Slowdown in the US may lead to weaker US Dollar: US is signalling signs of concern over its GDP growth, which is expected to slowdown partly due to the trade war. However, inflation continues to remain stable in the desired level of 2.0 per cent. Analysts expect a higher probability for a rate cut, which could be as much as 50bps, in the second half of 2019. Thereby, the US Dollar is expected to weaken during the second half of 2019, possibly favouring the Sri Lankan Rupee.
Sri Lanka consumer demand to remain weak, maintaining weaker imports: Sri Lanka’s consumer confidence index compiled by Neilson recorded a major plunge in the last couple of months subsequent to the Easter Sunday attacks, which is expected to lead to a further dent in imports amidst lower consumer demand.
Following the 50bps rate cut by CBSL, there is a tendency for the rupee to weaken as demand in the system is expected to improve. However, First Capital Research expects the recovery in demand to be at a significantly slow pace considering the severity of the impact to all sectors by the Easter Sunday attacks and the subsequent incidents. Demand is expected to normalise by 4Q2019, supported by the possible improved sentiment with the announcement of the Presidential Election.
CBSL targets dollar debt inflows to maintain reserves: Central Bank’s foreign reserve position is key in building confidence in the exchange rate. Currently as at May 2019, Foreign Reserves stood at US$ 6.7 billion, which is estimated to be above the targeted four months of imports. A heavy dip in imports has reduced the overall comfortable level of foreign reserves. To maintain reserves at the US$ 6.5-7.0 billion range, CBSL needs to raise a further US$ 2 billion, for which Cabinet approval has already been obtained. CBSL also targets an additional US$ 2.5 billion to be raised to meet payments falling due in 2020 before the election season, which starts in 4Q2019 and may continue up to 2Q2020 (Presidential, General and Provincial elections). If Sri Lanka is successful in raising the required funds via foreign debt over the next couple of months, the foreign reserve position could be maintained at a reasonably comfortable level, which First Capital believes is US$ 6.5 billion, considering the prevailing environment.
Rupee weakening may soften: In spite of the rate cut, the weakness of the rupee may be limited, considering the delay in consumer demand, while the rupee is also likely to be supported by the weak dollar and targeted debt driven inflows. First Capital upgraded its Exchange Rate Outlook for 2019E to 1 USD:LKR 180.0 (from 194.0) as its 65 per cent Base Case Scenario. Further, it is introducing a 12-month target for Jun 2020E of 1 USD:LKR 185.0 as a 60 per cent Base Case Scenario.
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