Midyear Economic Update 2021

Economy at a glance for 1H 2021

  • First quarter recorded a modest economic growth (4.2%) but the rapid escalation of the third wave of COVID infections stalled the momentum telling us that the pandemic will continue to cast a longer shadow over the economy. Our nowcasting models indicate that Sri Lanka’s GDP may have grown at around 4.1% in 2Q.
  • Improving economic activities post relaxation of the lockdown brought the wages on an upward track on the back of growth in services and industries wages.
  • Headline Inflation started to climb up in 1H as a result of uptick in non-food inflation. Following the fuel price hike in June, inflation made the biggest jump since the beginning of the pandemic last year. Supply shocks caused food inflation to remain high at double digits before moderating to upper single digit levels in 2Q.
  • The CBSL maintained a dovish stance in monetary policy throughout 1H. The money market rates remained broadly steady and subdued in 1Q. Treasury yields edged up. Retail lending rates further declined.
  • Improved mobility after the relaxation of lockdown measures together with the April new year festive season elevated consumer spending and retail trade activities boosting willingness to lend among lending institutions to drive private credit. However, the gloomy outlook that followed immediately in the wake of the rising third wave of infections eroded the optimism.
  • In April rupee abruptly appreciated for a short duration only to spring back and remained around 200 for the rest of the quarter in what appears to be an attempt to use moral suasion to prevent rupee from depreciating. Consequently, the liquidity in the interbank forex market dwindled giving way for black market to thrive.
  • Monthly merchandise exports during the first five months of 2021 outperformed its corresponding year-ago levels by 33.3%. Imports went up by 26% mainly due to increasing commodity prices. With the deterioration in terms-of-trade, Sri Lanka was unable to achieve a material improvement in the trade deficit.
  • Remittances managed to perform consistently well above the last year levels (+18.2% in 5M 2021). However, tourism receipts (-97%) remained at dismal levels under current international travel restrictions.
  • Throughout 1H Sri Lanka struggled to preserve or improve its reserve position while the country’s import cover was on a downward trajectory (5.7 months in January to 4.6 in May).
  • Following sovereign rating downgrades by multiple agencies towards the end of 2020, the yields on SLISBs were on the rise mostly during 1H apart from few occasions where markets responded to positive news. Government revenue stagnated in 4M 2021 growing only by 0.8% despite modest recovery in GDP in 1Q. As a result of elevated expenditure level together with stagnant revenue, the fiscal deficit has further expanded (+15.1%). The deficit was primarily financed through domestic borrowings in the form of treasury bonds and bills. This has brought the total stock of debt over LKR 16 Tn by the end of April 2021

Economic forecasts for 2021/2H

GDP (real)LKR Bn9,8839,5319,858
GDP (nominal)LKR Bn15,01314,97316,262
GDP (growth)%2.3-3.63.4
Government revenueLKR Bn1,8991,3731,487
Government revenue, % of GDP%
Government expenditureLKR Bn3,3383,0413,221
Government expenditure, % of GDP%22.320.319.8
Fiscal balanceLKR Bn-1,439-1,668-1,734
Fiscal balance, % of GDP%-9.6-11.1-10.7
Government debtLKR Bn13,03215,11717,043
Government debt, % of GDP%86.8101.1104.8
ExportsUSD Bn11.910.012.3
Exports, % of GDP%23.116.516.7
ImportsUSD Bn19.916.120.3
Imports, % of GDP%29.222.927.5
Trade balanceUSD Bn-8.0-6.0-8.0
Trade balance, % of GDP%-9.5-7.5-10.9
Current account balanceUSD Bn-1.8-1.1-1.4
Current account balance, % of GDP%-2.2-1.3-1.9
Exchange rateLKR/USD178.8185.5200 – 220**
Gross official reserves, year endUSD Bn7.65.73.9
AWCMR%7.454.454.60 – 5.10**
T-bill yield (3M)%7.514.695.10 – 5.30**
T-bill yield (12M)%8.455.055.20 – 5.40**
AWPR%9.745.815.50 – 6.60**
SLFR, year end%74.504.50
SDFR, year end%85.505.50
Inflation rate, CCPI (2013=100)%4.34.65 – 6**

Performance in 1H 2020

Interest Rates

Short-term Rates

Figure 1: Treasury bill yield (3M) and money market rates

Notes: AWCMR- Average Weighted Call Money Rate, SDFR- Standing Deposit Facility Rate, SLFR- Standing Lending Facility Rate, T-bill yields are for the secondary market, ARR – simple average of daily repo rates

Source: CBSL

The CBSL maintained a dovish stance in monetary policy throughout 1H 2021. During this period the CBSL did not conduct any auction based open market operations and resorted to changing its stock of treasuries to influence the money supply. The money market rates remained broadly steady and subdued in 1Q. Liquidity averaged LKR 159.9 Bn a day in 1Q down from 192.4 the quarter before. Occasionally, the market liquidity fluctuated owing to the CBSL’s intervention in the forex market.

In 2Q the liquidity level further declined averaging LKR 113 Bn a day pushing call and repo rates up by about 16 bps. Consequently, call and repo market volumes jumped to the highest levels seen since the beginning of the pandemic. Despite having witnessed the largest surplus liquidity in the money markets in recent times, a considerable amount of funds has been borrowed via the SLF facility since mid-March.

T-bills, the treasury’s preferred mode of financing the fiscal deficit now, saw yields soaring with the relaxation/lifting of caps imposed. The cost of imposing these distortionary caps was sloppy auctions with significantly low offer-to-acceptance ratios. In addition, the CBSL ramped up average quantity of treasuries offered in a single auction to compensate for poor offer-to-acceptance ratio. In numerous instances, the CBSL stepped in to purchase the unsold treasuries from primary auctions causing liquidity spikes which were sometimes offset by selling forex in the open market or selling down of treasuries in the secondary market. In this setting, the CBSL’s stock of treasury holdings grew 26.7% in 1H. In the secondary market T-bill volumes were at record levels throughout the reference period.

