Global Economic Outlook

Following an evaluation of current issues, emerging trends, and potential scenarios, the prospects for a significant worldwide economic revival in 2024 seem unpromising, though dire predictions of a global economic downturn have become muted in recent months.

The International Monetary Fund (IMF) anticipates a marginal decrease in global economic expansion, dropping from 3.0% in 2023 to 2.9% in 2024. Advanced economies might decelerate from 1.5% in 2023 to 1.4% in 2024. Emerging markets and developing economies could experience a slight decline from 4.1% in 2022 to 4.0% in both 2023 and 2024. Global inflation, at 6.9% in 2023, is projected to decrease to 5.8% in 2024. A gradual decline of core inflation is also generally envisaged.

Meanwhile, the ongoing war in Ukraine continues to dim prospects of a post-pandemic economic recovery for emerging and developing economies in Europe and Central Asia, states the World Bank’s latest Economic Update for the region. The Gaza conflict in Israel could spiral out of control, as the region is a crucial supplier of energy and a key shipping passageway. In such a scenario, oil prices could soar to USD 150 a barrel and global growth drop by 1.7% – which could effectively wipe out about USD 1 Tn off world output.

In a region that produces 35% of the world’s oil exports and 14% of gas exports, the impact of a potential production disruption looms large. However, unlike in past episodes, even if prices were to spike in response to events, oil producers, particularly those in the region, can tap into ample spare capacity to quickly boost production, helping to mitigate the impact.

On a positive note, chances of a widespread recession among the world’s leading economies appear to have reduced somewhat, as the IMF’s quarterly World Economic Outlook (WEO) report shows. The recent spike in hostilities in the Middle Eastern seas can disrupt trade, cause commodity prices to escalate, dampen growth, and remain a major risk.

Sri Lanka Economic Outlook

Having achieved economic stability compared to the previous turbulence, the Sri Lankan economy has been recovering in 2023. Stakeholder confidence has rebounded amidst a sense of caution relating to future uncertainties.

Funding from International Agencies

The most welcome news for the year-end is the release of the second tranche of the International Monetary Fund (IMF) Extended Fund Facility (EFF) of SDR 254 Mn (around USD 337 Mn), making the total disbursement of IMF financial support SDR 508 Mn (around USD 670 Mn) to date. Another inflow of approximately USD 600 Mn in staggered disbursements from the Asian Development Bank (ADB) has been assured. This financial support is expected to follow the disbursement of the second tranche of USD 3 Bn bailout package sanctioned by the IMF.

Prior to receiving the second tranche from the IMF, Sri Lanka received USD 495.6 Mn in interest-free budget support loans from the World Bank in September 2023, following its eligibility for reduced-rate International Development Association (IDA) credits.

The Government has also officially announced an agreement with China to restructure its USD 4.2 Bn in debt. With a total foreign debt amounting to USD 46.9 Bn, where 52% is attributed to China, its primary creditor, finalising agreements with all lenders will enable Sri Lanka to maintain access to funds within a USD 3 Bn bailout programme provided by the International Monetary Fund (IMF).

Economy on the Mend

The Asian Development Bank (ADB), in its recent report, stated that the Sri Lankan economy contracted by 7.8% in 2022 and is forecast to contract by 3% in 2023 as it continues to grapple with the challenge of debt restructuring and balance of payments difficulties. Growth will reach 1.3% in 2024. This is in contrast to World Bank’s projection that Sri Lanka’s economy is expected to grow by 1.7% in 2024 after contracting by 3.8% in 2023, as stated in its recent biannual update. “Sri Lanka has carried out critical reforms since the start of the economic crisis. Staying on the course of reforms while managing fiscal risks is crucial to restoring a sustainable growth path,” according to the World Bank, points towards optimistic outcomes in the year ahead.

Fitch Ratings has upgraded Sri Lanka’s Long-Term Local-Currency Issuer Default Rating (IDR) to “CCC-” from “RD” (Restricted Default). Fitch typically does not assign Outlooks to sovereigns with a rating of “CCC+” or below. The Long-Term Foreign-Currency IDR has been affirmed at “RD” and the Country Ceiling at “B-”. This was followed by S&P Global Ratings, which raised Sri Lanka’s local currency rating to CCC+/C from SD (selective default) after the completion of the domestic debt restructuring. Such upgrades to our sovereign ratings, while modest, still indicate a positive trajectory, resulting from a reform momentum which should be maintained at least in the medium-term by policy makers.

Foreign Exchange Earnings

Foreign remittances have risen 58.8 % in 2023, recording USD 5.97 Bn. Earnings from Tourism saw a 82% growth for the year bringing in over USD 2 Bn. Gross Forex reserves as of December 2023 were USD 4.4 Bn (including the swap facility from China). In 2023, the combined merchandise exports witnessed a 9.33% decrease, falling to USD 11,850 Mn compared to the same period in 2022. This decline in merchandise exports is linked to reduced demand for export items, specifically in sectors such as apparel and textiles, rubber and rubber-based products, coconut and coconut-based products, and gems, diamond, and jewellery. The Machinery and Mechanical Appliances, Base Metals and Articles, and Food, Beverages, and Tobacco segments saw moderate to flat YoY growth in export income.

