpone some planned/promised

(Budget 2016) capital expenditure items § Possible IMF programme would have implications on fiscal management § Govt targets of raising tax-GDP ratio to 16.4% still well below median for B-rated sovereign debt: 21.4% -

risk of a ratings downgrade (or at least a ratings outlook change) § Heavy reliance on import trade taxes; problematic in a depreciating LKR era § Foreign borrowings will be trickier in 2016 – higher global interest rate environment, fund pullouts from

emerging markets (already 1/3rd drop in foreign bond-holdings) Rupee Outlook Depreciates closer to LKR 150 Analysis § Comparator country currencies in the region have depreciated around the same or more. Will also be

driven by further Yuan depreciation § Key will be how much of the adjustment borne by the currency sliding vs. by expending reserves. So far,

burden of adjustment has been placed disproportionately on foreign reserves

3

External Sector Outlook § Monthly exports at ≈ US$ 900 million; remittance inflows continue to slow down; FDI inflows from

projects getting underway (Port City, Sampur, Chinese SEZ, etc) Analysis § Improvements in US economy will help exports

§ Lacklustre performance in EU will continue to affect exports, but can be helped by regaining GSP+ (but unlikely to happen soon)

§ Exports not growing, remaining stagnant at around US$ 800 mn each month for last 2 years. Negative YoY monthly export growth on average in 2015

§ Remittance inflows falling is a critical concern, it finances 1/3rd of SL import bill. Middle East oil price crisis is a key driver of the slowdown. 50% of remittances come from the Middle East