Sri Lanka bond yields to move up in 2020, credit to recover: research house

ECONOMYNEXT – Sri Lanka’s bond yields are likely to move up in 2020, but a pick-up in growth to around 4.0 percent of gross domestic product will help profits of publicly traded firms, though external risks remained, analysts said.

Bond yields may move up 50 to 100 basis points across maturities in 2020, partly due to higher state borrowings due to tax cuts and an expansion in the deficit, Dimantha Mathews, head of research at First Capital, an investment house told a business forum in Colombo.

Interest Rates

Average weighted deposit rates may remain around 9.5 percent in the first of 2020, but move up towards the end of the year, he said.

Sri Lanka’s budget deficit is expected to move up to 7.5 percent of GDP according to official forecasts, while an International Monetary Fund estimate put it at 7.9 percent.

Sri Lanka’s new administration has cut taxes, including value added tax, causing concern among analysts and rating agencies. The outlook on Sri Lanka’s ‘B’ credit has already been cut by Fitch and Standard and Poor’s.

The central bank cut rates in January adding to the mix. However private credit is still weak, though recovering.

After general elections a new administration will come to into power with a stronger political clout to carry out an economic program, reducing policy uncertainty, he said.

Business confidence had already improved.

Any economic reforms should be carried out early in the political cycle for benefits to come, Deshal de Mel, an economist at Colombo-based Verete Research said.

On the expenses side Sri Lanka’s state salaries and interest was relatively inflexible and there was generally room to delay capital projects or get public private partnerships, he said.

Debt

Sri Lanka faced some foreign debt repayment pressure in 2020, Mathews said and a rating downgrade could hurt the external sector.

Sri Lanka has already requested India and China for a debt moratorium according to media reports.

Mathews said based on statements made by some government officials, repayments to India was about 180 million dollars and China about 600 million dollars, which was bigger.

There were also some expectations of a billion dollar loan from China in 2020, he said.

Sri Lanka has to re-finance a billion dollar sovereign bond around the third quarter and had about 6.0 billion dollars of debt falling due, he said.

Foreign reserves measured against debt repayments is about 1.3 times in the year term, and forex reserves may end the year at 7.5 billion dollars after accounting for any inflows of China.

However any extra inflows may strengthen the external position he said.

Pick Up

A pick up consumption which was already taking place and recovery in private credit would drive up imports and the trade deficit in 2020, he said.

While higher rates would hurt bonds, a consumer and credit recovery and overall pick up in growth would benefit publicly traded firms, Mathews said.

First Capital is expecting growth to pick up to 4.0 percent in 2020, higher than international agencies and credit growth to go up to 14 percent in 2020.

The rupee may depreciate to around 188-190 to the US dollar towards the end of the year, Mathews said.

However analysts say Sri Lanka’s soft-peg with the US dollar can suddenly collapse as private credit recovers with or without an expansion in domestic borrowings and with or without a rise in oil prices, due to liquidity injected to target interest rates.

In 2015 the rupee collapsed as oil prices plunged, though private and state credit picked up.

Both in the 2011/2012 and 2018 currency collapses, there was no steep expansion of the budget deficit, though in the 2008 crisis there was a doubling of domestic borrowings as foreign funding dried up.

Sri Lanka has a tendency not allow interest rates to rise in time, triggering monetary instability, which leads to a currency collapse.

Forex market interventions then lead to liquidity shortages.

Injections of money through domestic operations inserts rupee reserves into the banking system, allowing banks to give credit without deposits, or buy bonds, leading to excess demand which ends up in forex markets. (Colombo/Feb19/2020)