ECONOMYNEXT – Russia’s invasion on Ukraine could hit Sri Lanka’s tea exports, a reviving tourism industry and trigger more external trouble and inflation, if rising oil prices are not raised and energy utility losses are financed with bank credit leading to more monetary expansion, analysts said.

Sri Lanka’s cabinet last week decided not to raise fuel prices, which will result in higher credit demand and pressure on interest rates if losses are financed by bank loans.

If money is printed to keep rates down (reserve money is inflated), further pressure will emerge on the rupee, forex reserve losses may worsen, bringing the country closer to default and inflation could go up further, analysts say.

Monetary expansion from energy utility losses

In countries that market prices oil, total aggregate demand is balanced (non-oil consumption is reduced as money is diverted from other spending areas into fuel) re-balancing total demand. Inflation is a monetary phenomenon.

Sri Lanka’s inflation rose 14.2 percent in the year to January 2021, the fastest in Asia though the country has the lowest oil prices in South Asia.

Any refusal to raise oil prices by authorities, which leads to credit pressure, has to be countered by a rate hike to compensate for shock on the credit system to keep inflation down. Losses at the Ceylon Electricity Board would also rise, leading to more demand for credit.

Due to the existence of a policy rate enforced with liquidity injections, general interest rates do not automatically go up in countries with central banks.

Sri Lanka’s central bank has asked banks to follow single borrower limits in lending to Ceylon Petroleum Corporation.

Central bank Governor Nivard Cabraal has pushed for a price increase so that Ceylon Petroleum Corporation could find rupees from customers to buy oil, which will reduce non-oil consumption, imports and eliminate the need to borrow borrow from the banking system putting brakes on monetary expansion.

Sri Lanka’s broad money and reserve grew 40 percent in the two years to December 2021 and food prices also went up 40 percent.

Russia had bombed Ukraine and troops have crossed the border in what the Kyiv has described as an invasion and the move has rattled the global crude prices to eight-year high of 100 US dollars.

“We are already struggling to allocate US dollars to clear the shipments we bought at around 90 dollars. With the crude prices are expected to hit 115 US dollars soon, how Sri Lanka is going to buy oil is a huge challenge,” Dimantha Mathew, the Head of Research at First Capital told EconomyNext.

“Tourism and tea also could hit if this blows up into a full war.”

Russia is the world’s second-largest oil producer, mainly selling its crude to European refineries, and is the largest provider of natural gas to Europe, providing about 35 percent of its supply and a war could disrupt global energy supplies, analysts say.

Sri Lanka is struggling to import fuel because it is facing a severe dollar shortage from money printing. Energy Minister Udaya Gammanpila has said the risk of fuel shortages will remain at least until April.

The island nation is facing nearly five-hour power cut on a daily basis now because of fuel shortages.

“The economic impact will be in the form of high Energy cost, with Gas and Oil prices expected to increase,” Capital Trust said in a research note to investors.

“As a result of the conflict, supply chain disruptions in the European trades routes are expected. Therefore upward pressure on freight rates can be expected.”

However, Capital Trust said there is a positive impact as well in the event of a severe fighting as investors will look into bet on risky assets at the Colombo Stock Exchange.

“(It is) positive for the CSE as it increases higher negative returns on fixed deposits,” the Capital Research said.

“Cost of Production expected to increase. Only market players with 70%+ market share or cartels can maintain profit margins through passing on price increases. Freight prices expected to increase which will positively impact EXPO.”

Tea at risk

Russia is one of the biggest importers of Sri Lankan tea, which accounts for nearly 140 million US dollars of our the total 1.3 billion US dollar exports.

Any sanction by the US on Russia could hit Sri Lanka’s tea export revenues.

Analysts said such sanction could adversely affect hundreds of producers in Sri Lanka tea industry, which is already facing a wage increase protest.

“Both Russia and Ukraine are important markets for Sri Lanka. Losing them will be detrimental for the industry,” said a commodity analyst asking not to be named.

“If China is going help Russia through ports controlled by it, then we can still continue to export, but the cost will be higher. The ruble depreciation could also reduce tea imports from Sri Lanka.”

Russia and Ukraine also have become the key market for Sri Lanka’s reviving tourism industry.

Tourism

Foreign visitors from the both countries have been helping Sri Lanka’s post-Covid-19 tourism recovery this year, the official government data have showed.

“An analysis of Russian arrivals in the consecutive years reveals that it has almost exceeded the pre-pandemic levels as experienced in January 2019,” the state-run Sri Lanka Tourism Development Authority said in its January monthly report.

Russians accounted for 18,044 or 15.8 percent of the total 113,670 holiday makers who visited Sri Lanka this year up to February 11, while Ukrainians accounted for 9,883 or 8.7 percent of the total visitors in the same period.

“An analysis of Russian arrivals in the consecutive years reveals that it has almost exceeded the pre
pandemic levels as experienced in January 2019,” the state-run Sri Lanka Tourism Development Authority said in its January monthly report.

“This could be likely due to increased interest by Russian tour operators in alternative destinations to Thailand and Goa with strict public health measures in place and the launching of direct flights to
Russia.”

The country saw an increase of Ukrainian and Russian travelers after a tourism revival projected targeting those countries was launched in late 2020 by former Sri Lankan Ambassador to Russia Udayanga Weeratunga. (Colombo/Feb24/2022)