A palpable sense of optimism emerged regarding Sri Lanka’s economic outlook at a recent high-profile economic forum hosted by HSBC Sri Lanka in Colombo attended by key business leaders, economists, and officials. The country has faced unprecedented challenges in recent years, including droughts, political changes, the global pandemic, and economic turmoil. However, the speakers at the event including the Chief Executive of HSBC Sri Lanka and the Maldives, the Central Bank Governor of Sri Lanka, and leading economists of HSBC, highlighted several positive developments rekindling hope for the nation’s economic recovery.

Despite the hardships, Sri Lanka has witnessed signs of progress, such as a notable decrease in inflation rates, a decline in interest rates, and increasing foreign interest and investment. The Central Bank’s successful efforts to stabilize inflation were particularly applauded, as they reached their inflation reduction target well ahead of schedule. The speakers also discussed structural reforms, foreign debt restructuring, and efforts to manage trade deficits as essential components of Sri Lanka’s path to economic stability.

Moreover, the forum shed light on Sri Lanka’s strategic position within evolving global supply chains, the potential for outsourcing simpler services from India, and the country’s improved wage competitiveness compared to China and other Asian nations. These factors, coupled with the resilience of the Sri Lankan private sector, contribute to the cautiously optimistic sentiment regarding the nation’s economic future.

While acknowledging ongoing challenges, the collective sentiment among the speakers was one of determination and hope as they emphasized the importance of concerted efforts from various sectors to pursue economic reforms that began with the IMF to achieve sustainable economic growth and foster a brighter tomorrow for Sri Lanka’s economy.

Improving Sentiment

Mark Surgenor, Chief Executive of HSBC Sri Lanka and the Maldives, expressed optimism about Sri Lanka’s economic trajectory and growing appeal to the global investor community.

Reflecting on the country’s journey over the past 18 months, Surgenor pointed out that while challenges persist, the once-familiar scenes of fuel queues and power cuts are becoming a distant past. The notable end to the widely used QR code system further underpins the nation’s progress.

Signs of economic recovery are evident as inflation rates dip, interest rates follow a downward trend, and foreign exchange becomes readily available. This turnaround has not gone unnoticed on the international stage.

These positive shifts have drawn global attention and rekindled international investors’ interest in Sri Lanka. “In recent months, we’ve seen a significantly heightened interest from the international investor community eager to engage with Sri Lanka,” said Surgenor. He shared that investor delegations from both the West and East have visited Sri Lanka, sparking robust dialogues and discussions around potential investment opportunities.

Reiterating HSBC’s commitment to Sri Lanka, Surgenor highlighted a recent investor roadshow they held in collaboration with HSBC India. The event saw an encouraging turnout, indicating a renewed investor interest in Sri Lanka.

As the country’s foremost international bank, HSBC possesses a unique blend of local understanding backed by global insights from its expansive network across more than 60 markets. “Our longstanding presence in Sri Lanka for over 130 years showcases our unwavering dedication to standing by Sri Lanka through thick and thin,” Surgenor remarked.

The event served as a platform to reiterate HSBC’s dedication to supporting Sri Lankan businesses and fostering meaningful discussions to assist business leaders in navigating their futures.

Expressing HSBC’s intent, Surgenor said, “We aspire to unlock global opportunities for our customers, bringing the best of Sri Lanka to the world and vice-versa.”

Foundation for a Rebound

Delivering the keynote address at the HSBC hosted economic forum, Central Bank Governor of Sri Lanka, Nandalal Weerasinghe, articulated the monetary board’s commitment to economic stabilization and controlling inflation. In a candid reflection on the past year, Weerasinghe drew attention to the Central Bank’s efforts in stabilizing inflation. A year ago, the bank set out to reduce inflation by 2024, but in a commendable achievement, reached its target by the end of July 2023. “We walked faster than the talk when it comes to inflation,” Weerasinghe declared.

The Central Bank’s commitment to maintaining single-digit inflation was also highlighted. Despite some minor fluctuations, the bank assures that inflation will stabilize at around 5%, which is seen as an optimal rate for a thriving economy.

The Governor underscored the new Central Bank Act, emphasizing greater independence and transparency in its operations. This includes obligations to make monetary policies more transparent through inflation reports, commitments to parliament, and agreements with the government.  Such steps are intended to stabilize inflation expectations, a vital factor for investment and consumption decisions. Amidst the discussions about inflation and monetary policies, Weerasinghe acknowledged the challenges faced in the banking sector, especially the debt moratorium and restructuring efforts. “Those were difficult times,” he recalled, “but the actions we took were necessary to stabilize the economy.”

