eiu economic outlook 2016

7/25/2019 EIU Economic Outlook 2016

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Economic Outlook2016Global Risks | Sri Lanka Outlook | Key Forecasts

Prepared by Economic Intelligence Unit, Ceylon Chamber of Commerce

January 2016


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GLOBALECONOMY

Part 1


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Global growth forecast

3.1%2015

3.4%2016

3.6%2017 *Downward revisions by 0.2%

Source: IMF WEO Jan 2016


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Key Economies in 2016

US: 2.6%Europe: 1.7%

Japan: 1.0%

China: 6.3%

UK: 2.2% Russia: -1.0%

Asia: 6.3%

India: 7.5%

Brazil: -3.5%

Saudi: 1.2%

Africa: 4%

Source: IMF WEO Jan 2016


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UK: FTSE US: NASDAQ

China: SHCOMP Paris: DAX

Japan: NIKKEI Hong Kong: HANGSENG

Source:Bloomberg


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What are the headwinds?

Slowdown in China and associated spillovers on emerging markets(especially Asia)

Adjustment to a higher interest rate environment; high outflows fromemerging markets

Weaknesses in key EMs - Russia and Brazil both in recession

1% drop in BRICS growth = 0.9% drop in EM growth within ayear

Impact of low commodity prices mixed - exporters adverselyaffected and purchasing power falls; importers gaining from lowimport bill


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Baltic Dry Index at all-time low

Baltic Dry Index measures shipping prices & utilisation - fallen to all time low Seen as a proxy for world trade activity/volumes

Source: Bloomberg


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Emerging Markets Facing Funds Pullout

2015 was the first time

in 27 years that EMs sawnet outflows of capital

In Q3 2015 investorspulled out US$ 52 bnfrom EM equity andbonds

-50

-37.5

-25

-12.5

0

2008 GFC 2013 QE Taper 2015 Turmoil

EM equity EM bonds

Source: World Bank Global Economic Prospects Jan 2016


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Europe: 1.7%

EU region continues to see fragility

Southern Europe struggling, Northern Europe doing better

Multiple crises - banking/finance + refugee/migration + terrorism(now)

ECB has cut rates below 0% , more stimulus measures

Only Germany and few others showing resilience and growth

Youth unemployment remains v. high - will hurt long termprosperity of these countries


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USA: 2.6%

Most optimistic outlook among developed countries

Business activity has picked up, consumer spending

accelerated and overall employment up by 292,000 jobs inDecember

Inherent dynamism and innovation has helped keep the

economy agile

Biggest positive has been US shale oil, new impetus forindustries


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China: 6.3%

Growth had been driven by investment and exports ; now rebalancingtowards consumption and regional development

Questions of a hard-landing + ability of authorities to manage the transition(e.g. messy handling of stock market collapse)

China now more systemically important than ever before - commoditydemand + Asian supply chains

Chinas devaluation of the Yuan would weaken emerging market currencies

Chinas going-out strategy with Maritime Silk Route + One Belt One Road

Chinese currency (Yuan/RMB) added to IMF SDR basket


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Oil prices will remain low,inventories remain higher/increase

Down 47%in 2015

Down 18%in 2016

$41 a barrelaverage this year

US shale oil/gas supplycontinues to grow strongly

OPEC keeping high supplyhigh and low prices tomaintain market share

Iran production (post-sanctions lifting) will add tosupply glut

Oil demand slowing withgrowth slowdown - esp.China

*See separate EIU Research Note on Unfolding Dynamics of the Global Oil Market


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SRI LANKANECONOMY

Part 2


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Growth Recent growth drivers unable to sustain themselves Services have been a strong contributor but almost entirely domestic non-tradable services Construction likely to continue to drive growth, but this time driven by private spending Exports unable to take full advantage of LKR depreciation and low oil prices due to supply

constraints - i.e., lack of diversification & competitiveness; will have to be built over time

Fiscal Lack of fiscal consolidation (mainly on spending side) Ambitious revenue measures unable to deliver in the short term Budget deficit enhances vulnerability to external debt and possible ratings downgrade

