Fitch Ratings expects growth in sales of automobiles, mostly small cars, in Sri Lanka to slow in 2016 due to higher taxes and a weaker currency, which will increase prices of vehicles in the local currency. Tighter regulation on vehicle loans will also impact affordability for buyers.

Registrations of new vehicles increased 375% in the first ten months of 2015 compared with registrations for the full year of 2014, data from JB Securities (Private) Limited, which tracks Sri Lanka's motor vehicle registrations, showed. Around 93% of the new registrations were for small cars. The sharp increase followed a reduction in total import taxes on small cars (with standard engine capacities of less than 1000cc) in February 2015 to 155% of cost, insurance and freight value (CIF), from 173%. A wage increase for civil servants and lower fuel prices in 2015 also spurred demand for small cars, which are
more fuel efficient and affordable.

In recent months, however, the Sri Lankan rupee has depreciated (it fell 5% in September 2015), raising the local currency prices of cars, which are all imported. In September 2015 the Central Bank of Sri Lanka imposed a cap on the loan to value ratio for vehicle loans at 70%. The limit is due to come into effect in December 2015, which will constrain affordability.

The government in its budget for 2016 proposed to increase taxes on vehicles, including small cars, which will increase to around 173% of CIF. In 2012, small car registrations more than halved after the government increased taxes on small cars to 200% from 120% of CIF. New regulation introduced in October 2015 aimed at arresting under invoicing of used vehicles will change the valuation method adopted for taxation of used cars, but will not impact new car importers.

Over the longer term, the government's vehicle policies are likely to be shaped by the outflow of foreign
exchange and traffic congestion. Sri Lanka's international reserves fell to USD6.5bn at end August 2015 from USD8.2bn at end2014.

The country's vehicle imports in the first eight months of 2015 increased 90% from a year earlier to USD905m. Vehicle imports accounted for 7.2% of total imports, up from 4.6% in 2014.

Traffic congestion in the Western Province, where the majority of vehicles are registered, is likely to increase further and experts expect the average commuting speed in Colombo, which is currently 12km per hour, to halve by 2020, highlighting the need for proper traffic planning.