Sri Lanka will face a number of security, investment and trading challenges in the coming months. In this article we provide a detailed forward-looking assessment of developments in the country.
While foreign investment will support the development of Sri Lanka’s infrastructure, it is also driving external debt levels. Sovereign credit risks are likely to remain elevated in the long term, with political uncertainty generating additional headwinds.
On April 21, 2019, a series of nine coordinated explosions in churches and hotels across Sri Lanka left 259 dead, and approximately 500 injured.
The incidents were claimed by Islamic State (IS), but are believed to have been carried out by Sri Lankans with links to domestic Islamist organizations. Since then, the government has strengthened counterterrorism operations, introducing a state of emergency and enhancing security at places of worship.
Further attacks are possible in Sri Lanka, although there is limited evidence of a widespread network of Islamist cells in the country.
The terrorist attacks have exacerbated communal divisions in Sri Lanka, with tensions between Buddhist-Sinhalese, Christians, and Muslims growing. In May 2019, anti-Muslim violence occurred in Negombo. Mosques and Muslim-owned assets were targeted, resulting in property damage and at least one death.
Further incidents are likely to include the use of bladed weapons and arson.
The Sri Lanka People’s Front (SLPP) candidate, Gotabaya Rajapaska, is well-placed to win the presidential election on November 16, 2019. Incumbent President Maithripala Sirisena is not contesting the election and his party, the Sri Lanka Freedom Party (SLFP), has not registered a candidate.
This makes it likely that the SLFP will form an electoral alliance with the SLPP, unifying the Buddhist-Sinhalese voter demographic. Rajapaska’s principal opposition is expected to be Sajith Premadasa of the United National Party (UNP).
The UNP’s electoral chances will be weakened by its need to appeal to voters across Buddhist-Sinhalese, Tamil, and Muslim communities.
High levels of foreign participation in the development of Sri Lanka’s infrastructure contribute to elevated levels of external debt. Government debt is forecast at 82.9% of GDP in 2020, marking a negligible improvement from the 2018 figure of 83%.
Principal payments on external debt are estimated at approximately US$4 billion annually between 2019 and 2023. Foreign exchange reserves will provide only a limited buffer to these obligations, with reserves falling to just US$5.1 billion in February 2019.
This followed the government’s decision to draw upon reserves to repay a five-year sovereign bond that matured in January 2019. Reserves were used to meet part of the US$1 billion in obligations, after state banks were unable to raise the whole amount.
The total value of reserves used was not disclosed. In the longer term, Sri Lanka’s ability to meet its payment obligations will be vulnerable to shifts in investor confidence linked to political conditions in the country.
In October 2018, a political crisis reduced the value of the rupee and increased sovereign bond yields. Siresena sacked Ranil Wickremesinghe as prime minister, leading to a seven week constitutional crisis, which was only resolved after the judiciary ruled that he be reinstated. During the crisis, the IMF suspended its loan program with Sri Lanka. The incident also affected Sri Lanka’s growth performance, with real GDP growth slumping to 1.8% year over year in Q4 2018, marking a four-year low.
Further political crises ahead of the 2019 presidential and 2020 parliamentary elections would generate further downside economic risks, and reduce Sri Lanka’s ability to meet its sovereign payment obligations.
Sri Lanka’s construction sector is forecast to perform well over the coming decade, growing in value by an annual average of 9.8% in the period up to 2028.
Sri Lanka’s strategic position in the Indian Ocean has made it a particularly attractive investment destination for China, India, and Japan.
The transport sector will be a particular beneficiary of investment. In August 2019, the Asian Development Bank approved a US$160 million loan to support Sri Lanka’s Railway Efficiency Improvement Project, which will modernize Sri Lanka Railways’ operations. The government will also provide US$32 million, with upgrades due to be completed by 2024.
However, there is an elevated risk of contract alterations or cancelations in the infrastructure sector. In March 2015, following the election of Sirisena, the new government suspended the Colombo Port City project in a rejection of Chinese-backed investment.
As president, Rajapaska may pursue closer relations with China at the expense of India. This may lead to greater scrutiny of Indian-funded projects in Sri Lanka, elevating the risk of contract alterations.
5 Key Takeaways
- Terrorist attacks in April 2019 have exacerbated communal divisions in Sri Lanka. Mosques and Muslim-owned assets may be targeted in incidents of civil unrest in the medium term.
- The Sri Lanka People’s Front (SLPP) candidate, Gotabaya Rajapaska, is well placed to win the presidential election on November 16, 2019.
- High levels of foreign participation in the development of Sri Lanka’s infrastructure contribute to elevated levels of external debt. Foreign exchange reserves will provide only a limited buffer to these obligations in the coming years.
- Sri Lanka’s construction sector is forecast to perform well over the coming decade, growing in value by an annual average of 9.8% in the period to 2028.
- However, government changes in Sri Lanka bring an elevated risk of contract alterations or cancellations in the infrastructure sector.
The monthly Risk Outlook is supported by our proprietary country risk rating tool, World Risk Review (WRR) which provides risk ratings across nine insurable perils for 197 countries. The country risk ratings are generated by a proprietary, algorithm-based modelling system incorporating over 200 international sources of data.