External Weak export performance, key commodities unlikely to recover LKR depreciation making import bill higher (except for oil), Remittances slowing down - losing valuable import cover Risks of further foreign fund outflows and BoP difficulty

Policy Policy confusion due to multiple agencies, individuals and initiatives Aggressive FDI push is a +ve, but wont materialise in 2016 itself

Key dynamics going in to 2016


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Growth

Part 2: SRI LANKAN ECONOMY


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Recent growth has been driven byconstruction and a few services sectors

15.7%

12.7%

11.1%

10.5%

9.9%

7.7%

4.6%

4.4%

3.0%

2.5%

2.0%

1.5%

1.4%

1.3%

1.0%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0%

Other personal service activities

Transportation of goods and passengers including Warehousing

Construction

Wholesale and retail trade

Financial Service activities and auxiliary financial services

Real estate activities, Including Ownership of dwelling

Manufacture of food, beverages & Tobacco products

Mining and quarrying

Professional services

Accommodation, Food and beverage service activities

Education

Marine fishing and Marine Aquaculture

Manufacture of furniture

Growing of spices, aromatic, drug and pharmaceutical crops

Public administration and defense; compulsory social security

Contribution to Change in GDP (2010-2014)

Source: EIU calculations based on Department of Census & Statistics


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Which sectors contributed to growth

in 2015?

1.6

0.7

6.2

4.4

5

2

7.9

6.76.9

6.2

3.4

4.8

Agriculture Industry Services GDP

GDP Growth (%) in Q1, Q2, Q3 of 2015Q1:95% of increase in GDP camefrom personal services, finance andinsurance, real estate. Post-elections, construction and miningwere key drops (over 32%)

Q2:70% of increase came fromthe same sectors + wholesaleand retail trade. Interim budgetstimulus measures had kicked inand this drove consumption

Q3:60% of increase came from

finance & insurance; personalservices; food & beverage andwholesale/retail (benefiting fromstimulus). Agriculture also pickedup sharply with favourableweather

Source: EIU calculations based on Department of Census & Statistics


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Q4 growth?: will be close to 6%, with2015 full year at 5.5-5.6%

Source: EIU calculations based on Department of Census and Statistics

9.5

6.3

4.3

4.9

6

4.8

8.3

Q1 Q2 Q3 Required growthin Q4

GDP Growth in 2015

ADB @ 6.3% IMF @ 5% IMF @ 6% Budget Speech @ 6

!


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Inflation



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Core inflation will edge up through 2016 and then stabilise

-2%

0%

2%

4%

6%

8%

10%

12%

January

February

March

April

May

JuneJuly

August

September

October

November

December

January

February

March

April

May

JuneJuly

August

September

October

November

December

January

February

March

April

May

JuneJuly

August

September

October

November

December

January

February

March

April

May

JuneJuly

August

September

October

November

December

2012 2013 2014 2015

Movements in CCPI and CCPI (Core) Year-on-Year Jan 2012 to Jan 2016

CCPI CCPI (Core.Ind)

Core inflation has begun edging up: LKR depreciation will drive higher prices from import side

Benign oil prices will continue to help but full benefit not enjoyed due to lack of pricing formula

2016 Outlook: 4.5-5.0%

So

urce:

CBSLMonth

lyEconom

ic

Indicators


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Currency



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LKR depreciation will continue in 2016- Alongside other EM currencies driven by Yuan depreciation

- CBSL intervention will be limited except for large movements

130.73 130.45

130.29

130.19130.60

130.94

131.02

132.73

132.90

133.50

133.90 133.88

138.88

140.89142.02

143.45 143.90

143.94

120.00

125.00

130.00

135.00

140.00

145.00

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 01stJan

08thJan

20thJan

2014 2015 2016

Trend of USD:LKR Exchange Rate

10% slide froma year ago

2016 Outlook: LKR150

Source: Central Bank of Sr i Lanka


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Fiscal



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Declining tax ratio - Continued fiscalweakness - Possible ratings downgrade

