El Niño at a critical global juncture?

El Niño is a naturally occurring climate phenomenon associated with unusually warm sea-surface temperatures, in particular, across the central and eastern tropical Pacific Ocean. The warming changes atmospheric circulation and disrupts normal weather patterns across large parts of the world. The WMO estimates that there was an 80% probability of El Niño conditions developing during June–August 2026, with the probability rising to around 90% for the following months.

Reuters reports that the strong El Niño events of 1982–83 and 1997–98 were associated with estimated global economic losses of around $4.1 trillion and $5.7 trillion respectively. However, the current event is occurring under different circumstances. Global supply chains remain exposed to geopolitical disruptions, while fertiliser and energy markets are already under pressure due to conflicts in the Middle East.

On top of it, the current El Niño conditions are developing at a time where global temperatures and ocean temperatures are already exceptionally high. As a result the WMO expects above-normal temperatures across much of the world during the August–October period, while rainfall patterns are expected to become increasingly uneven.

However there’s a slight counterweight, a positive Indian Ocean Dipole (IOD) is also expected to develop, around the similar period. This occurs when sea-surface temperatures become unusually warm in the western tropical Indian Ocean and cooler than normal in the eastern Indian Ocean. This temperature contrast could change wind patterns and pump more moisture-laden air towards the South Asian region. While a strong El Niño typically promotes drier conditions or suppresses rainfall in parts of South Asia, a positive IOD could partially offset these effects. When both occur together, the positive IOD can cushion El Niño’s drying effects, potentially resulting in heavier-than-expected rainfall or mitigating extreme drought risks during monsoon transition periods.

What are the costs attached to such conditions?

El Niño does not produce the same weather conditions everywhere. Some regions experience drought and extreme heat, while others receive unusually heavy rainfall and flooding. These changes can affect agricultural production, fisheries, hydropower generation, transport infrastructure and energy demand. The economic importance of El Niño therefore comes from its ability to simultaneously affect supply, prices and productivity across several sectors.

The most immediate economic transmission channel is likely to be food prices. The FAO has warned that a combination of geopolitical conflicts, higher energy and fertiliser costs and the effects of El Niño could create a new wave of global food inflation. When droughts, floods or extreme heat reduce agricultural output, global supplies of affected commodities decline, resulting in higher prices. These higher commodity prices can eventually feed into consumer prices for food and beverages.

El Niño can also affect energy markets through both supply and demand. Hotter temperatures increase demand for electricity for cooling, while drought conditions can reduce water availability for hydroelectric power generation in some regions. At the same time, extreme weather can disrupt energy infrastructure and transportation networks. This creates the possibility of higher electricity and energy costs in vulnerable economies, adding another source of inflationary pressure with current energy prices already seeing upward pressure due to the uncertainties around Iran.

How will Sri Lanka be impacted from all this?

For Sri Lanka, El Niño is particularly important because the country is highly exposed to changes in rainfall, agriculture, as well as food and energy costs. Changes in rainfall and temperature could affect the production of agriculture and energy generation. A reduction in domestic agricultural output could add further pressure to the current account by requiring additional imports of goods in short supply. This could also add to inflationary pressures, which have already shown signs of volatility.

In terms of hydropower generation, if El Niño-related weather patterns reduce water availability in strategic areas, Sri Lanka could become more dependent on thermal generation and imported fuel. However significant growth in solar generation still acts as a significant counterweight towards it but still a reduction in hydro still opens up space for a possible increase in costs for energy generation.

The contest has now shifted from what the companies build to what governments will allow. On July 7th Bloomberg reported that American officials are looking at how Chinese firms rent computing power in other countries, which is legal today. That follows guidance issued on May 31st saying a Chinese company needs a licence to buy advanced chips even when the office doing the buying sits outside China.

Washington has changed its mind twice on selling chips to China. In January it allowed the sales, capped at a volume analysts put near a million units. The sales never happened. Security scrutiny from both countries stalled these sales. A bigger rewrite of the rules is now promised before September 30th, and it will take effect immediately, without a comment period.

The argument has since also moved to the usage of Chinese systems by American firms. The administration is considering rules that would stop American businesses and cloud providers from using Chinese AI, in the same way Chinese cars, robots and routers are already blocked. Treasury Secretary Scott Bessent has called the way Chinese firms learn from American systems intellectual property theft. American companies do not agree. Twenty-five of them, including Nvidia, Microsoft, Meta, OpenAI and Google, signed a letter warning that restrictions would push the work abroad. Anthropic did not sign it.

China is finding workarounds for this problem. Beijing has drafted a $295 billion plan for a national computing network running on 80% domestic chips. The difficulties are the factories, the memory supply and the software. One large Chinese firm lost three months of work when it moved from American hardware to a local alternative. The switch is being reflected by the current market share. Chinese chips took close to 41% of their home market last year, roughly half of that from Huawei. Before 2023 foreign suppliers held 90% or more.

America’s position in the race for dominance depends on a very large bet. AI companies produced 85% of the gains in the S&P 500 this year. Data centre building is half of all business investment. More than 80% of global venture money in the first half went to AI startups. That spending ends up at buildings that require copious amounts of power which is currently a major limitation. Bank of America expects data centres to add about 125 gigawatts of American demand by 2030, and the turbines needed to supply it are already spoken for.

What does this mean for Sri Lanka?

The exposure primarily comes through the IT sector. ICT and BPM exports earned $150.49m in June, up 11.31% on the year, while services exports as a whole grew 3.75%. Cheaper machine-written code lowers what clients will pay for the coding and back-office work that produced most of that growth.

The second channel is the data centre plan. Deputy Minister of Digital Economy says procurement is underway to set up AI data centres for local and regional customers, and to earn foreign exchange from them. Sri Lanka AI Week runs from September 28th to October 4th, against a target of $5bn in technology exports.

Looking at the labour market, birth rates are falling and a large share of the workforce is moving towards retirement. Over the medium to long term, it leaves the country trying to grow with fewer people in the working population. This concern raises the question of whether capital can do what labour used to? If the lack of labour results in a situation where growth is affected, could we plug this gap by using AI-augmented capital? Much of this is still unknown, but if this is a possibility it would be a considerable shift from the traditional workflows Sri Lanka is currently used to.

In such a context, how the EU and Chinese decide to play this out remains key not only to the domestic players of the two regions but also to those who lie in between those supply chains that connect the East and West.

What’s the big worry?

Immediate concerns of the EU – similar to the US – is circled around the massive trade imbalance China runs against the bloc which has resulted in increased competition, forced de-industrialization and a number of different issues both lawmakers and businesses in the EU have had to deal with. The EU’s trade deficit with China roughly doubled in five years from 2020 to 2025. In 2025, China’s trade deficit with the region reached a record USD 1.2 Trillion! It was a massive eye-opener for the bloc as ALL member states recorded a trade deficit with the country for the first time. The trend continues into this year as well. According to latest figures, China’s June trade surplus with the European Union reached a record USD 32.9bn, up 27% from a year earlier.

