brand logo
logo

If floated, exchange rate to hit Rs. 240-270 by December: First Capital Research

01 Feb 2022

  • First Capital projects a ‘stronger’ depreciation of LKR in 2022 
  • Says decreasing forex, high debt weakens currency 
First Capital Research in its “Investment Strategy 2022: Sri Lanka” report for January 2022, stated that it expects a stronger depreciation of the Sri Lankan rupee during 2022 than previously forecasted and accordingly has further downgraded the forecasted exchange rate target for June 2022 from Rs. 225-240 to Rs. 230-245 and expects the Sri Lanka rupee (LKR) to depreciate to Rs. 240-270 by December 2022 if the currency is floated.  In its report First Capital highlighted the fact that Sri Lanka’s decreasing foreign reserve position and high foreign currency debt repayments are the primary concerns for the significant weakness in the currency. Furthermore, the rise in imports despite the ongoing import restrictions was also noted as an added concern.  First Capital justified the Rs. 30 range taken for its exchange rate target in December 2022, stating that considering the significant macroeconomic weaknesses and the extreme uncertainty in the economy and lack of policy direction justify a larger than usual range.  The report forecasted that the gross domestic product (GDP) growth during 4Q 2021 will reach 3.6% amidst the strong growth witnessed in the industrial segment led by manufacturing construction segments and consequently GDP growth in 2021 to be 4.0%.  However, according to forecasts by First Capital, inflation is likely to take a toll on GDP growth for 2022 and consequently GDP growth in 2022 will fall to a range of 0.5% to a negative 1.6% on the back of rising interest rates and the depreciation of the currency.  The report forecasted tourist arrival to increase to 1.6 million in 2022 up from a mere 194,000 in 2021. Parallelly, revenue from tourism is expected to increase to $ 2.1 billion in 2022 from 200 million in 2021 and is forecasted to reach $ 4.9 billion by 2024.  Foreign worker remittances which fell to a 10 year low of $ 5.5 billion in 2021 are expected to recover in 2022 reaching $ 6.7 billion.  According to First Capital, Sri Lanka is estimated to receive $ 6.8 billion borrowings in 2022 which includes: $ 500 million swap facility from Qatar; $ 2-3.5 billion relief package from Japan; a loan from China (unknown quantity); and $ 2.4 billion from India in the form of a $ 1 billion credit facility for importing food and essential items, $ 500 million fuel credit line, $ 400 million swap facility from the Reserve Bank of India, and the deferred ACU settlement of $ 500 million. The report further forecasted that if all such expected inflows are received, Sri Lanka’s Balance of Payment (BOP) deficit will fall to $ 2.2 billion in 2022 from $ 2.5 billion in 2021. However, if the expected inflows are not received, in such a crisis situation the BOP deficit is expected to fall to $ 4.2 billion. However, the report holds that a BOP deficit is just a part of the problem and that even if the BOP position is managed temporarily the Government budget deficit is expected to once again be a serious concern resulting in high Government borrowings. Accordingly, First Capital forecasted the budget deficit in 2022 to be around 9.7% and consequently Government borrowings are expected to reach Rs. 17 trillion. According to First Capital, investors will increasingly look at equity markets in 2022, in response to the negative real interest rates observed in the country. According to their report, the real interest rate as of December 2021 was a negative 3.47% due to fixed income rates including fixed deposits remaining below 10% and increasing inflation with the Colombo Consumers Price Index (CCPI) surging to 12% as of December 2021. They further stated that while the fixed deposit (FD) ceiling stands at 10.11% at present, marginally above 10%, most large to mid-size finance companies are offering well below maximum interest rates due to the lack of lending opportunity, thereby market FD rates by most finance companies may remain below 10% over the next two to three months. Furthermore, the continuous quantitative easing strategy coupled with import restrictions and controlled currency by the current Government is pushing inflation to higher levels while also keeping interest rates under check. This, according to First Capital, may lead to a continued environment of negative real interest rates in the short to mid-term. Consequently, First Capital forecasted the All Share Price Index (ASPI) to reach 15,000 during 1Q 2022. This bull run is expected to be supported by December 2021 quarter earnings which are likely to be extremely strong, similar to September 2021 with the transportation sector, construction and building material sector, and diversified financial sector leading the way in terms of earnings.


More News..