Long-term Rates

Figure 2: Yield curve of treasuries

Notes: Yields are based on the weekly averages that prevailed at the last week of the month, Shorter-end – less than 2Y, mid/intermediate tenor – 2 to 10Y, longer tenor – above 10Y

Source: CBSL

Policy rate cut in July last year shifted the yield curve down in 3Q 2020. Thereafter, yields began to rise with rising inflation expectation due to gradual normalization of economic activity. The shorter end of the curve remained by and large flat while the belly and the tail of the curve steepened overtime.  Market showed appetite for fresh bond issues throughout 1H barring the April auctions. Secondary market also posted record turnover.

Figure 3: Secondary market T-bill yields and AWPR

Note: AWPR – Average Weighted Prime Rate is calculated based on the submissions made by the commercial banks to the CBSL on the rates offered to customers who borrowed more than LKR 10 Mn for less than three months.

Source: CBSL

Retail lending rates further declined (AWNLR by 506 bps and AWLR by 395 bps in 5M 2021). Nevertheless, AWPR whilst being volatile, bounced back to the level that prevailed at the beginning of the year towards the tail end of 2Q. The spread between AWPR and 3M T-bills, which has historically remained above 200 bps, is currently narrowed to about 70 bps.


Figure 4: Credit demand and supply

Notes: Indices in the credit supply survey are calculated as ‘Diffusion Indices’, that take values between -100 and 100, by weighting responses of the licensed banks using exposure of each bank to Total Gross Loan Portfolio of the banking sector. Index value > 0 means an increase; Index value < 0: decrease; Index value = 0: unchanged, *2Q 2021 outlook

Source: CBSL

Improved mobility after the relaxation of lockdown measures together with the April new year festive season elevated consumer spending and retail trade activities boosting willingness to lend among lending institutions to drive private credit. However, the gloomy outlook that followed immediately in the wake of the rising third wave of infections eroded the optimism. Concurrently, since the beginning of the pandemic the government has been borrowing extensively from the banking system.

Given the current historically low interest rate setting, there was a strong interest among institutional investors on good quality corporate debt instruments. A 6M commercial paper issued by an A-rated entity fetched around 150 bps spread over AWPR while that of a BBB-rated entity fetched around 300 – 400 bps. According to ICRA Lanka estimates roughly LKR 130 Bn debt instruments have been rated between 2Q 2020 to 2Q 2021 period and 1Q 2021 marks the highest amount of debt rated in a single quarter for the last five years.

International Rates

Figure 5: International lending rates

Notes: The SOFR Averages are compounded averages of the SOFR over rolling 180-calendar day periods.

Source: New York Federal Reserve and global-rates.com

Expedited COVID vaccine rollout in the US brought infection and death rates lower helping to normalize economic activities. The US treasury yields started to move up over inflation fears due to Fed’s inflation overshoot target. The Fed made several reassurances that it would continue with the ongoing QE programme to calm the markets. In June the markets were rattled when the Fed announced that they are forecasting rate hikes in 2023 – a move which the Fed initially said would not initiate until at least 2024. Meanwhile, Eurodollar rates LIBOR USD and SOFR continued to move down as markets were flushed with US dollars due to the Fed’s dovish policies.

The CBSL held three SLDB auctions in 1H 2021 which collectively offered USD 1,050 Mn. With the crippling state of the country’s external sector situation, the CBSL managed to collect only USD 774.3 Mn from the auctions of which about USD 700 Mn were utilised to rollover a maturing SLDB tranche in May. The CBSL has not offered any floating rate notes (which were tied to 6M LIBOR USD earlier) so far this year and average yields during auctions remained elevated.

Read ICRA Lanka report on the LIBOR 2021 Transition is a bigger deal than you might think…Is Sri Lanka ready?

Read ICRA Lanka report: Low interest rates. Who are the winners and losers?

Figure 6: SLISB quarter end yields

Source: CBSL

Following sovereign rating downgrades by multiple agencies towards the end of 2020, the yields on SLISBs were on the rise mostly during 1H 2021 apart from few occasions where markets responded to positive news – most notably confirmation of USD 1.5 Bn swap with China in March and signing of USD 500 Mn Foreign Currency Term Financing Facility (FCTFF) in April. The pressure on yields was most felt in the near-dated maturities amid worries over Sri Lanka’s challenging external sector situation. In June the CBSL lifted the ban preventing banks from buying SLISBs to make SLISBs more liquid.

External Sector

Figure 7: External trade (USD Mn)

Source: CBSL

Monthly merchandise exports during the first five months of 2021 outperformed its corresponding year-ago levels three months in a row while managing to maintain exports at around USD 1 Bn a month helped by faster recovery in key export destinations (i.e., US, UK, and Europe). For the said period, on year-on-year basis exports grew 33.3% and the increase was mainly attributable to the growth in garments (+34%), rubber products (+50.8%) and tea (+15.3%).

Imports shot up by 26% despite having import controls on account of increase in prices of intermediate goods, especially fuel (+51.9%), textiles (+32%), chemical products (47.3%), and base metals (+88.4%). Furthermore, there is a notable increase in machinery and equipment (+30%) imports.

With the deterioration in terms-of-trade, Sri Lanka was unable to achieve a material improvement in the trade deficit. In this context, the trade deficit worsened by USD 562 Mn to USD 3,663 Mn during 5M 2020 vis-à-vis 2021.

Figure 8: Remittances (USD Mn)

Source: CBSL

Remittances managed to perform consistently well above the last year levels (+18.2% in 5M 2021). This is in spite of a significant number of returnees particularly from Middle Eastern countries. The increase is attributable to increased remittances from Sri Lankans living in developed countries to Special Deposit Accounts with higher interest rate. However, tourism receipts (-97%) remained at dismal levels under current international travel restrictions.

