On top of narrow fiscal buffers and high indebtedness, COVID-19 pandemic related impacts could worsen Sri Lanka’s vulnerabilities to shifts in global sentiment, according to the Institute of International Finance (IIF), a Washington-based global Association of the financial services industry.

In its latest report titled ‘Macro Notes – Frontier Asia Remains a Bright Spot’, IIF highlighted that Sri Lanka in particular was hard hit by the pandemic, which exacerbated its already challenging macroeconomic situation, in comparison with most frontier Asian markets.

The report focused on three Asian frontier Markets— Sri Lanka, Vietnam and Bangladesh. IIF projected Sri Lanka’s economy to grow by over 4 percent after contracting by 4 percent in 2020 due to pandemic-related impacts. Meanwhile, Bangladesh and Vietnam are among the few countries that were able to maintain growth in 2020. 

IIF projected the budget deficits of the three countries to remain large in 2021—due to additional pandemic relief and recovery expenditures, stable capital spending, and subdued tax revenue collection.

However, it pointed out that Sri Lanka faces additional challenges given its weak debt dynamics compared to other two countries.

“In the case of Sri Lanka, this means additional divergence from the IMF-recommended policy path and growing risks to macro stability. Public debt will likely rise to above 90 percent of GDP, with more than half of the debt stock denominated in foreign currency. With already narrow fiscal buffers, we see significant external financing needs and growing pressure on debt sustainability,” it elaborated. 

Similarly, it noted that although Sri Lanka’s current account deficit is projected to remain relatively small, scarce financing sources and ‘potentially overvalued’ exchange rate would be challenging for external account. 

On Tuesday, Sri Lanka’s US$ denominated ISBs set to mature between 2022 and 2028 fell around 2 cents on the US dollar, while leaving ISBs maturing beyond 2025 at roughly 40 percent below their face value, after India refused to extend US$400 million swap arrangement citing need for a new International Monetary Fund (IMF) deal.

However, the government has announced that a US$ 1.5 billion swap line from China will be secured soon.

Sri Lanka faces US$ 4.6 billion worth of bond redemptions this year and another US$ 500 million payment in January 2022.

Meanwhile, IIF highlighted that Sri Lanka’s cumulative rate cuts are currently one of the highest in the region (250bps cuts since the end of 2019) followed by Vietnam (200bps) and Bangladesh (125bps) and further said the Central Bank had also implemented a quantitative easing-type government bond purchase programme. Despite, large liquidity injections, the slowdown in economic activity has kept inflation in check.

“We expect inflation to remain close to the authorities’ respective targets in 2021, under the assumption that oil prices stay subdued and food prices broadly stable,” it stated.