From Europe’s perspective, the core issue is China’s industrial “overcapacity.” China is ramping up production capacity across a number of industries including electric vehicles, batteries, solar technology, critical minerals, and advanced tech enforcing increased competition for EU businesses. Specific countries face specific issues that have put domestic players under pressure. For instance, despite traditionally excelling in the capital goods sector, German manufactures are now under constant pressure as a result of Chinese manufacturing prowess coming into the space. Italy’s metalwork and machinery industry is also facing severe competition and have continuously called for better measures to protect domestic firms.

What looks to be EU’s strategy?

Driven by heavy state subsidies and large-scale production advantages, Chinese companies’ expanding presence in Europe has unsettled European businesses and pushed policymakers in the bloc to respond.

At the last EU summit, leaders gave the European Commission a mandate to develop a diversification instrument aimed at reducing European businesses’ reliance on foreign suppliers for critical goods. Discussions of “global economic imbalances” – a euphemism for the China problem – was a key topic in the recently concluded G7 summit as well. Denis Redonnet, the European Commission’s chief trade enforcement officer says that both structural and contingent trade protection measures have and will be implemented to curb the surge in Chinese imports including anti-dumping and anti-subsidy investigations alongside so-called ‘safeguard’ measures aimed at protecting EU businesses. Tariffs – particularly on Chinese EV’s and closely monitored quality standards continue to play a central role in EU’s protectionist measures.

How may China respond?

China enters into this landscape under heavy scrutiny – not only by its trading partners but also by international organizations such as the IMF and World Bank who have kept a close eye on its structural balances over the years. As a result, the country is also looking to re-shape its economic engine by taking various measures to boost domestic consumption and better navigate its growing surpluses. Alongside the battle against EU, Beijing is also having to deal with high pressures stemming from US as well.

Looking at how the country may respond to the measures taken by the EU, similar to how they did with the US, tariffs seem to sit at the bottom of the retaliatory ladder. Another prominent step taken by the Chinese are the heavy export controls imposed on rare earth minerals - a market that China dominates accounting for roughly 70% of global mining, and 90% of the world’s refining capacity AND could possibly bring European automotive and defense production to a halt within a matter of weeks!

However, given how high-level talks have progressed and the context in which the global trade landscape stands right now, it appears that even though the possibility exists, any extreme measures are just too costly for any party involved.

What does this mean for Sri Lanka?

For Sri Lanka – similar to many players who lie in between these East-West supply chains, the specific policy and trade measures taken by both China and EU could bring about a number of different and new opportunities and costs. For instance, as the EU tightened access to its market through tariffs, export controls and trade defense tools, the possibility of Chinese products flooding local markets is something domestic players might need to keep an eye out for. Similarly, new opportunities and developments may surface particularly to those players who are connected to global trade routes as countries increasingly look to reduce dependency and diversify trade with the intention of long-term sustainability.

We also observe how Sri Lanka’s debt burden, despite being considerably higher than its B- peers, has improved from 2022 numbers, where public debt levels stood above 100% of GDP. At the same time, while Sri Lanka’s interest payments levels are much higher than most economies that have a B- rating, the data of the past 5 years suggest that Sri Lanka has been able to improve its numbers at a faster rate than IMF forecasts.

While the elevated debt burden and interest payment obligations remain key constraints, the focus looks at the pace of improvement and relative performance against similarly rated economies and the possibility for Sri Lanka to receive a credit rating upgrade.

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Our clients would have already received a detailed report to their emails on this; alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 28th of July 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

It doesn’t have to come from an extended war alone. We think the world itself is far too shaky to be in a place of complete stability. Prices spiking one week, markets crashing another week, and even the immediate recovery back are all near certainties in the world of today. However, actual hostilities are still nowhere near the levels seen in April. Even the costs are still well below those levels.

Sri Lanka’s markets haven’t been able to withstand these volatile pressures too well. The currency went haywire in May, electricity and fuel prices have skyrocketed, and the market has even raised its risk premium for long-term interest rates. All this point towards markets that are quite nervous. Sri Lanka’s markets which has been used to heavy government/central bank intervention in the past which possibly took part of the costs, these mechanisms do not exist anymore hence they are seeing shocks move through them this fast.

But things aren’t that bleak on a broader level. In past oil shocks, Sri Lanka needed to heavily borrow from foreign markets to keep economic activity ongoing. The country doesn’t really need to do so anymore. The government keeps earning far more in tax revenue than it can spend, and even with the biggest supply shock in a generation, the economy is still able to meet its own dollar requirements. Even in a context where more shocks materialize, we think markets will take the hit rather than the structure of the economy itself.

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Our clients would have already received a detailed report to their emails on this; alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 28th July 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

The new 10-12.5% tariff. How does it work?

The newly implemented tariffs are based on claims that key trading partners have failed to properly tackle forced labour and are therefore implemented to “punish countries for not doing enough” to reduce forced labour. Consequently, 60 countries, including the UK, China, the European Union, and Canada, will face a tariff ranging from 10% to 12.5% based on the gravity of the claim.

However, US trade expert Caroline Freund said the move is “not about forced labour” but that Trump is simply “looking for a legal reason to put the tariffs in“. The latest tariffs fall under Section 301 of the Trade Act of 1974, which had been used sparingly before Trump’s presidency. This allows the president to impose tariffs if the US Trade Representative has conducted the required investigations and found sufficient evidence of unfair labour practices that affect American commerce. According to Alan Wolff, a senior fellow at the Peterson Institute for International Economics and the former deputy director-general of the World Trade Organization, it is very likely that these latest tariffs will once again be challenged in court.

How will US consumers and importers be affected?

The new duty applies to nearly 99.4% of US imports; however, economists say that the Section 301 duties are less likely to affect inflation and consumer finances, given the relatively lower tariff levels compared to the previous year, which likely already pushed prices up and contributed to inflation. According to Angelo Kourkafas, senior investment strategist at Edward Jones, “the new tariffs are broadly consistent with the previous tariff levels that expired and should not trigger another round of rises in goods prices”. At the same time, a number of importers have already filed lawsuits after the tariffs took effect, arguing they revived a tariff regime the Supreme Court had already struck down.

How other countries have reacted?

The UK government said firms are not likely to face a change in tariffs, given its previously agreed rates around the 10% level. However, a government spokesperson said that matters regarding forced labour are taken very seriously to “ensure that in global supply chains UK businesses are not complicit” in forced labour participation. Brazil called the 12.5% tariff it is facing “unjustified”, while the Japanese government said it regrets the new tariff. Australian Trade Minister Don Farrell said the levies were “completely unjustified”, while China called the move a “political manipulation”.

What does this mean for Sri Lanka?