Figure 9: Net foreign purchase of equities and treasuries (LKR Mn)

Source: CSE, CBSL

Notwithstanding the boom in CSE in January 2021, foreign investors showed very little appetite in Sri Lankan equities. Foreigners were consistently on the sell-side and in aggregate accounted for USD 119 Mn net outflow in the first five months of the year. In this respect, treasury instruments fared marginally better with a net inflow of USD 14 Mn during the same period. Successive rating downgrades and surging US treasury yields have narrowed the interest rate differential making Sri Lankan treasuries less attractive for foreign investors. Foreign direct investments (FDIs) have also suffered a major blow, totaling only USD 198 Mn in 5M 2021.

Figure 10: Interbank spot market for forex

Source: CBSL

Sri Lankan rupee faced a high degree of selling pressure in January 2021 with the uptick in US treasury yields. In this context, the CBSL temporarily suspended forward contracts and extended the restriction on outward remittances on capital transactions. In addition, direct intervention by the CBSL added more liquidity to the domestic forex market to ease the pressure. In February, rupee was broadly stable with better forex inflows but rupee came under pressure again in March amid a spike in imports. In April rupee abruptly appreciated for a short duration only to spring back and remained around 200 for the rest of the quarter in what appears to be an attempt to use moral suasion to prevent rupee from depreciating. Consequently, the liquidity in the interbank forex market dwindled giving way for black market to thrive. Sri Lankan rupee’s Real Effective Exchange Rate (REER)[1] index slid to 82.51 in May making it the most undervalued instance on record since 2010.

Figure 11: Interbank forward market for forex

Source: CBSL

Forward premiums were inverted for most part of 1H 2021 as a result of narrower LKR – USD interest rate differential. With the suspension of forward contracts by the CBSL in January, liquidity in the forward market moderated with the exception of March where demand for forward contracts grew on the back of a spike in imports (imports rose 26% in March from April). By the end of 1H outstanding forward volume contracted by 40% compared to the year open.

Figure 12: Gross official reserves (USD Mn)

Source: CBSL

Throughout 1H Sri Lanka struggled to preserve or improve its reserve position while the country’s import cover was on a downward trajectory (5.7 months in January to 4.6 in May). Several major forex obligations were settled in a span of four months (February USD 400 Mn swap with Reserve Bank of India, March USD 500 Mn with Fed and USD 694 Mn SLDBs in May) while few key inflows (USD 1.5 Bn swap with Peoples Bank of China in March, USD 500 Mn FCTFF in April, and USD 200 Mn swap with Bangladesh Bank in June) helped to offset outflows. The CBSL absorbed forex through mandatory conversion of dollar proceeds and remittances, swaps with commercial banks, SLDB auctions, and open market purchases while providing liquidity when the currency was under pressure in a few occasions.

Fiscal Sector

Table 1: Government revenue and expenditure (LKR Bn)

 4M 20204M 2021Change (%)

Notes: *Revenue includes grants, **Expenditure includes net lending

Source: CBSL

Government revenue stagnated in 4M 2021 growing only by 0.8% despite modest recovery in GDP in 1Q. The figure is not far off from ICRA Lanka’s previous projections. Meagre growth in revenue is mainly on account of the fall in income tax and excise tax revenues.

Table 2: Performance of the government tax revenue – 4M 2021

Tax typeComposition (% of the total revenue)Y/Y Change (%)
Income tax11.5-32.1
Import duty7+1.2

Source: Ministry of Finance

The drop in income tax revenue was owing to the failure of the 2020 tax revisions to bring about envisaged economic revival amid the pandemic[2]. However, in January this year there is a marked improvement in capital gains tax income.

Primary hit to the excise tax revenue in 2021 came from the restrictions imposed on passenger motor vehicle imports. In addition, excise revenue from cigarettes and petroleum have suffered, while revenue from liquor shot up by 46.5%.

The GoSL abolished Nation Building Tax (NBT) and Economic Service Charge (ESC) in 2020 cutting the total government revenue by about LKR 125 Bn annually. Furthermore, the GoSL slashed Special Commodity Levy (SCL) and import duty on selected commodities in October 2020 to quell mounting food prices thereby leading to nearly a 15% decline in SCL revenue.

With Sri Lanka’s main source market for imports, China embroiled in the COVID crisis, imports plunged sharply (-21%) in 1H 2020 weakening revenues from import duty and import based Value Added Tax (VAT), Port & Aviation Levy (PAL) and Cess. During 5M 2021 imports bounced back 20.8% more-or-less on par with pre-crisis level leading to a substantial increase in income from aforementioned taxes from the previous year.

Improved mobility post lockdowns triggered higher consumer spending leading to greater retail trade volumes in March and April compared to last year thereby helping to boost VAT revenue quite significantly.

In contrast to government revenue, the expenditure grew by 7.7% in 4M 2021 – well over ICRA Lanka’s expectation – driven by stronger expansion in recurrent expenditure.

Biggest contribution to the increase came from the interest payments which accounted for 41.7% of the increase, followed by salaries and wages (28.1%), and pension payments (16.2%). During the same period, capital expenditure grew only marginally (+2.3%).

Table 3: Outstanding government debt (LKR Bn)

 2020 End Dec2021 End AprChange (%)

Source: CBSL

As a result of elevated expenditure level together with stagnant revenue, the fiscal deficit has further expanded (+15.1%). The deficit was primarily financed through domestic borrowings in the form of treasury bonds and bills. This has brought the total stock of debt over LKR 16 Tn by the end of April 2021.