The revised target set by the Board of Investments (BOI) for Foreign Direct Investments (FDI) for 2023 is USD 1.0 Bn. The recorded investments in the first three quarters of 2023, amounted to USD 445 Mn. The BOI has further signed and approved investments of USD 1.5 Bn. Bringing in more FDIs, Sri Lanka has also approved a proposal from Chinese state refiner Sinopec to build a USD 4.5 Bn dollar refinery.

Gross YTD inflows into the Sri Lankan Government securities market during 2023 amounted to USD 824 Mn which is many multiples of the inflows recorded in 2022, reflecting a sea change in sentiments among such investors. Fitch has acknowledged the following positive developments arising from the completion of the domestic debt restructuring exercise: the reduction in the Government’s GFNs or Gross Government Financing needs, easing of risks to the Banking Sector via funding and liquidity pressures and adequate capacity of bank balance sheets to absorb risks from any future forex debt restructuring.

Restructuring and Resizing

Yet another positive development includes the proposed restructuring of Sri Lankan Airlines (SLA) and the interest shown by 16 investors, including Emirates, Etihad Airways and the Adani Group. SLA bears a debt of USD 1.2 Bn to a range of entities, comprising local state banks, unpaid fuel bills, outstanding dues on international bonds and leased aircraft, and an accumulated loss of LKR 594.4 Bn. SLA is among a number of loss-making State-Owned Enterprises (SOEs), that accumulated losses of LKR 1.8 Tn from 2005 to 2021. The Government has also planned to divest its ownership stake in Sri Lanka Telecom (SLT), the flagship Telco already partially privatised decades ago. SLT unlike SLA has been a profitable entity and the divestment can be expected to fetch lucrative proceeds for the Government.

Utility tariffs across power, energy, and water have been revised to ensure cost recovery pricing and enable future economic viability of SOEs like the CEB, CPC and the Water Board. The new direction taken on cost reflective prices was also vital to prevent the further accumulation of debt under these debt burdened entities. Power sector reforms are on the horizon, with a new Electricity Act approved recently by the cabinet. Increased transparency, competition and efficiency are envisaged in the reformed Power sector.

A comprehensive and effective privatisation and liberalisation programme can attract further foreign direct investments into the country as foreign businesses and investors gain confidence with the improving investment climate.

As part of the overall rationalisation of the Public sector, the Government intends to review the number of personnel on the public payroll across civilian and security structures as one of the major avenues to settle on a sustainable fiscal path.

Near Term Challenges

The IMF has cautioned that Sri Lanka’s bailout programme might face insufficient funding, potentially leading to a resurgence of social unrest and derailing reforms due to the 2024 elections. “Social unrest could re-emerge, fuelled by falling real incomes, tax rate hikes and cost-recovery pricing in the energy sector, insufficient anti-corruption efforts, and delayed local elections”, the report said.

Over 300,000 Sri Lankans have decided to leave our shores since 2022, when the nation defaulted on its foreign debt. More than 700 doctors have left the country in only a year, including 125 consultants who were experts in their professions. University lecturers, too, have been leaving in droves, partly attributed to economic uncertainties and partly due to sudden cost of living increases compounded by a heavy tax regime.

Growing the ICT workforce over the medium-term to long-term will be crucial to building a strong IT sector, which will help drive Sri Lanka’s economic revival. The shortage of ICT personnel due to overseas migration is a trend that will need to be addressed by decision makers. In addition, the country needs to do a lot at policy level to retain and develop the ICT sector, with multiple threats emerging at a regional level. Several Sri Lankan apparel companies are opening branches or subsidiary companies overseas in African and Middle Eastern countries to keep costs down. Though it is small at present, there could be a sizable outflow over the years. Increased earnings from the revival of the leisure sector can help mitigate these effects. The economy has benefited immensely so far in 2023 from tourist arrivals. Rising tensions in certain regions of the world present an important opportunity for Sri Lanka to promote itself as a relatively peaceful tourist location.

The Port City Colombo project could have tremendous potential for the country if major investments materialise. However, the economy may have to enter a successful post-debt restructuring phase in order to credibly attract large numbers of impactful investment. The incentives, business friendly laws, and dollarised transactions promoted by the project could generate robust investments, jobs and crucial forex earnings in the medium-term if the project were to take off.

Outlook for 2024

Fitch Ratings expects greater divergence in the performance of Banking sectors in Asia Pacific (APAC) in 2024, with five countries, including Sri Lanka, set to report broadly improving results. Given below are the fiscal projections for the coming year, which show expenditure outpacing revenue.

The Agency expects consumer prices in Sri Lanka to rise by 8.7% on average in 2024, compared with 22.1% in 2023. The increase from economic growth, which Fitch projects at 3.3% in 2024, will also be modest. Fitch Ratings further states: “the presidential election in late 2024 will incentivise the Government to keep to its spending plans, which include a 14% increase in spending on salaries and wages. Nevertheless, if revenue falls short, there may be some room to trim capital expenditure, which amounts to almost 20% of total planned spending and is budgeted to rise 55% in 2024, excluding bank recapitalisation”.

In the final analysis, Sri Lanka has come a long way since the economic and political upheaval of 2022. Despite the adverse developments of 2022, the economy has displayed remarkable resilience in 2023, as well as a number of positive indicators which point to a fairly improved business climate. As Sri Lanka braces itself for a parliamentary and presidential election in 2024, which is likely to be keenly contested, the outcomes of the same will become important determinants in influencing the economic policies and political trends in the coming years and bring with it opportunities and risks.