Sri Lanka stands in a relatively better position than its initial 44% rate implemented during Liberation Day, which was then adjusted down to 30% and later to 20% after a few rounds of negotiations, before finally settling at the temporary 10% global rate. According to the Office of the United States Trade Representative (USTR), Sri Lanka qualified for the lower 10% as it had either adopted/partially implemented, or committed to enforcing, restrictions on imports linked to forced labour. This followed a gazette issued on the 10th of July 2026 by Sri Lankan President Anura Kumara Dissanayake, which immediately prohibited the importation of goods produced wholly or partially using forced labour. The measure followed warnings that Sri Lankan exports could face a 12.5% tariff. The newly implemented 10% rate, therefore, puts the country on an equal footing with its competing exporting peers, including India, Bangladesh, Indonesia, and Malaysia.

What was discussed?

This year’s discussions focused primarily on regional security, maritime disputes, economic resilience, energy security and strengthening ASEAN’s partnerships with major global powers.

One of the most significant issues on the agenda was the South China Sea, where numerous regional nations dispute over territory.Shortly after the 10th anniversary of the historic 2016 arbitral tribunal decision that nullified the legal foundation of China’s expansive claims to a large portion of the South China Sea, the subject has gained fresh attention. Beijing has disregarded the decision and is still standing by its assertions. Foreign ministers expressed concern over continued tensions in disputed waters and emphasized the importance of maintaining peace, stability and freedom of navigation in accordance with international law. The ministers also reiterated the need to accelerate negotiations on an effective and substantive Code of Conduct between ASEAN and China to reduce the risk of future confrontations.

The worsening humanitarian and political crisis in Myanmar remained another key priority. In 2021, after the Myanmar military overthrew the elected government, widespread armed conflict began between the military government, pro-democracy resistance groups, and several ethnic armed organizations. Years of fighting have displaced millions of people, damaged civilian infrastructure, disrupted healthcare and education, and left large parts of the country dependent on humanitarian aid. The ASEAN’s primary diplomatic response has been the Five-Point Consensus, which intended to reduce violation and provide humanitarian assistance. During the recent meeting, ASEAN ministers reviewed the progress made under this Five-Point Consensus and reaffirmed their commitment to facilitating inclusive dialogue, expanding humanitarian assistance and working toward a peaceful resolution of the conflict. While acknowledging the continued challenges, member states stressed the importance of maintaining ASEAN’s engagement with Myanmar while seeking practical avenues for progress.

Developments in the Middle East, particularly the ongoing tensions involving Iran and disruptions to global shipping routes, also featured prominently during the meeting. Ministers expressed concern over the implications for global energy markets and regional economic stability, calling for restraint, diplomacy and peaceful resolution of conflicts. Discussions also explored strengthening regional energy cooperation and improving ASEAN’s resilience against potential disruptions to global oil supplies.

Beyond security, ministers discussed ways to enhance regional economic resilience amid an uncertain global environment. Priorities included strengthening supply chains, improving food and energy security, accelerating digital transformation and expanding cooperation in emerging technologies, including artificial intelligence. The gathering also provided an opportunity for extensive engagement with ASEAN’s dialogue partners. Meetings with the United States, China, Japan, India, Australia, South Korea, the European Union and Russia focused on trade, investment, connectivity, maritime security and regional stability. Amid growing strategic competition between the United States and China, ASEAN leaders reaffirmed the importance of maintaining the bloc’s neutrality and central role in promoting dialogue and cooperation across the Indo-Pacific.

What could this mean for the global economy and trade

The discussions at the 59th ASEAN Foreign Ministers’ Meeting re-emphasized Southeast Asia’s growing importance in maintaining stability across global trade and investment networks. Continued efforts to preserve freedom of navigation in the South China Sea are critical, given that a substantial share of global maritime trade passes through these waters. Progress toward a Code of Conduct could reduce geopolitical risks and provide greater certainty for international shipping and regional commerce.

The emphasis on strengthening supply chains, energy security and digital cooperation also reflects ASEAN’s intention to position itself as a reliable manufacturing and investment hub amid ongoing diversification away from excessive dependence on single-country supply chains. Meanwhile, closer engagement with major economies is expected to support investment flows and reinforce ASEAN’s role as one of the world’s fastest-growing economic regions.

How will Sri Lanka be impacted from all this?

Although Sri Lanka is not a member of ASEAN, developments within the bloc carry important implications for the country’s economy. ASEAN represents one of Sri Lanka’s largest regional trading partners, and stronger economic integration and regional stability could create additional opportunities for exports, investment and tourism.

Efforts to safeguard maritime security in the South China Sea are particularly relevant for Sri Lanka, as smoother shipping routes contribute to more stable global trade flows and lower transportation costs. Reduced disruptions to international energy markets could also help moderate fuel prices, easing import costs and inflationary pressures domestically. As regional investment patterns evolve, Sri Lanka could benefit by positioning itself as a complementary logistics and services hub within the broader Indo-Pacific region.

The shape of China’s economic model

China’s economic model has historically focused on building capacity first and worrying about demand later, with Gross Capital Expenditure accounting for over 40% of GDP - about double that of the United States. A state-dominant banking system has reinforced the supply side through subsidies and credit allocation to exporters and manufacturing sectors, while consumption has remained structurally weak due to contained deposit rates, lower welfare spending, and social behaviors. This imbalance between strong supply and weak domestic demand led China to become a global manufacturing powerhouse reliant on international consumers to absorb its surpluses. Alongside this, policies supporting FDI and massive infrastructure investments - from expressways to telecommunications - reduced logistical costs and strengthened trade competitiveness, while rapid technological transformation and digital adoption across both private and state sectors further propelled China’s rise as a surplus-driven, innovation-led manufacturing giant.

What everyone is worried about

However, over the past few years, challenges around weak consumer spending, shaky confidence and slower growth have surfaced repeatedly creating some level skepticism about the country’s growth momentum that affects pretty much all corners of the world.

Domestic consumption has remained structurally weak causing massive imbalances that have triggered not only domestic authorities but also trading partners and international organizations to rectify policy measures. Even though in recent months, the state has signaled support to boost domestic consumer spending, the data doesn’t really reflect a considerable pick-up as of yet. Part of it could be attributed to slower growth in wages and industrial overcapacity causing some layoffs across factories that has kept spending at bay. However, authorities continue to indicate consistent support even its five-year plan to ramp up spending.

Investment growth is also slowing down with local governments which spent considerably on infrastructure and manufacturing investments now being pushed to cut down costs as excess production capacities and misallocated resources are coming back to haunt them.

The underlying structural changes

As a result of these factors alongside other issues such as ballooning debt and slower growth numbers in some areas, overall confidence about China’s performance has been quite shaky over the past few months. However, while these stories often change with topline numbers, focusing on the underlying structural changes taking place within the economy in the context of the overall changes taking place in the global landscape could be a game changer for those involved.

In addition to consumer goods, advanced manufacturing taking center stage in China’s industrial economy is one such change we see. Increasing investments towards semi-conductors, AI, and advanced equipment have become the prominent feature.