Prices & Wages

Figure 13: CCPI and Wage Rate Index of the informal private sector (Y/Y)

Notes: WRI (100=2012), CCPI (100=2013)

Source: CBSL

Improving economic activities post relaxation of the lockdown brought the wages on an upward track on the back of growth in services and industries wages. However, the spike in wage growth in May is owing to the lower base that prevailed last year. Sri Lanka’s unemployment reached a decade high in 2020 as a result of the pandemic. Services sector employment broadly remained weak in 1H 2021, while that of the manufacturing sector grew in 1Q.

Headline Inflation started to climb up in 1H 2021 as a result of uptick in non-food inflation. Following the fuel price hike in June, inflation made the biggest jump since the beginning of the pandemic last year. Supply shocks caused food inflation to remain high at double digits before moderating to upper single digit levels in 2Q.

Figure 14: Growth in Producer Price Index (Y/Y)

Note: PPI (100 = 4Q 2013)

Source: DCS

PPI (Producer Price Index) shows input prices of producers escalating in 5M 2021. PPI has been growing at a faster pace than the headline inflation (CCPI). In most of the months this year ending May, agricultural and manufacturing producers saw prices escalating by double digits. Compared to last year, agricultural producers saw growth in prices slowing down, while manufacturers experienced prices accelerating.

Figure 15: Property prices

Notes: Average price of a four-bedroom house, three-bedroom apartment, and one perch land

Source: ICRA Lanka Research data based on Lankapropertyweb.com

Lower interest rates pushed the demand for housing loans up, resulting in housing prices soaring by over 16% from the 2Q 2020 level which is in stark contrast to apartment prices which only saw about 3% increase. Land prices experienced a sharp rise in 2Q 2021 (+44%). Higher cost of construction triggered by the import controls may also be keeping the resale house prices buoyant.


Figure 16: Share market performance – ASPI (M/M)

Source: CSE

January 2021 marks the all-time high performance of CSE recording over 25% and 30% gains in the ASPI and the S&P20. Domestic investors shored up their portfolios as foreign sellers exited. Yet, investor optimism did not last long as CSE went through two consecutive months of market correction wiping out over LKR 700 Bn from the market. In the subsequent months market recovered somewhat, but overall PBV (price-to-book-value) reverted to year open level. Transportation and diversified financials were among the top performing sectors during 1H 2021.

Table 4: GICS sector performance- 1H 2021

SectorIndex Points Gained
Diversified Financials909
Food & Staples Retailing172
Capital Goods141
Household & Personal Products83
Consumer Durables & Apparel43
Real Estate2
Food, Beverage & Tobacco-6
Telecommunication Services-11
Automobiles & Components-29
Consumer Services-38
Commercial & Professional Services-84
Health Care Equipment & Services-193

Source: CSE

Financial Sector

Financial sector was recovering in 1Q 2021, but the escalation of corona infections in 2Q 2021 presented financial institutions with yet another quarter with a challenging operating environment. ICRA Lanka observes that pandemic readiness of the financial institutions has improved markedly this time around and therefore the business continuity was comparatively better. Operating efficiency has also improved across banking and financial sectors on account of remote working arrangements and extensive use of online infrastructure to deliver services.

In the current context, financial institutions are increasingly preferring asset backed and short-tenured lending thereby having a high concentration in safer assets in their portfolios. As such there is an uptick in exposure to the housing and construction sector among banks and pawning among finance companies. A number of banks and non-bank financial institutions (NBFIs) in ICRA Lanka’s rated pool demonstrated noteworthy improvement in non-performing assets (NPAs) by March 2021 and the impact of the 3rd wave on NPAs is expected to be moderate. Heavy investment in treasury securities have also contributed to improved asset quality and liquidity position among banks. However, in the absence of major swings in the interest rates, income received from capital gains by trading treasuries was rather low.

During 1H 2021, ICRA Lanka changed the outlook from Negative to Stable for three NBFIs of which one of the entities received a rating upgrade. There have been no rating changes in the banking sector.


Banks experienced relatively better growth in private credit in 1Q 2021 which moderated somewhat in 2Q. Meanwhile, state banks’ exposure to government credit shows a substantial increase as the government’s funding requirement amplified with the pandemic. Demand for loans was growing but the willingness to lend among banks moderated in the face of the third wave.

Funding profile of the banking sector has gone through some transformation lately. Cost of funding of banks further declined as witnessed by the rising CASA ratio. The growth in time deposits also slowed down due to lackluster fixed deposit rates. In addition, the share of institutional deposits among licensed commercial banks (LCBs) has grown.

Banks have been able to remain somewhat profitable as a result of higher net interest margins (NIMs) enabled by systemic interest rates. Adverse impact of import restrictions on banking sector’s fee income from letters of credit was somewhat offset by fee income from ATMs and online transactions.

Banks continued to maintain a comfortable level of capital buffers stipulated by the regulatory authority. Quality of capital also remained favourable from a risk standpoint. In addition, ICRA Lanka saw the state banks shoring up their capital bases by issuing hybrid debt instruments in the market. Two of the largest state banks issued rated Additional Tier 1 Capital bonds during the period. But higher liquidity levels built up overtime due to slowdown in credit was weighing down on the profitability of the sector.

Banks occasionally faced difficulties with shortage of forex which became severe after the currency volatility in March. In addition, banks were seen operating very close to their net open positions (NOPs) which hindered their foreign currency operations.


Under the sector consolidation roadmap of the CBSL, there were a number of mergers and acquisitions (M & A) in the NBFI. ICRA Lanka expects the number of the NBFIs to reduce over the coming year and views this to be a positive development for the sector stability.

Capital levels among NBFIs improved on account of shrinking loan portfolio and contraction of some high-risk products. With credit still recovering, NBFIs had to absorb some revenue losses at the expense of liquidity.

Asset quality deterioration is more acute among the NBFIs and relatively higher than banks due to inherent vulnerabilities of its clientele. However, there is a notable improvement in asset quality in 1Q 2021 before moderating in 2Q.

