Boston, MA -- (SBWIRE) -- 07/09/2013 -- Recent developments, such as the impeachment of a chief justice and the government's inaction on political reconciliation with the Tamil minority, have only bolstered our view that the political unassailability of the ruling United People's Freedom Alliance greatly increases the risk of government overreach.

Sri Lankan exporters are feeling the effects of the EU's decision to withdraw preferential tariff benefits to Sri Lanka. The ruling government's inadequate progress on the human rights front suggests that these privileges are unlikely to be reinstated any time soon.

We expect weakness through H113 and are maintaining our forecast for 6.4% full-year real GDP growth in 2013.

Economic tailwinds such as falling global oil prices and loose monetary policy from the central bank are likely to see economic conditions improve in the latter half of the year.

We believe the Central Bank of Sri Lanka (CBSL) will focus on economic growth over the coming quarters. We are projecting 100 basis points worth of additional easing in 2013, taking the reverse repo rate to 8.50% by end-2013. Crucially, the CBSL's annual road map signals further loosening of monetary policy in the months ahead.

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While we continue to expect further rupee strength, currency stability is likely to be the overriding theme after a fairly volatile 2012. The CBSL explicitly expressed exchange rate stability as one of its policy priorities in its annual road map, reiterating its willingness to intervene if need be.

The government aims to narrow the fiscal deficit to 5.8% of GDP by end-2013; however, we believe the amount of fiscal consolidation will likely be minimal at best. That said, the government's recent decision to hike electricity tariffs bodes well for the country's shortto- medium term fiscal position.

While the country's overall business environment remains mediocre from a pan-Asian perspective, we cannot ignore the rapid and dynamic changes taking place in its regulatory framework, which indicate that its business environment is making significant strides.

Major Forecast Changes

The extreme pace of disinflation and a slowdown in broad money supply growth has led us to downgrade our consumer price inflation projections. We now forecast inflation to average 6.5% in 2013, down from 7.5% in 2012.

We have marginally upgraded our end-2013 rupee target to LKR123.00/US$.

On the back of the government's latest decision to hike electricity tariffs, we have marginally upgraded Sri Lanka's fiscal deficit projection to 6.0% for the year.

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