Export destinations are also evolving alongside these trends. While trade with traditional partners in the ASEAN continue to expand, the country continues to move away from being dependent from a single market and strengthen its trade resiliency against a heavily uncertain global environment.

What does this mean for Sri Lanka?

China’s domestic policy and structural changes that could alter its growth trajectory undoubtedly carries global consequences on multiple fronts and thereby, could affect Sri Lanka as well. Given the current context, one such key area are oil prices. For instance, outside of the effects of the Iran war, if China’s demand remains weak, it could reduce global oil demand, which may limit oil price increases caused by geopolitical risks. This in-turn could ease the oil import bill and further assist Sri Lanka’s external current account balance.

Similarly, as Chinese consumers are encouraged to spend more, Sri Lanka stands to benefit from the considerable number of Chinese tourists flying into the country every year. From a tech standpoint, as China continues to drive the tech/AI boom parallel to the US, Sri Lankan players who are connected to tech supply chains could benefit massively as opportunities arise. Overall, as China navigates its domestic challenges in the backdrop of this increasingly uncertain global landscape, any old or new driver that is emerging is set to have spillover effects that could bring forth new opportunities and costs for those even connected even remotely.

We have been bullish on Sri Lanka’s economy for a few years now. We think that the country turned over a completely new leaf after 2022 and now looks like a completely different beast. The government’s coffers are overflowing, the economy generates extra dollars that fatten up the government’s AND the banks’ books, and many companies see new revenue records every year.

Yet this isn’t all that has happened. Shock after shock has hit the Sri Lankan economy across these years too. The country saw once-in-a-generation storms, once-in-a-generation political changes, trade wars, hot wars, and all other flavors of shocks in between. Every single time that Sri Lanka faced a shock like this in the past, the country would have immediately gone back to its worst habits. The central bank would dust off the money printer, the government would force prices down, and everyone would (rightfully) panic knowing that all this would blow up in everyone’s faces.

Sri Lanka may be different now, with all this history, no wonder that markets were so jumpy this year! It’s obviously much harder to believe in a bullish story when history tells you that shocks prevent even the echo of one from being heard. We think markets are pricing in quite a lot of this. After all, “this time is different” is a very very dangerous phrase to base a market call on!

Sri Lanka’s economy has stayed quite strong outside of the immediate costs of the Iran War

Shocks are costly for any economy, especially when they’re as large as the Iran War. Sri Lanka is no different here. It’s just that the costs are now paid by an economy which has BOTH some money saved up in the bank AND an actual income coming into its pockets.

The obvious cost of the war – Sri Lanka’s oil import bill – will certainly reach a new high. But remittances have also been quite strong this year. In fact, if you exclude oil and tourism - the most affected by the conflict - the external current account doesn’t really look so different from last year.

While all this happens on the dollar side, the fiscal front looks to be far stronger. While we might have a different view to others on the size of the fiscal strength, we think most would agree that the fiscal strength exists.

Given the balance of both these fronts and how they have turned out during the first half of the year in the context of these massive shocks, we start to wonder - is the entire economy now different than the past?

Markets probably need more time and proof to believe such a bullish story, especially when the world is misbehaving

With how the currency depreciated in May and how rates shot up in June, it appears that markets don’t seem to have this sort of story as their own baseline. After all, markets simply don’t have the luxury of waiting for a long-term story and have to deal with the messiness of the real world. Unlike those of us who can pontificate from afar, market participants actually have to deal with the day-to-day reality of doing business and making investments during these world-shaking shocks.

However, we think a lot of Sri Lanka’s underlying story has been masked by all these shocks and at least some level of masking will continue. Yet, despite these shocks, the economy has been beyond resilient. As more and more data comes through that shows this, we think it becomes harder and harder to hold the view that Sri Lanka goes back to where it was.

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Our clients would have already received a detailed report to their emails on this; alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 30th June 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

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Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

We explore how these underlying improvements are likely to shape growth conditions, government finances, external balances, reserve accumulation, and private sector credit expansion over the coming years. While external volatility remains a key risk factor, we believe the strength of Sri Lanka’s fundamentals means that future shocks are more likely to be reflected through market variables such as the exchange rate and interest rates, rather than a return to the macroeconomic imbalances of the past.

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Our clients would have already received a detailed report to their emails on this; alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 30th of June 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

The ceasefire deal that brought about stability in the region remains in doubt. Speaking at the NATO summit in Ankara, President Donald Trump declared the ceasefire over. The US Treasury has revoked the licence that allowed Iran to sell crude through August 21st. Neither government however has formally withdrawn from the Islamabad Memorandum of Understanding, and both still have negotiators working on a deal.

Markets have repriced accordingly. Brent crude climbed 3.3% in early Monday trade to $78.50 a barrel, up from a recent trough of $70.14 resulting in a 5.4% gain last week. American crude, on the other hand added 3.4% to reach $73.83. Stock markets slipped across Asia. The US dollar has strengthened along with bond yields as investors now bet on the Federal Reserve increasing interest rates to counteract rising inflation. The headline rate is expected to cool down from 4.2%, by falling fuel prices, though rising crude might undo these expectations.

Gold behaviour throughout this year makes it seem like it has stopped behaving like a safe haven asset. Gold prices fell as much as 1.4% on Monday to near $4,060 an ounce, and it also fell on the day Iranian missiles struck a Qatari LNG carrier. One reason this could be the case is as a result of interest rate expectations in the US. Higher energy prices feed into inflation, and investors are likely betting that the Fed will respond by raising rates. That expectation does two things. It suppresses long-run inflation expectations and since the market believes the central bank will act, nominal yields rising while expected inflation falls will cause real yields go up. Long term government securities, become a more attractive haven than non-interest-bearing assets such as gold, which could partly explain the dip in prices.

Given the current circumstances, it looks like the Strait of Hormuz again is neither open nor closed. Iran’s newly created Persian Gulf Strait Authority says transit is not currently possible; CENTCOM says the strait is open and traffic is flowing. American officials said some 20 vessels had been escorted through in the previous 24 hours, while ship-tracking services showed little movement.

The mediators are working on the sidelines to restore stability in the region. Oman, which has been hosting Iran’s foreign minister to discuss safe passage through the strait, summoned Tehran’s ambassador on Sunday to protest at drone attacks on its own territory. Qatar, which hosts the talks experienced one of its LNG carriers struck by Iranian missiles on July 7th. Pakistan is urging restraint.

What does this mean for Sri Lanka?

The import bill is one to keep an eye on. Fuel cost the island $886m in April and $536m in May, up 112% year-on-year; between January and May it spent $2.7bn on fuel, roughly two-thirds of its entire 2025 oil bill in five months. Additionally, the Rs20-a-litre cut to petrol on July 1st, the first since the war began, came in after global prices eased in the weeks before it. Given that this easing has now reversed what will happen to fuel prices locally will depend on how far global prices climb and for how long. If prices continue to increase as much as they did in March, it will inevitably result in elevated prices at the point of purchase.

