ME conflict: External sector-gains threatened

The ongoing war in the Middle East has the possibility to reverse the positive trends seen in Sri Lanka's trade deficit, and may exert pressure on its limited foreign reserves, due to the continued anticipated upward trend in global crude oil prices, Ambeon Securities’ flash note on the impact of the Middle Eastern conflict said.

“Higher global crude prices increase Sri Lanka’s fuel import bill at a time when external buffers remain limited. With energy accounting for a sizable portion of total imports, prolonged elevated oil prices will worsen the trade balance and exert pressure on foreign reserves,” the report said.

In January, Sri Lanka’s trade deficit narrowed to $ 654.5 million with a 9.1% growth in exports outpacing imports, ending the month with a $ 369.7 million surplus.

As of yesterday, the conflict in the Middle East involving the attacks instigated by Israel and the United States on Iran had pushed Brent crude prices up by 6% to 8%, leading to the price of a barrel costing $ 79.44, and registering weekly gains of around 7-10%.

Sri Lanka's gross official reserves in January, according to Central Bank data, reached $ 6.8 billion, the highest since its economic crisis four years ago. However, reserves are still below the aspirational target of $ 7 billion that was expected to be reached by the end of 2025, as echoed by the Central Bank and the President last year.

“A sustained period of elevated oil prices will directly and significantly increase the national fuel import bill. This will widen the merchandise trade deficit, eroding the very gains seen in January and putting renewed pressure on foreign reserves, which stood at $ 6.8 billion at the end of January,” the investment research unit said in its report.

It further added that a possible deterioration in the current account position could heighten external sector vulnerability and may even reduce the economy’s resilience against future shocks.

“Additionally, global economic uncertainty stemming from prolonged geopolitical tensions could dampen export demand, further constraining foreign exchange inflows and slowing overall economic momentum.”

Addressing possible threats to remittances, it stated that the escalation of the conflict across Gulf economies raises risks to employment conditions for Sri Lankan migrant workers in the region, particularly given that the highest remittance inflows originate from the UAE and Kuwait, amounting to approximately $ 212 million and $ 206 million, respectively.

Highlighting risks to capital inflows, the unit stated: “Furthermore, heightened geopolitical risk and global financial market volatility could reduce foreign direct investment and delay externally-funded development projects, thereby affecting medium-term capital formation and growth prospects.”

source: The Morning