14.6%14.2%

13.3%12.8% 12.9% 12.9%

12.0%11.6%

10.7%

2006 2007 2008 2009 2010 2011 2012 2013 2014

Annual Average Tax Rate

SL tax ratio is well belowrecommended levels for a

middle-income country

of around 18%

Heavy reliance on indirecttaxes, particularly importtrade taxes, which isproblematic in adepreciating LKR era

Fiscal deficit hasimplications for possiblesovereign ratings revision(50% likelihoodaccording to SCB)

2016 deficit target of 16.4%is well below the median for

countries that have B-rated sovereign debt of 21.4%

Source:

EIUca

lcu

lations

base

don

Min

istryo

fFinance,

CBSL


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0 500 1000 1500 2000 2500

2012

2013

2014

2015

2016*

Tax Revenue

Non-Tax Revenue

Grants etc

Ambitious revenue targets for 2016

are unlikely to be met Heavy reliance on

non-tax revenue

Unprecedented

increase of 200%

Projected tax

revenueincreases are

unlikely to be met +tax policy uncertainty

RAMISmay help

improveadministration

Source: EIU calculations based on Ministry of Finance Budget documents


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Unrealistic revenue expectations?

78.7%

5.3%

18.5%

0.9%

-2.9%

5.1%

0.3%

0.2%

-6.2%

0.1%

30.4%

18.4%

2.4%

1.6%

45.7%

0.6%

0.4%

0.2%

0.0%

0.3%

Taxes on Domestic Goods And Services

Taxes on International Trade

Taxes on Income & Profits

License Taxes & Other

Return on Government Assets

Sale Proceeds and Charges

Social Security Contributions

Current Transfers

Capital Revenue

Revenue From Departmental Enterprises

2016 Projections

2015 Revised Estimates

Tax

Revenue

!"#$%&'Rev

enuev

affected by LKRdepreciation

unlikely tomaterialise inone year

consumptionaffected by

tightening

interest ratesSource: EIU calculations based on Ministry of Finance Budget documents


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Inconsistencies in revenue numbers

In LKR Bn 2014 2015 2016

Budget Speech 1,050.00 1,284.00 1,584.00

Budget Estimates 987.93 1,292.70 1,461.00

Difference 62.07 (8.70) 123.00

Inconsistenciesin taxratio data betweenBudget Speech, BudgetEstimates sheet, and

CBSL Annual Report

Inconsistenciesin taxrevenue data betweenBudget Speech andBudget Estimates sheet

Difference of LKR123bn in 2016


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FinancingDebt



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0 100 200 300 400 500 600

2012

2013

2014

2015

2016*

Non-Bank Borrowings Bank Borrowings Foreign Purchases of Treasuries

Domestic borrowing in 2016 reliant on non-bankborrowing, implications for upward movement ofinterest rates

Higher non-bank andbank borrowing cancrowd out privatesector credit availability

Greater reliance onnon bank borrowingwill have implicationsfor upward movementof domestic interestrates

Foreign investmentinto LK Treasuries mayfall alongside pulloutsfrom EMs, falling riskappetite, and globalinterest rate rise

Source: EIU calculations based on Ministry of Finance Budget documents


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FX Reserves hit by foreign investors exitinggovernment securities since H2 2015,

but this appears to be tapering off

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

28th

Janu

ary

25th

Febr

uary

25th

Mar

ch

29th

Apr

il

27th

May

24th

June

29th

July

26th

Aug

ust

23rd

Sept

embe

r

28th

Octo

ber

24th

Nov

embe

r

22nd

Dec

embe

r

VOLUMEINR

SMN

Government Securities held by Foreigners

foreign bond-holdingshave fallen by 33%in

a year

Source: EIU calculations CBSL monthly indicators


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-400 -300 -200 -100 0 100 200 300 400 500 600

2012

2013

2014

2015

2016*

Project Loans Commercial Borrowing Debt Repayment

Financing from international capital

markets will be trickier in 2016 Already the yield onthe 2025 LK sovereignhas edged about 1%higher in thesecondary market