Another significant update was regarding market interest rates. With inflation losing steam and policy rates revised downwards, the Governor expects these rates to align more closely as the market stabilizes. He strongly advised businesses and individuals to negotiate for lower rates with banks, emphasizing that the bank’s guidance should lead to reduced rates, benefiting not just prime customers but also smaller enterprises and individuals.

The address also touched on the challenges Sri Lanka faced in the past, particularly the balance of payments situation, which was affected by global conditions, reducing remittances and tourism.
However, the Governor expressed optimism for the future. Both sectors have shown signs of recovery, and with the Central Bank’s strategic policies in place, he expressed confidence in managing any potential challenges.

Regarding the future outlook, Weerasinghe mentioned the establishment of a diverse monetary policy board, which will include 11 members, a significant increase from the current five. This is seen as a move to bring more technical expertise into the Central Bank’s decision making processes. In conclusion, the Central Bank Governor emphasized the direction Sri Lanka’s economy is taking, pointing towards recovery and stability. He expressed confidence in the strategies implemented and highlighted the increasing interest from foreign investors, indicating a brighter future for the nation’s economy.

Global Headwinds & Opportunities

Frederic Neumann, Chief Asia Economist and Co-Head of Global Research at ASP, HSBC, shed light on the current global economic landscape from U.S. inflation to China’s sagging construction sector and the impact on the global economy to the emerging opportunities for markets like Sri Lanka.

He began by focusing on U.S. inflation and interest rates. Despite a 4-year high in core inflation in the U.S., the Federal Reserve is not expected to cut interest rates quickly. Even though inflation has started to decline, full normalization of price pressures remains a distant reality. Despite U.S. economic sectors like housing and manufacturing showing signs of slowing, the resilient labour market and rising wages signal a reluctance by the Fed to reduce rates anytime before mid-2024.

With the world witnessing a slowdown, from Europe to China, the relatively high U.S. interest rates result in a strong dollar. This potent currency situation isn’t just a Chinese concern; many emerging markets grapple with the dollar’s strength.

Neumann next transitioned to explain the recession risks hanging over Europe. The European market, essential for many Asian exporters, is showing signs of an impending recession. Factors like the energy price shock after Russia’s gas cutoff and decreased consumer spending have hurt the European economy. Although Europe, similar to the U.S., has unemployment rates near multi-decade lows, lingering inflation pressures may compel central banks to consider raising interest rates, further exacerbating recession risks.

Shifting the attention to China, Neumann elucidated China’s investment predicament. China’s economy, significantly driven by investment, faces challenges, especially in the property sector. Although manufacturing investment remains positive, property investment has plummeted by 20% year-on-year. This decline affects global demand as a substantial portion of global steel demand is funnelled into Chinese housing construction. Until China stabilizes its housing construction, a sharp economic recovery seems unlikely. China, known for its staggering growth rates of 6-7%, now projects a growth of 4 to 4.5%. This subtle decline resonates with shifts in Europe and the US as well, Neumann avered, before highlighting the paradox of global commodity price movements.

Historically, a slowdown in the Chinese economy saw a dip in global commodity prices. However, despite the current economic slowdown in China and globally, prices of commodities like iron ore and oil remain surprisingly high. This anomaly is due to the constraints in global commodity supplies.

Why the Supply Constraints?

Neumann explained that climate change is impacting agricultural commodities, pushing prices up, and the transition from fossil fuels to sustainable energy sources, is leading to a decline in investment in fossil fuel extraction, leading to a scarcity in supply. Yet, the demand persists as the shift to sustainable energy is still in progress. Metals like lithium, nickel, and copper, vital for electric vehicle batteries, are in heightened demand, keeping their prices elevated.

While there’s a buzz about factories moving back to the US and Europe and a potential decline in globalization, the data suggests otherwise, Neumann said. Asia’s exports, as a fraction of global GDP, are at a record high. Furthermore, North American and European consumption of Asian-made goods continues to climb. Also, despite an ongoing deglobalization debate, foreign direct investment in Asia is soaring. China continues to attract major foreign investments, especially in sectors like automobile manufacturing. However, lower-end manufacturing investments are shifting to Southeast Asia. “This creates a strategic opening for countries like Sri Lanka, which can potentially tap into these evolving supply chains,” Neumannpointed out.

