December 5, 2012, 8:00 pm
Less than a week after the release of a global report highlighting Sri Lanka’s economic prospects for next year (see The Island Financial Review Friday November 30), Standard Chartered Bank yesterday (05) released a more detailed report on the domestic economy. It said the economy was on a stronger footing, but raised concerns over inflation and the already high fiscal deficit.
"We expect 7.2% growth in 2013 (slightly lower than the budget estimate of 7.5%), supported by a pick-up in investment, strong remittance inflows, and steady growth in the construction and tourism sectors. Weak demand from Sri Lanka’s key export markets, the EU and the US, is likely to persist, but overall demand should pick up in 2013 as the global recovery gathers momentum. The finance minister highlighted that exporters’ margins have deteriorated due to weak global demand but that exporters had benefited from exchange rate flexibility. Export earnings, at an estimated USD 9.5bn for 2012, are modest (c.6% lower than in 2011) but have exceeded expectations despite the downturn in Sri Lanka’s export markets," Standard Chartered Bank economists Ms. Samantha Amerasinghe and Nagaraj Kulkarni said in the latest report.
"The trade balance is likely to remain in deficit as demand for investment goods increases to support growth. However, we expect an improvement in the current account (to 4.5% of GDP in 2013 from an estimated 6.1% in 2012) as exports recover, supported by robust remittance inflows and tourism receipts. The balance of payments should remain in surplus, but there is substantial risk from higher oil prices (oil accounts for c.25% of Sri Lanka’s total imports), which could exacerbate the fiscal position."
"The high fiscal deficit and the risk of higher inflation due to the possible escalation of food prices are key concerns. The deficit has been under strain due to lower-than-expected tax revenues and higher debt interest payments. The increase in non-interest expenditure on wages and welfare spending has also contributed to fiscal slippage. For 2012, the government maintains that it will achieve its 6.2% deficit target, but we think it will be closer to 7% of GDP. Headline CPI inflation is likely to inch higher in Q4-2012 due to upward revisions of administered prices of fuel (and electricity) and supply-side constraints (Cyclone Nilam damaged crops in the northeast in early November). However, we expect inflation to moderate by Q2-2013 due to improved domestic supply and buffer stocks of rice, while the government’s prudent wage policy should suppress near-term wage demand pressures. We think this will provide the central bank with sufficient flexibility to cut policy rates by 25bps in Q1-2013. In 2013, the policy focus is likely to shift to supporting growth," the report said.
Standard Chartered Bank says balancing the budget would be a tough act.
"The 2013 budget remains development-oriented while maintaining the government’s fiscal consolidation stance. The government projects ambitious revenue growth of 19.2% (versus a 12.8% increase for 2012), and plans to increase expenditure by 15.9%. We note that while the expected pick-up in revenue growth in 2013 (to 14.7% from 14.2% of GDP in 2012) is insignificant, expenditure – at 20.5% of GDP – is unchanged.
"The government expects tax revenue growth of 22.9%, while non-tax revenue is projected to fall by 6.1%. Tax collection is expected to increase versus 2012 levels, at 13% of GDP. The government plans to increase infrastructure spending by 20.2% and expenditure on education and health by 28.4%, and to boost subsidy spending by LKR 35.9bn (though, as a percentage of total expenditure, it will remain flat at 15%). Interest costs, at LKR 444.8bn, remain the largest recurrent expenditure item, increasing by 12.9% versus 2012, but are flat as a percentage of total expenditure, at c.25%.
"For 2013, the government continues to focus on development and remains resolute in its efforts to tackle the twin deficits – trade and fiscal. The overall thrust of the 2013 budget is poverty alleviation and food security, but there is a strong emphasis on import substitution (in industries such as sugar, dairy, and livestock and fisheries), enhancing export competitiveness (tea, rubber, coconut and spices), and on sectors defined as key drivers of economic growth and new sectors such as IT and business process outsourcing (BPO). Import levies on dairy products, canned fish and milk powder have been increased to protect domestic industries."