The strikes began merely six days ago, making it difficult to pinpoint the implications the Sri Lankan economy may or may not face as a result of this renewed escalation. Whether it does at all depends on things not yet knowable such as whether Oman’s two-route proposal will be accepted by both parties or whether Iranian officials meant it when they privately told Washington the ship attacks were a mistake.

A broad-based slowdown across the bloc

It is worth noting that there has been a spread in disinflation across the Eurozone with Germany experiencing a 2.3% inflation in June from its 2.6% in the previous month. The Federal Statistical Office of Germany attributes much of this drop to fuel-duty cuts introduced to reverse the war-driven price spike which resulted energy inflation dropping from 6.6% to 3.4% in June. France also experienced a similar trend with its June inflation slowing down to 2.0% from 2.8% well below the 2.3% forecast. INSEE and AFP point these numbers to lower energy costs “after oil prices retreated amid easing concerns over Middle East supply disruptions,” with services inflation also cooling to 1.8%.

However, Spain inflation for June held flat at 3.6% unchanged from May with core inflation also remaining sticky indicating that underlying price pressures have not reduced completely. For Spanish households, the steady inflation rate means that purchasing power remains under strain, especially for lower-income families. The steady price pressure could keep European Central Bank (ECB) on alert and maintain pressure on household budget.

What this means for the ECB’s July 23 rate decision

ECB recently delivered its first-rate hike since 2023, in June due to expectations of further energy shock to spill over into broader inflation. However, with the most recent inflation numbers, Reuters reported that multiple policymakers, on and off the record have said “there’s no rush” for another hike in July following June’s quarter-point rate hike, despite June’s inflation reading still staying well above the ECB’s 2% target. The ECB is concerned that the initial energy shock could start pulling up prices of other goods and services, eventually spilling into wage push inflation as well. However, economists point out that such second-round price effects and wage pressure have not materialized supporting the stance for a rate hold.

There is still an expectation of a one more rate hike in September or October, since energy prices could remain well above pre-war levels and with uncertainty on the peace-deal between Iran and the US over the Middle East situation. There are also worries on the side of Agricultural supply with the shortage of fertilizer as a result of the Middle East conflict and the European heatwave reducing crop yield that could put upward price pressure on food, lifting inflation despite fall in energy prices.

At the time of writing this piece, the ECB Watch, point to a 96% probability of a rate hold at its current deposit facility rate at 2.25% and a 4% probability of a 25-bps increase to 2.50% for the July 23^rd policy decision signaling the market implied stand on the ECB’s policy decision.

What does all this mean for Sri Lanka?

The fall in global oil prices would have a significant favorable impact on the country’s rising oil bill. With fuel imports bill spiking at USD 630 million in March and USD 866 million in April before reducing to USD 536 million in May, a fall in global oil prices would positive impact Sri Lanka’s current account and a similar negative pressure on Inflation with CCPI rising to a 3-year high in June.

A fall in Europe’s consumer prices would also further reduce domestic inflation as a result of reduction in prices of Sri Lanka’s imports from EU which accounts for about USD 1.15 billion worth of goods annually. A fall in global oil prices would also have easing pressure on the rupee, which has depreciated 7% so far this year, possibly bringing more positive macroeconomic dynamics into the economy since the start of the Middle East conflict earlier this year.

What prompted Brexit in the first place?

The UK’s relationship with the EU has been anything but a smooth ride. Ever since joining the European Economic Community (ECC - a six-member trading bloc back then) in 1973 as result of slow economic progress, there have been multiple efforts by many parties to reverse course and take the solo path. Heavy scepticism towards deep integration with the EU was the main driver here. Given the scale of the UK economy back then compared to the rest, much of the bloc’s growth was mainly driven by the UK and this had mixed sentiments with some advocating for, while many claiming that this undermined the countries’ potential for growth. For instance, data from the Centre for Economic Policy Research (CEPR), indicated that Britain’s GDP per capita was almost 30 percent higher than that of the EEC nations in 1950, yet by 1973 it was roughly 10 percent lower.

Constant pressures by multiple parties including MPs within his own Conservative Party prompted Prime Minister David Cameron to take a gamble and re-visit the UK’s involvement with the EU by calling the referendum on EU membership in February 2016. The results turned out and the electorate had voted to leave the bloc by 52% to 48%.

The promises of the campaign were simple - “take back control” of immigration, restore the country’s sovereignty, free up more money for the country’s health service, and forge trade deals with the rest of the world with the hopes of boosting economic prosperity.

How is it looking now?

Ten years later, as the data suggests, the economy has shaped to be quite different as a result of the move AND the rapidly changing global landscape on top of multiple shocks including the Covid-19 outbreak, the energy shock as a result of the Russia-Ukraine war in 2022, Trump tariffs and a bigger global energy shock as a result of the US-Iran war that are all outside of UK’s control.

However as far as Brexit alone is concerned, the results have not been very euphoric as promised. In terms of growth, the country hasn’t really picked up dramatically. Growth has been fairly contained and remained at levels similar to other EU countries such as Germany and France. Investments have not done dramatically well either, due to years of political or regulatory uncertainty. Employment and Productivity have also seemed to take a hit due to a combination of elevated uncertainty, reduced demand, diverted management time, and increased misallocation of resources from a protracted Brexit process.

Despite the promise to “take back control” of immigration, The UK now has net emigration with EU countries, but migration from non-EU states with work supply shortages, increase in international students, and emergency visa schemes extended to countries such as Ukraine. Similarly, studies show how the Sterling Pound, trade, inflation and equity markets have also indicated a downturn due to Brexit and a combination of other shocks that has changed how the economy has fared over the past decade.

Despite all of this, the UK continues to play a major role in the global economic landscape while maintaining its place among the top five economies and contributing to much of the world’s consumption and overall demand. The country has persistently made efforts to revive trade, attract investments, resolve social barriers and establish stability. In its latest sign towards change, the country is set to appoint Andy Burnham as the next Prime Minister who vowed on Monday to deliver radical change to the nation’s politics, pledging to give away a chunk of his power by handing greater autonomy to local leaders in a “circuit-breaker” for the sclerotic British state.

What could this mean for Sri Lanka?

As one of Sri Lanka’s largest trading partners, the UK plays a critical role in Sri Lanka’s foreign exchange earnings both in terms merchandise trade as well as service exports, Tourism in particular. As Sri Lanka re-builds and continues to gather momentum in terms of economic stability, strong demand conditions from its trading partners remains key to amplify exports and attract investments. Outside the traditionally known areas such as exports and tourism, the UK over the years, has evolved to become a key destination for Sri Lankan migrant workers as well. By end 2025, the UK stands as the third largest country in terms of remittances inflows to the country. It has, and still is contributing massively to sustain the performance of worker remittances despite the war in the Middle East.