He drew attention to the shifting economic dynamics, using compelling charts to demonstrate how countries like Malaysia, Thailand, Indonesia, Philippines, Vietnam, and India have dramatically improved their wage competitiveness against China over the last decade. The chart revealed that while in 2013, Malaysia’s wage costs were 110% of China’s, by 2022, several Asian countries, including Sri Lanka, had wage costs significantly below China’s. This development, Neumann emphasized, holds paramount importance for industries where wage costs remain a critical factor, such as apparel and low-end assembly.

Highlighting another crucial dimension, he shed light on China’s manufacturing investments in the ASEAN region. Contrary to common perceptions, these investments are not solely from Western multinationals but also from Chinese manufacturers looking to exploit wage competitiveness and burgeoning markets.

Delving deeper into the demographics, Neumann highlighted the significant demographic divergence occurring in Asia. While countries like the Philippines, India, Malaysia, Indonesia, and Sri Lanka still have expanding working-age populations, others such as China, Thailand, Korea, Taiwan, Singapore, and Hong Kong are experiencing shrinking workforces. The shrinking pool of workers in these nations is driving up wage costs. China’s escalating wage costs, in particular, are attributable to its declining working-age population, leading to a lack of affordable labour.

Neumann also emphasized India’s role as an emergent powerhouse in the global economy, with projections indicating its economy could rank third largest globally by 2032. Unlike China, India’s trajectory is not heavily predicated on low-cost manufacturing exports but leans more towards exporting services, especially hightech ones.

Using charts, Neumann further showcased how Asian economies, while having lower per capita incomes than some developed markets, are growing at a faster pace, resulting in lucrative incremental business opportunities.

Addressing concerns surrounding China’s slowing economy, he asserted that despite the slowdown, China continues to generate double the incremental output of the US on a trend basis.

Concluding his address, Neumann was optimistic about Asia’s future, with a particular focus on Sri Lanka. He highlighted how Sri Lanka stands at a strategic vantage point, poised to benefit from evolving Middle East-Asia relations and the shift in supply chains from Northeast to Southeast Asia.

Delivering the second special research presentation at the forum, Aayushi Chaudhary, HSBC’s Lead Economist for India, Indonesia and Sri Lanka, presented a cautiously optimistic outlook for Sri Lanka’s economy, highlighting the challenges and prospects for the island nation.

Hard Work to Reach the Light at the End

Despite enduring a series of setbacks since 2017, including droughts, political shifts, the COVID-19 pandemic, and a socio-economic crisis, Chaudhary believes there is “light at the end of the tunnel.” She remarked on Sri Lanka’s challenging journey: “Sri Lanka hasn’t had a single normal year.”

Among the challenges noted, Sri Lanka’s potential GDP growth decreased from 5% during 2014-2016 to a mere 3% at the onset of the pandemic. The nation also grappled with an average of -3% over the last three years. A significant cause for these figures, Chaudhary identified, was under-investment in productive capital.

But it’s not all grim. Recent indicators suggest a potential economic rebound. The Purchasing Managers’ Index (PMI) shows service sectors expanding and manufacturing steadily recovering. Tourism has also shown a promising resurgence, with anticipation of further growth in the upcoming peak season. Remittances are nearing pre-pandemic levels, with significant credit given to the Central Bank’s efforts in stabilizing the currency. Furthermore, a steady rise in oil prices, (the Middle East being the key source of remittances for Sri Lanka), is expected to positively influence remittance inflows.

Chaudhary also touched upon the role of foreign investment in the island nation. A notable uptick has been observed in foreign investment in government securities, with numbers reaching up to $500 million this year. Inflation, which posed a significant concern last year, has reduced to single digits, aligning with the Central Bank’s target.

A significant boost for the economy came from the announcement of domestic debt restructuring, which resulted in risk moderation. This positive trajectory, coupled with the correction of past excesses, has resulted in elevated sentiments within Sri Lanka.

Chaudhary emphasized the need for continued effort, especially in four key areas: (a) The implementation of structural reforms under the IMF programme; (b) Successful negotiations related to foreign debt restructuring; (c) Management of the trade deficit, especially with rising oil import bills and relaxed import restrictions; and, (d) Identification and nurturing of new growth drivers, like computer service exports.