Wider NIMs have helped to improve the earnings of NBFIs. Contraction in the sector loan portfolio has improved earning indicators. Unlike the banks, NBFI earning profiles are less diversified making them susceptible to shocks such as the current pandemic. But the collections have normalized since 2020 4Q mainly due to the performance of the vehicle leasing sector. Leasing portfolios of many NBFIs are expanding amid the booming secondhand vehicles market. while some NBFIs seemed to have exercised caution expecting an imminent price correction in case of a relaxation of import restrictions. Price appreciation in gold articles have encouraged the NBFIs to expand their pawning portfolio. Given the weaker economic outlook, some NBFIs have restricted their microfinance and SME lending portfolios.

Figure 17: Financial sector key indicators (%)

Notes: Capital adequacy indicators; for banks- Tier 1 Capital Ratio, for finance/leasing companies – Core Capital to Risk Weighted Assets, Earnings indicators; for banks- Return on Assets – before tax, for finance/leasing companies – Return on Assets (Annualized), Asset quality indicators; for banks- Non-performing Loans to Total Loans and Advances, for finance/leasing companies – Gross Non Performing Advances to Total Advances, Liquidity indicators; for banks- Liquid Assets to Total Assets, for Finance/leasing – Regulatory Liquid Assets to Total Assets

NBFIs in above only include Licensed Finance Companies and Specialised Leasing Companies Sector

Source: CBSL


Figure 18: Crude oil price (USD/bbl)

Source: Bloomberg quoted in CBSL

Demand for crude oil recovered rapidly stemming from global growth prospects after successful vaccine rollouts in major economies. The supply quota agreements in place by the OPEC+ countries inflated the prices even further pushing beyond the pre-crisis levels. As a result, global Brent crude oil prices have risen by around 50% (USD 50 – 75/bbl) during the first 6 months of 2021.

Figure 19: Auction prices of commercial crops

Notes: Tea prices for all elevations, rubber prices for LATEX Crepe 4X

Sources: Forbes & Walker, RRISL, CDA

Tea prices failed to maintain momentum for the most part in the first half of 2021. However, prices surged briefly in April, as a result of bulk buying due to potential supply restrictions in India amidst surging COVID cases. With many major tea producers gradually restoring their operations global supply soared bringing prices down.

Rubber prices which remained relatively subdued last year bounced back in the first few months on the back of growing industrial demand. Soaring crude oil prices and supply constraints also helped sustain the prices.

Weekly coconut auctions, which had been suspended since September last year, resumed in May. Auction prices continued to fall likely as a result of drop in nut quality due to adverse weather conditions that prevailed towards 4Q 2020.

Figure 20: Metal price index (2016=100)

Notes: Base metals index includes Aluminum, Cobalt, Copper, Iron Ore, Molybdenum, Nickel, Tin, Uranium, and Zinc, precious metals index includes Gold, Silver, Palladium, and Platinum

Source: IMF

During the first quarter of 2021, gold prices continued to decline. During this period high treasury yields and bullish equity markets drove investors away from gold. However, as inflation fears loomed, investors stacked up their portfolios with gold.

Growing global industrial activities prompted base metal prices to remain buoyant throughout the year. Base metal prices reached their 10-year peaks towards the end of the first quarter as a result of stockpiling by large manufacturers fearing potential supply bottleneck from India. However, prices moderated to a certain degree towards the end of the second quarter due to the intervention by the Chinese regulators to curb speculative buying.

Read ICRA Lanka’s report: Commodity price deflation is over! What next for Sri Lanka?

Real Sector


Table 5: Output growth of key agriculture sectors – 2021 (Y/Y)

MonthTea (%)Rubber (%)Coconut (%)Fisheries (%)

Source: CBSL

Agriculture sector saw a relatively healthy output level in the first half of 2021 compared to year-ago level. The official GDP data show the sector rebounding by 6.1% (Q/Q) in 1Q after experiencing a contraction of 6.1% last year. Key commercial crops, especially tea (47.6%), vegetables (19.7%) and fruits (11.7%) made a noteworthy contribution to the growth in overall sector output. However, marine fishing and aquaculture recorded yet another disappointing quarter by contracting 16% (Q/Q) in 1Q.

Though key commercial crops had a robust first quarter, we expect 2Q sector performance to be more-or-less mixed as the country went into an island-wide lockdown in the face of rising third wave of Corona infections impeding the entire agricultural value chain. In addition, we believe fisheries subsector output may have plummeted sharply as it was badly affected by the X-Press Pearly disaster [1].


Table 6: Growth in selected industrial activity indicators – 2021 (Y/Y)

MonthTotal electricity usage (%)Industrial electricity usage (%)Cement consumption (%)Ship traffic (%)Container handling (%)Cargo handling (%)

Source: CBSL

Industrial sector grew by 5.5% in 1Q 2021, recovering from 7.9% contraction in 1Q 2020. Most subsectors expanded but the recovery was uneven, with contribution to the output growth mainly coming from manufacturing of food & beverages (28% of the change in output), textile & apparel (22.7%), and construction sectors (13.7%). Petroleum refining recorded a sharpest drop in production among all subsectors (-44.3%, Y/Y).

Figure 21: Industrial production level indicators

Notes: Purchasing Managers Index (PMI) – negative values indicate the sector is generally contracting on a month-on-month basis while positive values indicate the sector is expanding. The strength of contraction or expansion is manifested by the magnitude of the figure. Index value > 0 means an increase; Index value < 0: decrease; Index value = 0: unchanged. IIP is Index of Industrial Production

Source: DCS

Industrial production suffered another blow with the advent of the third COVID wave in the 2Q. The PMI index shows manufacturing sector contracting in April and May before making a marginal recovery in June. Manufacturing activities generally drop in April due to New Year holidays. It is evident from the IIP data that the contraction is smaller than that of 1Q 2021. The delays in industrial input supplies were persistent as the shipping traffic level continued to remain below the pre-crisis level.