Therefore, any demand slowdown that could possibly take place - outside of the effects of the Iran war - due to higher inflation, lower productivity or any other factor could affect Sri Lanka as well. In that sense, keeping an eye out for any domestic policy changes subsequent to these political and economic reforms taking place is advisable particularly for those operating in international markets.

Since the Middle East went to war, a major oil supply route was under threat, and rising inflation has become a cause for concern across multiple economies, including Sri Lanka. These are conditions under which gold has historically performed well. It has not done so this time, at least not in the way many expected. Gold prices started falling a short while after the war began following which it recovered partially and has since been oscillating in a range that might seem like it lacks a clear directional movement. Is this the beginning of a longer decline in gold prices, or a temporary disruption before returning to its elevated nature, though not as strong as the rally experienced in 2025?

Given this context, Sri Lankan institutions in particular that lent at higher loan-to-value ratios during gold’s rally in 2025 are potentially at risk of any sustained downward adjustments of gold prices. This concern is greatly present in the LFC sector, where lending practices are less uniform, loan-to-value ratios have historically been higher, and the borrower base is more financially vulnerable.

Our clients would have already received a detailed report to their emails on this. The full report has also been accessible on our Athena reports platform since the 5^th of June 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

In addition to the leaders of the G7 member states and representatives of the European Union, French President Emmanuel Macron extended invitations to several prominent figures. Notable attendees included Indian Prime Minister Narendra Modi, Ukrainian President Volodymyr Zelenskyy, and the heads of government or state from Australia, Brazil, Egypt, South Korea, Kenya, Qatar, and Saudi Arabia. The summit also welcomed leading figures from the technology industry, reflecting the increasing prominence of technological innovation in global policymaking. Among these participants was OpenAI Chief Executive Officer Sam Altman, whose presence underscored the growing significance of artificial intelligence in international discussions.

History of the G7 Summit and its significance

The Group of Seven (G7) is an informal forum comprising seven of the world’s major advanced economies: Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. Established in 1975, the G7 serves as a platform for leaders to discuss and coordinate responses to global economic, political, and security challenges. This year marks the 52^nd edition of the summit, which has brought Évian to the centre of international diplomacy, 23 years after the city hosted the 2003 G8 Summit. The forum serves as a crucial platform for policy coordination among member states and for addressing pressing financial, geopolitical and other challenges affecting the global economy.

What was discussed?

This year, the summit focused on issues such as international security, economic stability, artificial intelligence, climate-related challenges, and global cooperation, highlighting the G7’s continuing role in shaping international policy and fostering multilateral dialogue.

In particular, the Ukraine war had been a key topic of discussion. It has been reported that President Trump had showed a “real change in approach” in this regard as the G7 leaders issued a joint statement that expressed a unified commitment to further supporting Ukraine and preserving its territorial integrity, while also agreeing to impose further sanctions on Russia. On a similar note, the leaders expressed their support for U.S. President Donald Trump’s preliminary agreement with Iran aimed at reopening the Strait of Hormuz and extending the fragile ceasefire currently in place. They viewed the arrangement as a positive step toward reducing regional tensions and promoting stability in the global economy. In this regard, discussions were also held on seeking possible alternatives to reduce the reliance on the Strait of Hormuz, which accounts for around a fifth of all of the world’s crude oil passage.

Besides security, the participants also held conversations about the topic of artificial intelligence and its future. During the summit in Évian-les-Bains, G7 leaders engaged with leading figures from the artificial intelligence sector, including Sam Altman of OpenAI, Demis Hassabis of Google DeepMind, and Dario Amodei of Anthropic. The discussions examined approaches to leveraging the opportunities presented by artificial intelligence while mitigating associated risks through effective governance and regulation. French President Emmanuel Macron emphasized that both governments and businesses can no longer overlook the profound impact that artificial intelligence may have on democratic institutions and society. On the other hand, OpenAI Chief Executive Officer Sam Altman called on governments to play a leading role in establishing regulatory frameworks for artificial intelligence. He noted that the debate surrounding the usefulness of AI has largely been settled and emphasized that increasingly advanced AI systems are expected to emerge in the years ahead. The leaders also considered the establishment of a “trusted partners” framework that would allow non-U.S. countries access to advanced artificial intelligence models developed by American firms such as Anthropic. In a joint statement, they announced that finance officials, regulators, and cybersecurity experts would be assigned to evaluate the potential effects of frontier AI systems on financial stability, productivity, and labour markets.

Furthermore, similar to past G7 summits, the influence of China on global markets was reviewed again in this year’s summit. China unsettled the global economy last year when certain industries were brought close to a standstill after Beijing introduced export restrictions on rare earth permanent magnets, which highlighted the extent to which Western supply chains in the energy, defence, and technology sectors depend on these materials. As such, the G7 countries committed to enhancing coordination to reduce reliance on China for critical minerals, including efforts to align stockpiling policies and develop a new platform with an expanded mandate for the International Energy Agency.

What could this mean for the global economy and trade

In general, the 2026 G7 Summit in Évian focused on stabilizing global energy markets, strengthening supply chains, and managing trade imbalances. The most immediate impact on the global economy is likely to come from the US–Iran peace deal reopening the Strait of Hormuz, which could ease oil prices and reduce inflationary pressures worldwide. However, a considerable amount of uncertainty continues to loom over the global economy, as President Trump threatened to order further military action in Iran, if there is any violation of the present agreement.

How will Sri Lanka be impacted from all this?

Eventhough there were no direct discussions on Sri Lanka, the discussions and commitments at this year’s G7 summit could have certain implications on the Sri Lankan economy. In particular, falling oil prices associated with the increased possibility of a more stable US-Iran ceasefire agreement can aid growth in demand, and improve chances of the island nation continuing its growth trajectory for 2026. There might also be knock-on benefits should the India=US trade agreement materialises fast, given that both these nations are significant trading partners of Sri Lanka. In addition, given the emergence of the IT sector as a strategic sector within Sri Lanka, the future of AI and how regulators of these advanced G7 economies govern AI would be of considerable relevance to local stakeholders.

What precisely has been agreed, however, is a question to which no complete answer can yet be given.

The Known Knowns

The framework of the announcement is at least clear in a broad sense. President Trump declared an end to the United States naval blockade of the Strait of Hormuz. Iran’s deputy foreign minister confirmed that the text of a memorandum of understanding had been finalised and would be signed on Friday. Prime Minister Sharif was unequivocal. All military operations have been declared immediately and permanently terminated.

The Known Unknowns

Three issues stand above the others in their ability to determine whether this agreement holds.

Trump’s initial declaration of an immediate, toll-free opening and the removal of the naval blockade has now changed to be contingent on the Friday signing and initially limited to mine removal. Iran’s state media reported that the memorandum calls for reopening within thirty days under “Iranian arrangements,” which creates considerable tension against the American stance that no single party would control the waterway. The UK, France, Germany and Italy have quickly added that any reopening must be unconditional and accompanied by unrestricted freedom of navigation. The question of authority over the strait remains uncertain.

