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Sri Lanka’s Foreign Reserves Surge in May 2023; Economic Recovery on the Horizon

In a recent turn of events, Sri Lanka’s foreign reserve levels have shown a promising upward trajectory, reaching a notable milestone in May 2023. During that month, foreign reserves experienced a remarkable month-on-month (MoM) increase of 26%, soaring to an impressive USD 3.5 billion.

This positive trend continued, with reserves steadily improving through July 2023. However, there was a slight setback in August, as reserves dipped by 4% to USD 3.6 billion. This dip was attributed to the country’s settlement of a significant portion of the Bangladesh swap facility, as reported by Capital Research in their Pre-Policy Analysis report.

The growth in reserves can be largely attributed to substantial progress in key sectors, including a remarkable 43.1% year-on-year increase in tourism earnings and an impressive 78.0% year-on-year surge in worker remittances.

Furthermore, Sri Lanka’s Balance of Payments (BoP) remained in positive territory, bolstered by a narrowing trade deficit, which was recorded at USD -2.7 billion in July 2023, compared to USD -3.6 billion during the same period the previous year. Despite these positive signs, reserves are still below the required levels, and the gradual easing of import restrictions and challenges in the export sector, particularly in apparel, may hinder further reserve growth.

In regard to the country’s debt restructuring efforts, Sri Lanka successfully completed the Domestic Debt Restructuring in September 2023. However, the External Debt Restructuring process is ongoing, with expectations of a delay in the second tranche until December 2023, pending the completion of external debt restructuring.

Sri Lanka’s GDP for the second quarter of 2023 revealed a contraction of 3.1% year-on-year, aligning with the earlier forecast of -3.0% year-on-year by the Financial and Capital Research (FCR). This contraction represents a significant improvement compared to the 7.4% output decline observed in the second quarter of 2022. The deceleration in inflation and the anticipated stabilization of interest rates during the quarter contributed to this positive development.

Notably, inflation in Sri Lanka has been on a decelerating trend for the past 11 months. This trend indicates that tight monetary measures have effectively curbed demand pressures. Additionally, cost-push inflation appears to be easing as global commodity prices stabilize, and China’s reopening paves the way for a faster-than-expected economic recovery.

Commenting on the monetary policy outlook, experts believe there is a 60% probability that the Central Bank of Sri Lanka (CBSL) may consider relaxing policy rates in the upcoming policy review meeting, potentially adopting a dovish stance to stimulate economic growth and accelerate the decline in interest rates.

As economic indicators continue to stabilize and with expectations of a robust recovery in the latter part of the second half of 2023, it is anticipated that a substantial monetary relaxation may be necessary to further support the country’s economic revival.

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