Figure 22: PMI deviation from point of neutrality (Index points)

Source: DCS

Services sector GDP recorded a modest recovery (3%, Q/Q) in 1Q 2021. Largest contribution to the gain in production came from the financial services (48.7% of the change in output) followed by wholesale and retail trade (25.3%) and real estate activities (14.1%). Despite hotels reopening for domestic tourism, with very limited foreign travelers coming to the country, the leisure and tourism sector contracted by 31.9% (Q/Q).

According to the PMI index, the sector contracted for the first two months of 2Q with most impact felt in May before recovering marginally in June. We believe the pandemic impact on the sector output is less severe this year compared to the corresponding period of last year.

Peak impact of the pandemic fell in the second quarter of last year. Over the course of the last few months, the economy has developed some resilience to withstand COVID induced disturbances. According to our nowcasting models GDP in 2Q may have grown at around 4.1%.

Outlook for 2H 2021

Global Outlook

Expedited vaccine rollouts in many major economies have enhanced global growth outlook for 2H 2021. The World Bank and IMF revised up their forecasts from 4% and 5.5% to 5.6% and 6% respectively for 2021. Latest estimate from the WTO sees the volume of world merchandise trade increasing by 8.0% in 2021 after having fallen 5.3% in the previous year. Many agencies and experts opine that inflation is going to be higher-than-expected, but the debate over whether it is transitory or not is still not settled. In any case, major central banks in the world have not indicated an end to their dovish outlook for the rest of the year.

There is little doubt that the global recovery is going to be even with less developed countries struggling to access vaccines while combating significant stress to their external sector. The IMF has cut the growth outlook for low-income countries by 40 bps.

Table 7: GDP growth forecasts for key trading partners – 2021 (%)


Source: IMF

Economies of Sri Lanka’s key trading partners are expected to recover in 2021. The IMF upgraded growth projections for the US (+0.6 pps) and UK (+1.7 pps) but downgraded the same for India (-3.0 pps) and China (-0.3 pps) in its July economic update.

Table 8: Vaccination progress – Sri Lanka vs. key trading partners

 Sri LankaChinaIndiaUSUKEurope
Received at least one shot (%)374325576948
Fully vaccinated (%)9167495538
Target vaccination coverageFrom early 2023 onwardsBy late 2022By late 2022By late 2021By late 2021By late 2021

Note: Vaccination data as of 27th July 2021, Target for achieving 60-70% of the respective adult population fully vaccinated as of end April 2021

Sources: Our World in Data [2], John Hopkins University [3], KFF [4], Economist Intelligence Unit [5]

Speedy vaccination is the key to global recovery. At the time of writing this report, the world population that is fully vaccinated stands at 14.1% while 27.6% of the world population has received at least one dose of a COVID-19 vaccine [2]. Developed countries are enroute to meeting target vaccination coverage sooner than the April forecasts, while emerging economies such as China and India are battling to keep up with the vaccination rates because of the sheer size of their populations. Meanwhile, Sri Lanka which was earlier expected to be a laggard, is now among the countries with the fastest vaccination rates in the world. Sri Lanka has set an ambitious target to vaccinate its entire population by end 2021/early 2022 [6].


Table 9: GDP growth 2021

GDP growth (%)

Notes: * Actual ** Nowcasted ***Forecasted,                                Source: ICRA Lanka Research

Previously ICRA Lanka forecasted Sri Lankan economy to grow by 3.6% in 2021. In light of recently released official 1Q GDP data and ICRA Lanka’s estimates for the rest of the quarters for 2021 we downgrade our initial projection to 3.4% assuming there will be no major shocks in 3Q and 4Q.

Sri Lanka’s growth in the medium-term is expected to hover around 4%. Structural weaknesses, external sector vulnerability, and absence of substantial real investments makes it difficult for the country to achieve a satisfactory growth level. We expect COVID induced shocks to last through 2H while their magnitude diminishes relatively faster over the next few quarters. Thus, the economy will operate with excess capacity during this time.

ICRA Lanka believes abrupt banning of chemical fertilizers and weedicides and indiscriminate introduction of organic fertilizer could do serious damage to the output level of the agricultural sector. The adoption of organic fertilizer should be done in phases spread across an adequate time span to avoid disruption to agricultural output.

External Sector

Table 10: External sector forecasts (USD Bn)

 5M 2021*2021
Trade balance-3.6-8.0
Net inflow to treasuries and equities-0.1-0.2
Current account balance-1.1-1.4
Gross official reserves4.03.9

Notes: * Actual                                                                                       Source: ICRA Lanka Research

Sri Lanka’s key export destinations –US (USD 2.7 Bn exports in 2020), Europe (USD 2.8 Bn) and the UK (USD 956 Mn) – are expected to have a stronger second half this year. Thus, monthly exports may consistently stay over and above USD 1 Bn for the remainder of 2021 beginning from June to bring total exports to USD 12.3 Bn by the year end.

According to a global survey conducted by UNWTO, the majority of the respondents (56%) in Asia/Pacific believe it would take another three or more years for tourism to return to pre-pandemic levels in their respective countries [7]. Before the COVID crisis, Sri Lanka’s tourism brought about USD 300-400 in forex revenue on average per month. If Sri Lanka can meet its target for vaccination coverage, then there is a glimmer of hope that tourism may resume. But when the country will be open for tourism remains uncertain.

Sri Lanka now has a more diversified source of foreign currency remittances across many continents helping to bring sizable forex inflow to the country. Remittances are expected to have a robust 2nd half contributing about USD 6.7 Bn in net forex inflows to the country in 2021.

