Quick Update – Don't rule out a possibility where movement of rupee and rates are "contained"

Sri Lanka’s financial markets have been experiencing modest pressure following the outbreak of Operation Epic Fury in the Gulf region roughly two weeks ago. Despite significant military exchanges and shipping disruptions driving oil prices past USD 100 per barrel, the Sri Lankan rupee has depreciated by only about 0.56%, slightly less than the 0.7% seen during a comparable 12-day conflict last year. This as a relatively contained reaction, particularly if the conflict proves to be short-lived.

A key reason for this resilience is the strong external position Sri Lanka enjoys. Inflation is also expected to remain manageable given that it had been running well below the CBSL’s 5% target prior to the conflict and any upward movement here could be contained.

The topline message for now is that if things do turn quite rapidly as we suggested in our full note, oil prices could snap back pretty quickly too. Alongside that, other fundamental factors encouraging a significant rebound indicate that if resolution comes faster and more decisively than expected, do not rule out a fairly sharp easing on both fronts. In a baseline scenario any costs can be absorbed as well, and in a case where there are costs outside the baseline scenario, we don’t think those will be existential given the strength of the buffers we have outlined.

Our full note covers further details.

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