Sri Lanka: Risk Assessment
Country Risk Rating
|B||Political and economic uncertainties and an occasionally difficult business environment can affect corporate payment behavior. Corporate default probability is appreciable.|
Business Climate Rating
|B||The business environment is mediocre. The availability and the reliability of corporate financial information vary widely. Debt collection can sometimes be difficult. The institutional framework has a few troublesome weaknesses. Intercompany transactions run appreciable risks in the unstable, largely inefficient environments rated B.|
Growth should remain strong
Growth should remain strong in 2016. Exports are likely to continue to feel the benefits of the strength of the US economy and the slight recovery in the Eurozone, as the United States and the European Union account for almost half of its exports. Household consumption, which represents 70% of GDP, should also remain strong with rising household incomes thanks to lower energy costs and the resilience of remittance from abroad. Private investments will continue to benefit from the favorable credit environment, with the base rate being lowered again by 50 base points in 2015. The development of infrastructure (airports, electricity power stations, road and ports) and tourist facilities will provide a boost for the construction sector. The continued expansion of tourism should feed through to all sectors of the service industry, which now accounts for more than 60% of GDP. However, the agriculture sector, which employs a third of the active population, remains vulnerable to climatic conditions and will only see moderate growth. On top of this, exports of tea, accounting for over 18% of total export sales, will suffer with the decline in demand from Russia and the Middle East. Industrial output however should feel the positive impact of the easing of the Generalized System of Preferences for the European Union as of 2016. The textile and clothing sector is expected to be the main beneficiary of this. Lastly, public investment will remain focused on the reconstruction of areas ravaged by the war (essentially the north and east) and on the construction of new infrastructure projects.
Inflation is set to rise in 2016, in a context of accommodative monetary policy. Prices of imported goods are likely to continue moving upwards as the rupee depreciates.
Deterioration in public finances
The government’s efforts to restore the health of the public finances do not appear to be enough. Current expenditure, such as public employee wages, is rising and revenues remain at a fairly low level. The budget deficit will increase in 2016 and public debt will remain at a high level. The country’s budget remains highly vulnerable.
The current account deficit will hold steady in 2016. Despite the reduction in the energy bill, the balance of trade is likely to deteriorate as a result of growing imports of consumer goods. The ongoing instability in tea importing countries (tea being the 2nd biggest export), such as Syria and Libya, will continue to depress exports. This balance of trade deficit will be partly offset by increased tourist revenues and by continuing sustained levels of private transfers. Although on the rise, FDI will remain slight compared to that of its neighbors. Moreover, the nationalization law adopted in 2011 continues to convey a negative message to investors. The rupee will thus continue to be under pressure, especially in a context of US monetary tightening. The central bank’s room for maneuver to contain the downward pressures on the currency is limited: foreign exchange reserves cover hardly more than 4 months of imports.
The changeover in political power was peaceful but religious tensions remain
Following the surprise defeat of the outgoing President by M. Sirisena (SLFP) in the early elections of January 2015, an interim government was formed. The parliamentary elections in August 2015 resulted in a victory for the President’s party with 106 seats out of 225. The Prime Minister, R. Wickremesinghe, formed a government with members of the opposition and is focusing on political and constitutional reforms. However, tensions between the Buddhist majority and the Muslim minority (9% of the population) remain serious. In addition Sri Lanka is facing international pressure under the aegis of the United Nations pending recognition by the government of the human rights violations and the adoption of recommendations enabling permanent reconciliation between Tamils and Sinhalese. A report from the international body in September 2015 recommended the setting up of a tribunal to assess the extent of individual responsibilities. The government has reacted by encouraging the creation of national commissions.
Finally, improving the business climate is one of the government’s priorities, but accusations of favoritism and corruption are sometimes leveled against the leaders.