ICRA Lanka expects the total import bill to reach USD 20.3 Bn in 2021. With gradual normalization of industrial activities in China (USD 3.6 Bn imports in 2020), its industrial output is expected to go up steadily. India (USD 3.1 Bn) is also a critical source market for industrial inputs for Sri Lanka. However, the current COVID situation in India has derailed its recovery creating supply bottlenecks. In addition, Sri Lankan manufacturers have been experiencing supplier delays since 2020 due to various logistical issues in the global supply chain, and still there is no sign of improvement.

Impact of import restrictions on the exports sector is relatively moderate as the government has accommodated some leniency for exporters in order to ensure uninterrupted production. The burden of the restrictions has directly fallen on the consumers in a way of rising prices of imported items and is expected to have a stronger contribution to inflation in 2H. To lessen the impact on the GDP, the government should consider relaxing import restrictions by imposing it on a narrower range of products.

Table 11: Key commodity price predictions

Commodity‌ Unit‌ 2020‌ 2021Change (%)
Crude‌oil,‌ ‌average‌ USD/bbl‌ ‌41‌7275.6*
Tea,‌average‌ USD/kg‌ ‌2.70‌ ‌2.50-7.4
Coconut‌oil‌ USD/mt‌ ‌930‌ ‌9370.8
Rice,‌Thailand,‌ ‌5%‌ USD/mt‌ ‌500‌ ‌498-0.4
Wheat, U.S., HRWUSD/mt‌ ‌2052071
Sugar,‌World‌ USD/kg‌ ‌0.28‌ ‌0.3421.4
Rubber,‌RSS3‌ USD/mt‌ ‌1.732.2530.1
DAP‌ USD/mt‌ ‌31245044.2
Phosphate‌rock‌ USD/mt‌ ‌75‌ ‌9020
Potassium‌ ‌Chloride‌ USD/mt‌ ‌220‌ ‌2056.8
TSP‌ USD/mt‌ ‌265 ‌41054.7
Aluminum (LME spot)USD/mt‌ ‌1,7042,00017.4
Copper (LME spot)USD/mt‌ ‌6,1818,50037.5
Iron ore (China)USD/mt‌ ‌10813525

Sources: World Bank, *U.S. Energy Information Administration

It will be challenging to curb expansion of Sri Lanka’s trade deficit especially in the midst of faster-than-expected rise in commodity prices in the global markets. Fuel and base metals alone contributed to 41.9% of the increase in imports in the first five months this year. Crude oil (USD 2.5 Bn fuel imports in 2020) is forecasted to grow 60-80%. Main base metals (USD 430.3 Mn) will see prices soaring by more than 15%. Over 20% increase in price of sugar (USD 277.1) is forecasted for this year.  Forecasted 7.4% fall in tea (USD 1.2 Bn exports) price will be a blow to tea exporters, but the overall adverse impact on country’s export revenue may be to some extent offset by the 30% increase in rubber (USD 810.2 Mn rubber and rubber products exports) prices. Nonetheless, Sri Lanka’s terms-of-trade will continue to deteriorate despite having import restrictions. We expect the trade deficit to widen to USD 8 Bn by the end of 2021.

Inflows to the capital (financial) account will continue to be weak in 2H. As of the end 1H, total foreign ownership in equities and treasuries was LKR 29 Bn which roughly translates to about USD 132 Mn. In this context, net outflows (i.e., primary income) from treasuries and equities would also remain low and we expect the total net outflow to be around USD 200 Mn in 2021. In light of improved global economic outlook, we revise up expected FDIs in 2021 to USD 500 Mn.

Initially, ICRA Lanka expected a smaller current account surplus in 2021 due to import compression. Rapid pace at which the prices of global commodities rebounded has overshot our expectations for the total import bill. Therefore, we expect the current account balance to reach USD 1.4 Bn which is about 1.9% of the GDP.

Going forward, fluctuation in the trade deficit is likely to be the principal determinant of the exchange rate assuming all export proceeds are converted to rupees. Currently, the rupee is pegged to USD at 200 and has caused severe shortage of foreign currency in the spot market among the banks. The Sri Lankan rupee has a strong tendency for volatility clustering. We believe the current peg is unsustainable unless there is a material improvement in forex inflows. Therefore, further depreciation of the currency is likely.

At the end of 2020 total foreign currency obligations stood at USD 6.8 Bn. This includes settlement of USD 1 Bn ISB maturing in July. We expect the GoSL to rollover about USD 1.5 Bn existing obligations, and borrow about USD 4.5 Bn via bilateral/multilateral arrangements. As per ICRA Lanka’s projections, in this setting total gross official reserves would fall to USD 3.8 Bn by the end of 2021.

Fiscal Sector

Table 12: Fiscal sector forecasts (LKR Bn)

Revenue**1,373 1,487
Expenditure***3,041 3,221
Outstanding Debt15,117 17,043

 Notes: * Actual, **revenue includes grants, ***expenditure includes net lending

Source: ICRA Lanka Research

ICRA Lanka revises its forecasts to reflect the impact of the third wave of infections on the fiscal variables. Accordingly, we expect the revenues to weaken to 9.1% of the GDP in 2021 from 9.2% in 2020 amid the current subdued domestic economic situation. However, the GoSL may observe gradual normalization of revenues in 4Q 2021. The expenditure will grow relatively slowly and will sit around 19.8% of the GDP. The overall expenditure in absolute terms may expand at the expense of capital expenditure. In this context we expect the fiscal deficit to improve to 10.7% of the GDP but the debt stock will further increase to 104.8% of the GDP.