On the regional front, she noted the potential for Sri Lanka to benefit from India’s service sector diversification. As India ascends the value chain, other types of services could be outsourced to Sri Lanka, capitalizing on the country’s already proven quality standards in manufacturing to attract companies to explore services exports. In conclusion, Chaudhary was upbeat about Sri Lanka’s economic prospects, stating, “Yes, there is light at the end of the tunnel, it’s getting brighter, but then the hard work must continue.”

Collective Heave

Addressing the forum, Duminda Hulangamuwa, the Chairman of the Ceylon Chamber of Commerce, underscored the unwavering resilience of the Sri Lankan private sector amidst numerous crises.

Speaking about the setbacks, including the Easter attacks, the pandemic, and ongoing economic upheavals, Hulangamuwa praised the private sector’s continued contribution to economic growth. He elaborated on the sector’s experience with persistent challenges, stating, “From external calamities to internal policy changes, inconsistencies, every day you have to deal with those problems. But the private sector is resilient because they are used to it.”

Reflecting on the cyclical nature of crises, Hulangamuwa expressed hopes for a calmer future, emphasizing that the responsibility for the nation’s trajectory isn’t solely in the hands of the business community. He stated, “Unless it’s a collective effort, I don’t think it’s an effort of the business community alone, it’s an effort of the country as a whole.” Hulangamuwa urged the need for a collective effort to drive significant growth, “We have survived, we have been resilient, and I think we’ll survive again. But we cannot go on like this. We have to get 8-9% growth.”

Amid global economic shifts and domestic challenges, Sri Lanka stands at a pivotal juncture. With the unwavering resilience of its private sector, strategic interventions by its central bank, and the renewed interest of global investors, the nation is poised for an economic resurgence. As experts from HSBC and other economic stalwarts have indicated, the potential for Sri Lanka’s rebound is palpable. Collective efforts, strategic reforms, and a focus on sustainable growth will be the key to unlocking this potential, paving the way for a prosperous Sri Lankan future.

Corporate Sector Potential

Speaking to Echelon at the sidelines of the forum, Kevin Green, Country Head of Wholesale Banking for Sri Lanka and the Maldives, shed light on the significant changes in the country’s wholesale banking landscape. He praised the sector for its adaptability and resilience, especially in the aftermath of Covid-19 and the country’s economic challenges.

A primary transformation Green spotlighted was the industry’s accelerated shift towards digital, marked by substantial investments in online and mobile banking channels. This move has enabled corporates to manage their payments, cash management and trade facilities in a very efficient and secure manner. “Our digital channels and product propositions have been instrumental in navigating the recent challenges,” he remarked.

Green further delved into global trade dynamic shifts, pinpointing specific trends that have surfaced in the services and transactions sought by Sri Lankan corporates. A noticeable trend has been the lean towards supply chain financing and trade credit insurance to reinforce balance sheet efficiency. In Sri Lanka, a move from open accounts to LCs was witnessed, primarily driven by the heightened risks during Sri Lanka’s economic downturn.

Sustainability also emerged as a central theme. There has been a noticeable surge in demand for Environmental, Social, and Governance-based financing products, mirroring the global pivot towards environment-friendly business practices. HSBC has been able to support many Sri Lankan corporates in their transition journeys through bespoke Sustainability Financing solutions.

Discussing HSBC Sri Lanka’s perspective on the market, Green identified several burgeoning areas of opportunity. “The depreciating Sri Lankan currency positions the nation’s exporters favourably” he noted. He also touched upon the growing demand for environmental projects such as solar and waste management as well as M&A opportunities as the economy emerges from recession. Foreign Direct Investment into Sri Lanka will likely increase in the year ahead given the improving economic outlook and the Port City project offers investors significant incentives.”

Highlighting promising sectors, Green earmarked IT/BPOs, apparel and tourism as standout areas. “Our nation’s rich talent pool propels the IT/BPO sector, the apparel manufacturers have world-class design and innovation capabilities whilst tourism benefits from the Island’s breathtaking natural beauty” he stated.

Green also reiterated HSBC’s dedication to Sri Lankan corporates. Citing the bank’s strong financial standing, vast international network and esteemed brand reputation, he said, “Positioning ourselves as thought leaders is paramount.” He referenced HSBC’s strategic alignment with the ESG Summit in Colombo in March 2023 and its partnership with the USAID Maldives Climate Adaptation Project in February 2023. With HSBC facilitating dialogue through economic forums in 2023, the bank remains steadfast in supporting Sri Lankan corporates through the evolving economic scenario.