EIU - May 2018
Sri Lankan Economy
Hike in Domestic Fuel Prices: The price of petrol, diesel and kerosene were increased on 11 May 2018. This is the first time since January 2015 that petrol and diesel prices were changed. In this time period, global oil prices have risen 55% (from an average of USD 48 a barrel to USD 75 a barrel). The average change in the latest upward revision locally for petrol was 16% while for diesel it was 11%.
Non-Tax Revenue drives Government Revenue in Q1 2018: Government revenue recorded an 8% growth in Q1 2018 on the back of a sharp rise in non-tax revenue. Tax revenue rose 2.5% while a primary surplus of LKR 15 billion was reached in the first quarter of 2018.
LKR weakens against USD, in line with peer countries: The Sri Lankan Rupee has weakened 3.4% against the US dollar so far in 2018. With the dollar strengthening close to 5%, currencies like Sri Lankan Rupee, Indian rupee and Indonesian Rupiah have seen significant depreciation. Asia and emerging market currencies have also seen currency pressure with foreign outflows from debt markets being recorded in recent weeks.
Import Growth Outpaces Export Growth in February: During February 2018, both exports and imports increased by 6% and 23% respectively on a Y-o-Y basis. The higher import expenditure relative to the export income resulted in the widening of the trade deficit by 43% on a Y-o-Y basis.
FDI Inflows Increase in 1Q 2018: According to the Ministry of Development Strategies and International Trade, the BOI has attracted USD 465 million as FDIs during the first quarter of 2018 and this amount is USD 87 million higher than the initial BOI target for the respective period.
BOP Surplus Recorded for 2017: As per the recently issued Central Bank Annual Report, the Balance of Payment (BOP) recorded a surplus of USD 2.1 billion, after two years of deficits. This surplus was largely owing to increased debt capital rather than improvements in the external sector since the trade deficit worsened and current account deficit widened during the year.
Decline in Foreign Holdings in Government Securities: Foreign holdings in government securities recorded a decline in May 2018 of about LKR 16 billion after recording a continuous increase over the past 11 months.
Quick fall in Oil Prices: Global oil prices increased to their highest level in three years in the third week of May 2018. However, since then oil prices have declined with Brent oil declining by 3% in the week ending 25 May 2018. The sharp price decline was triggered by talks by OPEC and Russia to pump more oil to ease global supply concerns.
China Agreed to import more from US: Reducing the trade imbalance between two countries and calming fears of a trade war between the world’s two biggest economies, China has agreed to buy more goods and services from the US.
UK Q1 Growth; Weakest Since 2012: The UK economy stalled in Q1 of 2018 growing by only 0.1%, the weakest quarterly growth since 2012. The growth in Q1 2018 was down from 0.4% expansion registered in Q4 of 2017.
Fuel Price Hike on 11 May 2018 – 5 pointers
Global oil price high: On the 9th of May 2018, global oil prices reached its highest level since November 2014; prices have been on an upward trend since July 2017.
Upward revision of domestic prices compared to global rise: Since the last time (January 2015) petrol and diesel prices were changed by the government, global oil prices have risen 55% (from an average of US$ 48 a barrel to US$75 a barrel). The average change in the latest upward revision locally for petrol was 16% while for diesel it was 11%.
A comparable situation to 2009? When the global oil price was around the current levels in December 2009, the domestic fuel price for petrol and diesel were lower by 15% and 42% respectively; relative to where it stands now. However, in this period the Sri Lankan rupee has depreciated 37% against the US dollar.
New pricing formula to be in place: According to the Finance Ministry, Sri Lanka is expected to introduce a pricing formula for fuel; which will be revised every 2 months. The last-time Sri Lanka had a pricing formula was in January 2002 and was revised almost on a monthly basis for two years. Since then, successive price changes have been administered, including the recent one.
Keeping domestic retail prices unchanged, increased the consumer subsidy: From July 2017, global oil prices have risen past US$ 50 a barrel, resulting in the government subsidizing petroleum products. According to the CBSL Annual Report for 2017, the estimated subsidy for petroleum products including kerosene was about Rs. 31 billion. The Ceylon Petroleum Corporation (CPC) moved from a profit of Rs 69.6 billion in 2016 to a loss of Rs. 5.1 billion in 2017. The unsustainability of the subsidies and the decline in profitability of the CPC with the trend in global oil prices are key reasons for the price change.
Non-tax Revenue Drives Government Revenue in Q1 2018
Government Revenue in Q1 2018 grew by 7.6% on a Y-o-Y basis supported by an unprecedented increase in non-tax revenue, which grew by 109.3% compared to Q1 of 2017. This increase of non-tax revenue is likely to be driven by an increase in profit transfers by Government institutions. Meanwhile tax revenue grew marginally by 2.5% Y-o-Y (an increase of LKR 10.1 billion).