Interest Rates

Gradual recovery of the economy and rising inflation expectations is driving the treasury yields higher which ICRA Lanka believes will resist downward adjustment of retail lending rates in the medium-term. We feel, T-bills may potentially move up by another 10-20 bps in 2H. Therefore, we expect the AWPR to fluctuate in a relatively broader range between 5.50-to-6.50% for the rest of the year. Due to external sector vulnerability, potential acceleration in credit, and expected rise in inflation, we do not believe the CBSL has scope for a further easing of the policy rates in 2H. On the other hand, the CBSL has emphasized its commitment to keep interest rates at single digits [8]. Hence, it is very likely that the CBSL will maintain its current policy window through 2H. In this context, we may see moderate levels of liquidity in the money market effectively driving overnight rates higher. Therefore, the average call rate for 2H may range between 4.60 to 5.10%.


ICRA Lanka views 2H to have a relatively higher inflation level than 1H due to number of reasons – (1) vaccination rollout is expected to add a boost to the consumer spending; (2) rising commodity prices; (3) scarcity of goods rendered by the import restrictions and speculative element that comes with it; (4) weaker rupee which makes imported goods even more expensive; and (5) vagaries of weather which results in supply shocks to agricultural produce. Thus, we revise our CCPI (Y/Y) average inflation forecast to be between 5-to-6% for 2H.

ASPIAll Share Price IndexSCLSpecial Commodity Levy
AWCMRAverage Weighted Call Market RateSDFRStanding Deposit Facility Rate
AWLRAverage Weighted Lending RateSLDBSri Lanka Development Bonds
AWNLRAverage Weighted New Lending RateSLFRStanding Lending Facility Rate
AWPRAverage Weighted Prime RateSLISBSri Lanka International Sovereign Bonds
bpsBasis pointsSMESmall and Medium Enterprises
CASACurrent Account Savings Account ratioSOFRSecured Overnight Financing Rate
CBSLCentral Bank of Sri LankaUNWTOThe World Tourism Organisation
CCPIColombo Consumer Price IndexVATValue Added Tax
CDACoconut Development AuthorityWRIWage Rate Index
CSEColombo Stock ExchangeWTOWorld Trade Organisation
DCSDepartment of Census and StatisticsY/YYear-on-Year
FCTFFForeign Currency Term Financing Facility  
FDIForeign Direct Investments  
GICSGlobal Industry Classification Standard  
GoSLGovernment of Sri Lanka  
IIPIndex of Industrial Production  
IMFInternational Monetary Fund  
KFFKaiser Family Foundation  
LCBLicensed Commercial Banks  
LIBORLondon Interbank Offer Rate  
M&AMergers and acquisition  
NBFINon-bank Financial Institution  
NBTNation Building Tax  
NIMNet Interest Margin  
NOPNet Open Position  
NPANon-Performing Asset  
PALPort and Aviation Levy  
PBVPrice-to-Book Value  
PMIPurchasing Managers Index  
PPIProducers Price Index  
ppsPercentage points  
REERReal Effective Exchange Rate  
RRISLRubber Research Institute of Sri Lanka  
[1]Wikipedia, “X-Press Pearl,” [Online]. Available: https://en.wikipedia.org/wiki/X-Press_Pearl#cite_note-7.
[2]Our World in Data, “Coronavirus (COVID-19) Vaccinations,” 2021. [Online]. Available: https://ourworldindata.org/covid-vaccinations. [Accessed 28 July 2021].
[3]John Hopkins University, “Understanding Vaccination Progress,” 2021. [Online]. Available: https://coronavirus.jhu.edu/vaccines/international. [Accessed 28 July 2021].
[4]A. Rouw, A. Wexler, J. Kates and J. Michaud, “Tracking Global COVID-19 Vaccine Equity\,” KFF, 21 July 2021. [Online]. Available: https://www.kff.org/coronavirus-covid-19/issue-brief/tracking-global-covid-19-vaccine-equity/.
[5]Economist Intelligence Unit, “The EIU’s latest vaccine rollout forecasts,” 2021 April 28. [Online]. Available: https://www.eiu.com/n/eiu-latest-vaccine-rollout-forecasts/.
[6]EconomyNext, “Sri Lanka to vaccinate all by early 2022, facilitate growth: Army chief,” 8 June 2021. [Online]. Available: https://economynext.com/sri-lanka-to-vaccinate-all-by-early-2022-facilitate-growth-army-chief-82778/.
[7]UNWTO, “International Travel Largely on Hold Despite Uptick in May,” 21 July 2021. [Online]. Available: https://www.unwto.org/taxonomy/term/347.
[8]Lanka Business Online, “CBSL to establish permanent single-digit interest rate structure in economy,” LBO, 4 January 2021. [Online]. Available: https://www.lankabusinessonline.com/central-bank-to-establish-permanent-single-digit-interest-rate-structure-in-economy/.
[9]Moody’s Investors Service, “Rating Action: Moody’s downgrades Sri Lanka’s ratings to Caa1, outlook changed to stable,” 28 September 2020. [Online]. Available: https://www.moodys.com/research/Moodys-downgrades-Sri-Lankas-ratings-to-Caa1-outlook-changed-to–PR_431359.
[10]IMF, “World Economic Outlook – Fault Lines Widen in the Global Recovery,” IMF, July 2021.
[11]CBSL, “Annual Report,” CBSL, Colombo, 2020.
[12]Ministry of Finance, “Mid-Year Fiscal Position Report,” Ministry of Finance, Colombo, 2021.
[13]World Bank, “Commodity Markets Outlook,” World Bank, April 2021.
[14]US Energy Information Administration, “Brent crude oil price forecast to average $72 per barrel in the second half of 2021,” 15 July 2021. [Online]. Available: https://www.eia.gov/todayinenergy/detail.php?id=48716.

[1] A rising REER typically means that a country’s goods are becoming more expensive to foreign counterparts, and therefore less competitive (i.e., stronger rupee), relative to its trading partners while a declining REER indicates the opposite.

[2] Income tax cuts were implemented in April 2020, which means the impact on the tax revenue would not be seen until the 3Q 2020. Therefore, the income tax revenue in 4M 2020 is essentially a higher base based on the previous tax regime to compare against the same period in 2021.


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