The second unresolved matter is Lebanon. Prime Minister Sharif and Iranian deputy foreign minister Kazem Gharibabadi both explicitly mentioned that the ceasefire will cover all fronts, including Lebanon. Trump, however has made no mention of Lebanon. Israel, which has not been in favour of the Iran negotiations, have not officially responded to news of the deal and struck a building in Beirut’s southern suburbs on Sunday, killing three and injuring six. Prime Minister Benjamin Netanyahu arguably has his own domestic political reasons to continue pursuing conflict with Iran and its proxies, including Hezbollah. The question of the durability of any arrangement that does not formally bind Israel remains uncertain.

The third, and arguably most consequential, known unknown is Iran’s nuclear programme. Nuclear negotiations are set to continue over the next sixty days, with the threat of renewed military action if talks fail. Iran has not publicly committed to surrendering its enriched uranium which amounts to more than 400 kilograms at near bomb-grade purity, held across three sites which are damaged due to American strikes. The UK, France, Germany and Italy group have stated their willingness to lift relevant sanctions in exchange for “ clear, verifiable steps by Iran on its nuclear program”. The question of what those steps would look like, and whether Iran will accept them remains uncertain.

What does this mean for Sri Lanka?

The most immediate impact would be on the import bill. Sri Lanka lately has been spending a considerable amount on petroleum related imports. A sustained fall in global oil prices, which the reopening of the Strait of Hormuz would produce reduces that outflow, strengthening the current account further and relieving pressure on the rupee. A more stable rupee and a cheaper import bill can dampen imported inflation which has been a significant component of Sri Lanka’s recent inflationary pressure, given the economy’s dependence on fuel for transport, electricity generation and industrial activity. Headline inflation can be expected to trend downwards in the near future.

The fiscal side has remained largely insulated from the Middle-Eastern tensions. Even so, lower global prices reduce the political pressure to subsidise which in turn protect the current primary surplus that the IMF programme requires Sri Lanka to maintain.

The known unknowns however pose risks to the positive implications the peace deal can have on the Sri Lankan economy. Until the memorandum is signed, the situation in Lebanon is made clear, the nuclear issue is addressed, and the Strait is unconditionally open, the peace deal, at the time of writing leaves us with more questions than clear cut answers.

This month, Frontier’s focus turns to what this means for 2026 and 2027. The fundamental drivers underpinning consumer momentum; private sector credit expansion, rising formal sector activity, improving household incomes, and an upward shift in consumer preferences, remain broadly intact. At the same time, the price dynamics introduced by the US-Iran conflict represent a near-term disruption, and our analysis examines how this interacts with an otherwise strong consumer trajectory.

A key theme in this month’s report is what we characterize as consumer “upshifting”; a discernible movement across income brackets and consumption tiers that we believe is now structurally underway. We explore how this transition is unfolding across different segments of the population, where it is most concentrated, and how cost pressures may temporarily alter, without fundamentally reversing, its direction.

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Our clients would have already received a detailed report to their emails on this; alongside the numbers we associate with each of these varied scenarios. The full report has also been accessible on our Athena reports platform since the 29th of May 2026. If you still haven’t had a chance to read through it, click here! If you are yet to be a subscriber, please do get in touch with us for a trial subscription to our reports at clientconnect@frontiergroup.info.

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Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

Part of this is also due to the current war, which we see two broad pathways where the could unfold. In one avenue, a prolonged limbo that gradually deescalates is possible, where escalations exist but at much lower intensity than in the last few months. In the other, a sharper but shorter escalation precedes a new normal settling in. We think both scenarios still carry significant costs, with the broader impact differing across the two pathways but creating volatilities nevertheless.

Given that May was largely an eventful month with the currency spiking to 350, a 100 bps CBSL rate hike, and market rates rising nearly 150 bps we believe all of this looks like an overshoot driven by sentiment, while the fundamental story, we feel, still holds enough firepower to correct these spike movements. Given the economic performance of the Sri Lankan economy over the few months and years fundamental strength remains the centerpiece of our view.

Factoring all of this we hold the current view that the present context reflects an accumulation of negative shocks, which we view as interruptions rather than structural reversals from Sri Lanka’s economic trajectory. That said, we do not rule out the possibility that risks remain, with significant knock-on effects worth watching — including further Iran War escalation with rapid intensity, Middle East supply destruction, and weather-related and geopolitical shocks that could leave a meaningful dent on the new fundamental trajectory.

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Disclaimer: Information collected/analyzed is from sources believed to be reliable or from the Central Bank/Government. Frontier Research Private Limited however does not warrant its completeness or accuracy. Opinions and estimates given constitute our judgment as of the date of the material and are subject to change without notice. The reports and presentations given are not intended as an offer or solicitation for the purchase or sale of any financial instrument. The reader must make their own independent decision regarding any securities or financial instruments mentioned herein. Securities or financial instruments mentioned may not be suitable to all investors. This communication including any attachments contained herein is governed and bound by the “Confidentiality and Disclaimer” detailed and available for your specific reference at our corporate website.

The latest update by the World Meteorological Organization (WMO) indicates an 80% likelihood of an El Niño event during June-August 2026 with over a 90% probability of it continuing until at least November this year. While this is not the first time the world faces an El Niño condition, the alarming feature is the intensity of it compared to the past and the possible implications it could enforce on the world economy that is already dealing with a lot currently.

What is El-Nino and how has it occurred in the past?

El Niño is a climatic phenomenon distinguished by intermittent increases in sea surface temperatures within the central and eastern equatorial Pacific Ocean. Its occurrences are sporadic, typically happening every two to seven years, and it possesses extensive consequences to worldwide weather patterns. When the sea surface temperatures in the eastern equatorial Pacific Ocean is relatively warmer compared to the central equatorial Pacific Ocean, these conditions are known as “El Niño” conditions. When the reverse is true, these are known as “La Niña” conditions.

Simply put, shifts in rainfall and temperature patterns across continents, raise the likelihood of drought in some regions and floods in others. Those meteorological shifts then cascade down to agriculture, energy, health and go all the way down to the social lives of people causing broader demand and supply disruptions that may alter the economic trajectory of countries.

The last El Niño, in 2023 to 2024 – which meteorologists said was strong, ⁠contributed to making 2024 the hottest year on record, said WMO Secretary-General Celeste Saulo. Predictions by the UN Agency at the point of writing this piece indicates the upcoming El-Nino phenomenon to be “at least moderate – and possibly strong”.

While each El Niño event is unique in terms of its evolution, spatial pattern and impacts, the broader perspective for the South Asian region signals below average monsoon rainfall and above average temperatures according to the South Asian Climate Outlook Forum.

How can it affect the current economic landscape?