Adverse global marketconditions, US Fedrate tightening cycle,reduced appetite foremerging market

investments

Commodity exporterspulling out their EMinvestments due tolow surpluses

Source: EIU calculations CBSL monthly indicators


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ExternalSector



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Slowdowns in remittances & tourism,and exports remain flat

-40

-20

0

20

40

60

80

100

2011 2012 2013 2014

External Trade Performance Year-on-Year Growth

Total Exports Total Imports Trade balance Earning from Tourism Worker Remittances

Exports fell4.5%

Tourism grew18%*base effect

2016

Source: EIU calculations based on DCS data


34/50

Export destination vulnerability needsto be addressed with diversification

65% go to high-income countries

10% go to Middle-East and North Africa

3% go to India

Source: EIU calculations based on EDB Performance Reports and CBSL Annual Reports (various years)


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Worrying slowdown in remittances

38

96

27-17

26

45

33 33

116

21 1910 6

0 5 2 6 5

-40

-20

0

20

40

60

80

100

120

2011 2012 2013 2014 2015

Quarterly Growth in Remittance Inflows (YoY) Why have remittances slowed?

Slump in oil prices have affecteddisposable income in Gulf regionmigrant-host countries

Saudi Arabian Government has begun(mid December 15) cuts to fuel andutility subsidies in order to bridgesoaring budget deficit

About 50% of SLs remittances (USD

7 billion) comes from the Middle East

Growing financial instability andgeopolitical unrest in the Middle East,driven by ISIS attacks

1/3rd

of annualimports

85%

of tradebalanceRe

mittances

cover

Source: EIU calculations based on CBSL monthly indicators and annual reports (various)


36/50

Tourism earnings not growing rapidly

Tourist arrivals have steadily risen but below targets set by government and industry

By now we should be seeing very strong growth - international media exposure, favourable security, etc

Some of the tourism earnings may not get captured in this data due to rising informal offerings (e.g.

AirBnB)

0

100,000

200,000

300,000

400,000

500,000

600,000

0

20

40

60

80

100

120

140

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

2013 2014 2015

Tourist Arrivals and Tourism Earnings

Tourism Earnings (Rs.mn) Tourist Arrivals


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Distressed Sectors: Tea

Severe de-valuation of the Russian Rubledue to sanctions Lower oil prices and fall in purchasing

power in the middle east Shortage of hard currency inUkraine due

to Ukraine-Russia conflict Economic sanctions on Iran, continuing

Syrian crisis, and the ongoing unrest inLibya,Egypt and Iraq.

OUTLOOK 2016 Export market conditions unlikely to improve significantly in 2016. Although sanctions on Iran have been lifted, demand conditions not expected to hugely

improve Auction prices are expected to improve marginally during the first half of 2016, given

low prices in 2015 and the positive sentiments seen in the market on a probable

improvement of prices Cost issues arising from low productivity will continue due to political nature of the

issue


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Distressed Sectors: Rubber

Rubber industry earnings declining since the 2010-2011, with both the volumesand F.O.B recording a falling trend from 2013 onwards.

EU accounted for 11.6% of Sri Lankas rubber export share - week economicconditions in the EU has contributed for a weaker demand

Competition from countries such as Vietnam has reduced Sri Lankas export share

in the world market

OUTLOOK 2016

63% of rubber industry is smallholders and they are heavily subsidised - lack of

competition from the reliance of subsidies will hinder the growth in this sector. The Ministry of Plantation is planning to allocate a sum of Rs 1 Billion will for the

purpose of rubber replanting - estimated cost: LKR 850,000 is needed to replant a

hectare).


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MonetaryPolicy



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Timeline of CBSL policy rate changes

5

5.5

6

6.5

7

7.5

8

8.5

9

9.5

10

JanFeb

Mar

Apr

MayJu

nJul

AugSep

Oct

Nov

DecJanFeb

Mar

Apr

MayJu

nJul

AugSep

Oct

Nov

DecJanFeb

Mar

Apr

MayJu

nJul

AugSep

Oct

Nov

Dec

2013 2014 2015

!"#$

!$

Currently held at 7.5% and 6%

Source: Central Bank of Sr i Lanka


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Private sector credit has soaredthroughout 2015

2014: Private sector credit growth hadcontinued to slow slow despite the recordlow policy rates and low inflation.

