Impact from the financial markets channel

▪ The effect of Britain’s EU referendum results on international financial markets would be a key channel of impact for Sri Lanka, as the external commercial borrowing environment becomes more volatile.

▪ The immediate volatility and uncertainty in currency and equity markets across Britain, Europe and Asia are at levels not seen since the 2008 financial crisis. At that time too, Sri Lanka was caught in the global storm and despite no direct impacts, had substantial indirect impacts. Sri Lanka now is much more exposed to international markets than at that time and therefore would face impacts through this channel.

▪ In an already volatile external environment, this poses substantial risks. Generally, in times of volatility, investors would tend to stay away from frontier and emerging markets like Sri Lanka and go to safer assets. This would include the USD, and any appreciate of the USD would also affect Sri Lanka.

▪ The IMF funding package is timely, then, as the country’s external reserves are provided some cushioning.

Impact from the trade channel

▪ According to the latest data, Sri Lanka exports 10% of our exports to the UK (around USD 1 billion) and 28.8% of our exports to the EU (around USD 3 billion)

▪ If the estimates from various expert groups on the impact of Britain’s exit on the British economy are correct, the impact on the health and dynamism of the British economy will be substantial and that will no doubt have impacts on Sri Lanka’s trade with Britain.

▪ In the medium-term, the impact on economic activity and dynamism in Britain and Europe would impact on the markets for our exports there. Britain is a substantial market for other EU countries, and any reduction in their export earnings and overall incomes would affect their demand for imports.

▪ The negotiations around the terms of Britain’s new engagement with Europe are likely to take a couple of years, and so the full impact on international trade is yet to be seen. We need to see what sort of a new trading arrangement Britain would have with the rest of the EU, in order to calibrate its own new trading arrangement with Britain, as the GSP Plus scheme will no longer include Britain.

Moving Forward

▪ All this further reiterates the need for Sri Lanka to aggressively pursue diversification of export markets (including through new trade agreements), create a conducive environment for our businesses to thrive and be agile in a volatile environment, and take measures to boost the competitiveness of our exports.