Farmers, fishermen and small-scale producers often absorb the first blow. Be it floods or draught – depending on which part of the world one is at – severe disruptions to the harvest, spreading of pollutants and increased risks to cultivations may be common.

In the event of a worse-case scenario, commodity markets which are already facing steep ups and downs, can face further price volatility even amidst moderate disruptions – particularly across fertilizer, fuel and agriculture commodities. Supply disruptions due to lower yields may push farm costs up and reduce food supplies that could weigh in food inflation. Low rainfall could also impact energy generation and fuel prices may experience further spikes causing more stress on vulnerable economies – particularly those in dry regions and rely heavily on hydro. Consumer markets may also face some level of demand destruction especially in non-essential spending if energy prices bite into inflation and raise everyday cost of living which are already on the rise in many countries.

A combination of these costs could further dampen growth which is already revised down as a result of the most recent oil supply shock. Depending on how bad the situation gets, governments may also enact export controls, subsidies, rationing or emergency imports which could possibly distort markets and cause distress in the short term. Given the volatile and heavily uncertain nature of the current global economic context, a severe climate disruption of a large scale – as most expect – would be the last thing the economy would welcome.

What this means for Sri Lanka?

As we’ve repeated many times before, the structural change in Sri Lanka’s macroeconomic landscape has now put the economy in a better footing to deal with external shocks like this than in the deficit driven past. A good example of this is how the country remains resilient currently despite the effects of arguably the biggest oil shock it has faced. While strong Fiscal space and FX surpluses serve as strong buffers to shield the country from the costs of such events, it doesn’t mean short-term pains are out of the picture.

Yes, the government does possess better ability to amplify relief efforts and increase imports if disruptions happen but maintaining growth and stable price levels remains key within the country’s broader macroeconomic trajectory. The structural changes taking place in the country’s energy mix and inflation are also factors that could support therein, helping the country to better deal with a El-Nino condition.

What caused this rise? What has been the impact within US so far?

US inflation surged to its fastest pace in three years in April, as the ongoing US-Israel war on Iran continued to strain global energy markets and squeeze household finances. The Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index rose 3.8% year-on-year, up from 3.5% in March, according to the Bureau of Economic Analysis. On a monthly basis, PCE gained 0.4%, following a sharper 0.7% rise in March. The primary driver of this raise remains energy prices. The national average retail gasoline rose by 12.3% in April alone, with prices at present being at USD 4.42 per gallon, a 48% increase since hostilities began on 28^th of February. Food prices rose by 0.5%, which was the steepest monthly climb since November 2022, while housing and utility costs rose by 0.6%. Core PCE which excludes food and energy too saw an uptick rising 3.3% year-on-year, which signals that inflationary pressures are beginning to impact beyond the energy sector.

The impact of this is mostly felt by households. Real disposable income fell for a third consecutive month in April, consumer savings fell to 2.6% of disposable income; their lowest level since June 2022. First-quarter GDP growth was revised down to 1.6%. With tax refund season drawing to a close, economists warn that consumer spending, which accounts for over two-thirds of US economic activity, is likely to decelerate further. The timing of this data is crucial as the Federal Reserve intends to hold its first policy meeting under its new Chair Kevin Warsh on 16^th and 17^th of June 2026. The reality is that the Fed’s options are constrained. Raising interest rates could dampen demand but cannot resolve the ongoing supply disruption from the US-Iran war. Retaining the rates as is, would risk inflation expectations to become unstable. The minutes from the April policy meeting indicate that many officials are in favour of a rate hike despite the slowing economy and weakening consumer spending.

Markets now expect the benchmark rate to remain in the 3.50 - 3.75% range well into 2027, with JPMorgan Chase flagging the possibility of a rate hike rather than a cut by mid-2027. Long-term Treasury yields; already at their highest since 2007 suggest markets are pricing in prolonged uncertainty without waiting for the Fed to act. The burden of the above lands on Kevin Warsh as he is challenged to not only changing or retaining rates, but to ensure inflation targeting of the Fed be cohesive and reliable without causing further damage to the US economy.

What are the ripple effects of this outside of the US?

One of the key components that saw an immediate impact were commodities, specifically Gold; whose prices dropped on Thursday following the release of the US inflation data. However, the metal was momentarily declining for a third straight session given the scepticism of the US-Iran deal. While this isn’t a long-term impact to the commodity itself, the current trend seen in gold acts as a symbol of the confidence in capital markets within the world at large.

The global economy is not immune from PCE inflation data either. Experts note that price pressures have continued to compound following the COVID-19 pandemic, the PCE data can well exceed the 4% mark by May of this year in this current trend. A majorly impacted sector is food; planting seasons are disrupted by food shortages which is pushing nations affected to ration certain commodities and goods such as cooking oil. Oil-producing countries too are affected, in that many lack the ability to refine oil which means they are unable to leverage their own resources. The spillover effects from the war and resulting inflation can move into 2027 if this continues.

International institutions such as the IMF in their Spring Meeting 2026 has noted that the world economy is drifting from the best-case outcome as per their projections. Which means they expected global growth to be around 2-3% and inflation to be in the 4-6% range. However, not all is bleak. Even if the conflict were to conclude this week, the shortage in oil is said to be comparable to the 1970s in terms of how much oil has been withdrawn from the market, but the world is not as dependent on oil as it was in the 1970s and central banks at present have built robust inflation-targeting frameworks. All of these factors help in maintaining expectations a lot more cohesively than decades ago. Despite the challenges, what is suggestive from all expert opinions is that the world economic systems are better geared to withstand the absolute worst outcomes in comparison to the past. While a shock to different sectors will take place, the ability to bounce back is stronger now.

Can Sri Lanka be impacted from this?

The impact from US’s PCE data is two sided. On the negative end, with the latest domestic CCPI inflation data of Sri Lanka coupled with PCE inflation data of the US, the impact is already seen in oil prices and is impacting many industries’ costs of production. This trend can last for some time provided the war continues and no resolution is reached. However, there are two pathways that counterbalances or softens the blow.

One aspect is the IMF’s Extended Facility Fund which is expected to disburse USD 695 Mn to Sri Lanka. The basis for this disbursement is the strong performance of Sri Lanka’s economy where the country met all end-December 2025 targets which resulted in a strong fiscal front. Overall, most of the structural benchmarks were met or completed with a short delay. However, it was flagged that the ongoing war coupled with the aftermath of the cyclone Ditwah can dampen the outlook to an extent, but the progress so far suggests a never before seen resilience in the economy at large on a macro-level. At the same time, the disbursement alone helps prevent adverse outcomes on the currency as well.

The second pathway is the structural changes in energy dependencies in the economy. Many households and some industries are moving towards renewable energy such as solar power. While the economy as a whole is still very much oil dependent, the trend from a household level does build the case for some cushioning on energy moving forward. If this trend grows and expands with greater investments by the public and private sector, it could improve the resilience of the energy sector.