Reasons: 1) Growth in non-tradables thatrequired little credit (except import trade);2) construction driven by public spending

(debt); 3) drop in gold prices alongside QEtaper led to dramatic fall in pawningadvances and rise in NPLs; 4) lagged

transmission of low policy rates into higherbank lending

By H1 2014 credit began to expand, andhas since soared throughout 2015,

accelerated by: consumption rise after Interim Budget

stimulus measures (early 2015),including rapid rise in motor vehicleimports

consumption spending fuelled byenergy price cuts (early 2015)

interest rate cut (April 2015)

0

5

10

15

20

25

Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar May Jul Sep

2013 2014 2015

Private Sector Credit Growth

Source: EIU calculations based on Central Bank of Sri Lanka


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LabourMarket


O ll l i l


43/50

Overall unemployment is low,female unemployment remains high

5.4

5.9

4.9

4.2 4

4.44.3

2008 2009 2010 2011 2012 2013 2014

2 2 2 3 3 3 3

Male Female Total

Unemployment ratehovering just above 4%

Remaining can beregarded largely asstructural unemployment

Female unemployment isdouble that of maleunemployment - mustbe addressed to tacklelabour shortage

N & E data notcomplete, but seems tonot have added lots tounemployment numbers

2 - excludes North & East3 - all island Source: Dept. of Census & Statistics


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Why are workers staying out of thelabour force?

57.1

55.555.7

54.5

53.854

53.4

54.9

54.2

2006 2007 2008 2009 2010 2011 2012 2013 2014

Labour force participationrates are declining YoY

Fallen from 57.1% to

54.2% in 8 years

Indicates that people arestaying out of the labourforce - not seeking work

Industries areexperiencing shortage ofworkers

Total Labour Force Participation Rate (%) - 2006-2014

Source:Dept.

ofCensus

&

Statist

ics


45/50

New effort to address labourshortages in industries

An effort by the PMs office : chamber invited to submit commentson their approach

EIU recommended:

accelerated TVET programmes in targeted sectors andoccupational groups to tackle immediate shortages, based onindustry demand (technicians, hospitality, IT, etc) - Penang model

of PPP for electronics industry

new policy and regulatory measures to boost female labourforce participation (incentives for setting up childcare services,reform of maternity benefits system, etc)


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What are we looking at on thepolicy and institutional side?

Policy:

Implementing tax policy changes and associated uncertainty?

New FDI strategy and new Investment Bill to update outdated laws

Overall: policy cohesion or confusion?

Institutions:

New Agency for Development, Agency for International Trade, andMegapolis Authority

Overall: institutional overlap or coordination?


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EIU FORECASTS

Part 3


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Global Risks and Headwinds in 2016

Sharper than expected slowdown in China; authorities unableto manage volatility; systemic effects aggravate

Faster than expected interest rate rise by US Fed, leading to

sharper contraction of EM funds availability

Sharp rise in global risk aversion(multiple possible triggers)leading to sharp depreciations; and idiosyncratic/unexpectedshocks in a large emerging market

Escalating geopolitical tensions escalate; affecting confidenceand disrupting global trade, financial, and tourism flows


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2016 Forecast: Key Macro Variables

Growth: 5.0 - 5.5% (GoSL: 6.5%; IMF: 5.5%)

Inflation: 4.5 - 5.0% (core inflation edging up, import costsdue to LKR depreciation, except oil)

Budget Deficit: rise to 6.5% above GoSL forecast of 5.9%

(likely to postpone some capital spending)

Rupee: depreciating further, closer to LKR 150


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Anushka WijesinhaChief EconomistCeylon Chamber of [email protected]

Jayani RatnayakeEconomist

Economic Intelligence [email protected]

Saumya AmarasiriwardenaResearch AssistantEconomic Intelligence Unit
mailto:[email protected]:[email protected]:[email protected]

eiu economic outlook 2016

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