Outlook 2019: A stable Rupee, but mixed economic outlook

SRI LANKA’S FOREIGN DEBT REPAYMENTS AND POLITICAL UNCERTAINTY ARE RISKS, ACCORDING TO STANDARD CHARTERED BANK’S ECONOMISTS

Economists from Standard Chartered Bank were in Sri Lanka in February 2019 to discuss the outlook for the global economy and discuss impact on Sri Lanka. They forecast Sri Lanka’s growth will pick up in 2019 but warned that managing the substantial foreign repayments will be challenging. The team of Standard Chartered Bank economist included David Mann, Global Chief Economist, Saurav Anand, South Asia Economist and Divya Devesh, Head of FX Research.

Here are some of the key highlights from a discussion.

What’s the outlook for the global economy?
In 2018, the optimism about global growth and low risks was a bit of a surprise, although there were warnings about the end of the quantitative easing era. Everyone was wary of it but had not appreciated how much of a challenge it would create. Now, it is tougher. Challenges countries face will not get the same benefit of doubt from the markets that they were used to. Investment flows have become more discriminate. The other challenge is populism. There has been a rise of populism in many countries some in the East, and mostly in the West. It is a challenge for long-run growth. There will be more difficult policy decisions to be made. Demographics is another long-term drag. Working age populations are declining in many countries. China is not the only one that will see a shrinking of working age population, dragging growth down there in the coming years. It will also be an issue for Korea, Taiwan, and all over North East Asia, which will soon have demographic profiles similar to that of Japan today.

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However, there are reasons for optimism too, in the short-term at least, especially compared to the excessive pessimism that crept into markets at the end of 2018. Global growth will be around 3.6% compared to 3.8% in 2018. US economic growth will be around 2.6%, a shade below 3% last year. Slower, but not collapsing. In 2018, due to US President Donald Trump’s fiscal policies, the US growth held up well compared to other countries. There was a growth divergent. That does not exist anymore. Now, there is a re-convergence in global dynamics. Almost all economies are slowing together. The labour market remains tight in the US. With a drop in immigration, there is a tighter supply of workers, who will have higher bargaining power for wages. There is not likely to be a surge of inflation. The Federal Reserve may hike rates another two times, before the hiking cycle comes to an end. However, the Fed is now dovish, and may be willing to go on either direction in terms of both balance sheet policies and interest rates. Oil prices are expected to trade in an optimum ‘goldilocks range’, which is good for global growth. This was unexpected until as recently as November 2018, when the US granted exemptions to the sanctions on Iran. Before the exemptions, projections were for the world to have the tightest oil market since 2008, with a barrel over $100.

US and China have called a truce on its trade war. But how long will this truce last? Because the underlying tensions are still present, and are not likely to go away anytime soon. Effectively, the glass has been broken and it isn’t getting put back together. As more risk premium gets attributed to investments going into China, other destinations become more attractive. On the top of the list is Vietnam, followed by the rest of the South East Asian nations. After that, the next wave will be into South Asia.

How will Sri Lanka weather 2019?
For Sri Lanka, 2019 will be a difficult year. However, it is hard to imagine a worse year than 2018. Sri Lanka continues to struggle with twin deficits on the current account and the budget. The fiscal deficit has not consolidated at the rate envisaged by the International Monetary Fund (IMF).

The significant debt repayments extends from 2019 to 2022 and the period from 2024 till 2027 is also a concern. So, roughly 10 years of repayments with reserves running short. The $6 billion in reserves at end-January is inadequate. The Central Bank is moving fast to raise $5 billion. Once the funding is secured, it would ease a lot of investor concerns. The positive end to negotiations with the IMF, and the extension of the support program until June 2020 would be a positive development for investors. The year will see the start of a political cycle with a number of elections to follow. Investors, both local and foreign will adopt a wait-and-see approach to investments. Therefore, foreign direct investments are likely to be flat in 2019 compared to 2018, where the numbers were boosted with tranches of China’s lease of the Hambantota Port. Growth is expected to be stronger in 2019 at 4.2%, and reach even higher to 4.5% in 2020, compared to around 3-3.5% in 2018. Banking, agriculture and industries are expected to do well. Apparel exports will do well with continued strong US demand. The EU market may suffer with Brexit and weaker than expected growth. Overall, it’s going to be a tough year, as Sri Lanka has to be on guard because of the amount of debt refinancing required over the next 4 years.

Will the rupee continue to depreciate against the dollar in 2019?
After a very negative 2018, 2019 is likely to be more favourable for the Sri Lankan Rupee. The dollar is at a medium-term peak. Stronger US growth and the Federal Reserve hiking rates had supported the dollar in 2018. However, the market had not responded strongly to the last two hikes, as they expect policy rates to fall in the next year or two. With the twin deficits in the US increasing sharply due to Trump’s policies, the US dollar is overvalued in the medium and long-term and is likely to move down. In the short-term, the dollar will be supported by a weak Euro.

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With space for US Treasury yields to move lower, and the Federal Reserve giving hints that it may be open to changing its stance on quantitative tightening, there will be relief for emerging market currencies such as the Rupee. The outflows from the local bond markets have already taken place. So, there will be inflows in 2019. Given the new 5% limit on foreign ownership of securities compared to 10% earlier, there’s still room for around $600 million in inflows. Oil importing countries such as Sri Lanka are not expected to face currency pressure from crude prices. After the rupee depreciated around 20% in 2018, the currency is no longer as over-valued as it used to be. In terms of sentiment, once the sovereign bond issuance happens, sentiment can push towards a more positive tone. Dollar-rupee trading in 2019 will be range-bound compared to 2018 when it was a one-way depreciation.

On domestic front, there is still some uncertainty due to the twin deficits and steep debt repayment schedule. The external environment is more friendly for rupee. The domestic picture is mixed. So overall, 2019 is going to be more positive for the rupee compared to 2018.