Government expenditure grew by 6.1% (Y-o-Y) in 2018, a marked slowdown from the 20.9% growth recorded in same period of 2017. This was mainly attributed to factors such as the contraction in public investment spending by 6.1%.
The government was able to record a positive primary balance of LKR 15 billion in the first three months of 2018 continuing on from the primary surplus recorded for the full year in 2017. The overall budget deficit expanded by 3.1% during the first three months of 2018.
Income tax collections are expected to bring substantial increase to government revenue with the implementation of the new Inland Revenue Act with effect from 01 April 2018. More broadly, the Government expectations are that these reforms will be an important step towards achieving government’s policy of a more balanced tax regime of 60% from indirect taxes and 40% from direct taxes.
Foreign holdings in Treasury Bills and Bonds recorded a decline in May 2018 of about Rs. 16 billion after recording a continuous increase over the last 11 months starting from March 2017 to January 2018. This decline has put pressure on the country’s foreign reserves and currency.
Foreign holdings fell to their lowest in February 2017. However the current level (as at 23 May 2018) of foreign holdings in government securities (Rs. 308.08 billion), is 28% higher than what the country had in a year ago (May 2017).
FDI Exceeded BOI Target for Q1-2018
The Board of Investments (BOI), the investment promotion agency of the government, has attracted USD 465 million as foreign direct investments during the first quarter of 2018.
The target of the BOI for the first quarter of 2018 was USD 378 million. However, the actual inflows exceeded the target by USD 87 million. The actual inflows during the first quarter is more than a quarter of the total FDI inflows in 2017 when Sri Lanka recorded its highest ever FDI inflows.
As per the BOI, during the first quarter it has approved USD 1 billion worth of new projects. Among those projects, the LNG project by China Machinery Engineering Corporation in Hambantota (worth USD 500 million) is one of the largest.
Tourist Arrivals Up but Downward Revision in 2018 Arrivals Target
Tourist arrivals during the first four months of 2018 were up by 17% to 896,401 compared to the same period of 2017. However, the government’s initial target of 3 million arrivals in 2018 was cut to 2.5 million citing the impact of the violence in March 2018 and outbreak of dengue fever.
Exchange Rate Movements in LKR and Peer Currencies against USD
The LKR has witnessed a significant fall in its value over the last few months. The value of LKR (spot) against the USD has fallen by 3.4% since the beginning of 2018. The LKR recorded its lowest ever trading value in May 2018 registering 158.14 as the USD: LKR exchange rate.
However, the LKR is not the only currency that has weakened in recent times. Peer currencies of countries such as India, Pakistan, Vietnam and Bangladesh have seen a fall in their currencies as well.
From a local perspective, the currency has been under pressure due to the uncertainty as a result of the local government elections and state of emergency declared in March 2018.
In the global context, the expectation of the US Federal Reserve to tighten interest rates further in the coming months and years ahead by taking steps towards slowing down the growth in US money supply affected the depreciation of LKR and other currencies of peer countries which are reference to the US dollar.
A slowdown in the US money supply growth affects the value of other currencies in two ways. Federal Reserve’s demand for various assets start to drop when the US interest rates rise. This causes a rush among investors to invest in safe haven assets such as US Treasuries where there could have a higher returns.
UK Jobless Rate Stays at 42 Year Low with the Basic Pay Rising
According to the recently released labour force statistics of UK, the unemployment rate was recorded at 4.2% in the first three months of 2018. The report also showed that the employment rate is at a record high during the first quarter of this year. The labour force was recorded as 32.34 million which is 396,000 more than from a year earlier. The employment rate was 75.6%, higher than for a year earlier (74.8%) and the highest since comparable records began in 1971. Number of unemployed population was recorded as 1.42 million which was 116,000 fewer than for a year earlier.
During the first three months of 2018, the basic pay of UK rose by 2.9%, up from 2.8% a month ago. Inflation for March 2018 was 2.5% highlighting that wages are rising faster than inflation.
China Agreed to Import More from the US
Reducing the trade imbalance between two countries and calming fears of a trade war between the world’s two biggest economies, China has agreed to buy more goods and services from the US
China currently sells the USD 462 billion worth of goods a year, far more than it buys. 18.2% of China’s exports go to the USA and USD 129 billion worth of Chinese made electrical machinery are bought by US. As per the CIA fact book, a 59.2% growth in Chinese services imported by the US was recorded between 2006 and 2016.
The US is having an annual trade deficit with China amounting to USD 347 billion and expects a substantial reduction in trade deficit after this agreement.
Quick Slump in Global Oil Prices
Global oil prices increased to their highest level in three years during the third week of May 2018. Since then the US crude oil futures have dropped by nearly 10% to trade around USD 66.50 per barrel. This a decline from USD 73 in the third week of May. Global benchmark Brent Crude oil has dropped by 6% to trade around USD 76, after peaking about USD 80 per barrel. The sharp price decline was triggered by discussions by OPEC and Russia to pump more oil to ease global supply concerns.
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