Transcription
Welcome everyone. Uh today we are unpacking what's happening in the Middle East, how it's influencing the global economy, and most importantly, what it means for Sri Lanka. We're a small import-dependent economy. We tend to feel these global shocks quite quickly. So to help us unpack this, I'm joined by well-known economist Mr. Tal Rafi, who brings deep insight into macroeconomic trends, policies, and global developments. Welcome, Mr. Tal.
>> Thanks a lot for having me.
>> So, in this conversation, we'll be looking at where the risks are emerging, which sectors are most exposed, and how prepared we are as a country. And, uh, whether situations like this could actually push Sri Lanka towards some of the structural changes we have been discussing. So, let me start. Sri Lanka is a small import-dependent economy. So, how do you think the current Middle East tensions are already impacting the economy, and which sectors do you think are most vulnerable in the near term?
>> Uh, so, uh, first of all, thanks a lot for having me. Uh, so Sri Lanka is going to be vulnerable on a number of fronts. Uh, if you look at the whole macro picture, the number one definitely is the oil imports. About, uh, $4.5 billion, according to the IMF projection for this year, we will be using up for imports of oil alone. So, any hit on that, I mean, uh, currently prices have gone up by 50%. So, even if, uh, prices stay at 10% higher than the projected value throughout this year, uh, then we could have another $500 million hit on the current account. 15% could be $700 million. That's almost the equivalent of, uh, what we got from Hurricane Idai. So, that is, uh, one, uh, impact. But many other areas also. But, uh, on condition that, uh, it all depends on how long this crisis is going to, uh, take place. I mean, if there is a resolution soon, then the impacts will be much less. But we are vulnerable on other sectors such as, for example, tourism, because, uh, the Middle East is a major hub, and jet fuel prices have also gone up. Remittances, about, uh, half of remittances come from the Middle East. Uh, so that, that could have an impact. Uh, and, uh, also other things like shipping costs going up, insurance, so our export sectors. So, and most of, most importantly, like when, uh, prices go up, especially another factor that is not, uh, taken into account mostly is, uh, about one-third of major fertilizers also pass through the Strait of Hormuz. So, that can cause food inflation around the world. And another factor is, uh, one-third of, uh, freight by value, not volume, by value, goes through the, is done through, uh, yak, yak cargo, and about 25% passes through the Gulf area. So, the longer the airports are closed down, it has an impact on that front as well. So, so considering Sri Lanka, I mean, I can go into this, uh, uh, later. The immediate impacts are, of course, uh, the fuel, uh, prices going up, inflation. But, uh, the other impact at the macro level will be a number of things to consider. We are in a much better situation than we were a few years ago. The buffers are up. We have around $7 billion in reserves. So, this should be okay. But if the crisis takes much longer, that can have an impact. Uh, so, overall, I would, uh, say that, I mean, it is vulnerable, but it really depends on how long the crisis may.
>> So, um, how would you assess Sri Lanka's response, uh, so far to these developments in the Middle East? Do you think that the policymakers have taken adequate measures for potential spillovers?
>> Right. So, uh, speaking about this, I would say that, I mean, at this moment, since Sri Lanka has no influence in the, I mean, uh, outcome of the war, there's very limited we can do. I mean, a lot of countries are in the same situation. But right now, I think it's in a positive direction. I mean, the, uh, QR code has been brought back, uh, uh, for fuel, uh, a four-day work week, at least holidays on Wednesday for the public sector, and, uh, some of the other measures like the government has reached out to China and India, India, uh, for fuel supplies. So, I think, uh, at this moment, some of the steps are being taken. But, uh, what could be taken in the medium, uh, term would be the secondary impacts. So, for example, food inflation, that is one area. What about, uh, the logistics, the inflation that could rise up? What are the plans we have to, uh, take on that front? So, I think the government should also, uh, start looking at these areas like how will the central bank respond to that. So, these are factors that could have a wider impact.
>> So, um, if disruptions in the Strait of Hormuz persist for an extended period, uh, do you think that it's heading for an energy shock which is similar to the 1970s, or how do you think Sri Lanka could navigate in this scenario?
>> Uh, so, I mean, uh, to be honest, comparing to 1973, there was a very interesting thing about the, comparing the impact on the US, for example. But now, the impact would be much less than when you compare to '73 for a number of factors. I mean, one thing is, uh, 20% of the oil passes through the Strait, of course. But then, another 5 million barrels can be taken through the route, uh, across Saudi Arabia by pipelines. Then there's another route that the UAE uses through the ports. So, the impact is 15 million barrels. Uh, but, but at the same time, now, unlike '73, economies are much, uh, more efficient when it comes to energy use. For example, vehicles are much more fuel-efficient. The economy. I mean, if you, uh, there was a recent study by, I think, Deloitte, which showed that, uh, the impact from '73 in the US to right now, which found that, uh, it's like 20, uh, 75% less, uh, because the, uh, economy has more diversified away from oil. So, the impact is much less. But it is having, it's going to have a significant impact in the short term. In the medium term, where I see is, I think after this crisis, or hopefully if it ends, it's going to definitely change the global economy and even the Sri Lankan, I mean, the way it's being seen. There'll be a push towards renewables. Many countries would start storing up oil more. So, these are green hydrogen, other things would be, uh, a factor that would be looked into. Because one thing is that, uh, uh, right now, I mean, if you do a comparison, oil prices, uh, haven't gone up as much as gas prices.
>> That is because oil could be stored. Gas is a bit more difficult to store. So, that is one of the reasons why oil hasn't gone up as much. I mean, for such a crisis, oil should have been 150, but it's still at 100. So, there would be a lot of focus on, uh, batteries to store energy. Hydrogen is a very good medium to store, uh, energy for the long term. So, I think there would be a shift towards more energy efficiency, uh, innovation in the food area. So, if you look at, like, every major crisis is an opportunity. So, that is how you come. I mean, the 2008 crisis that led to companies like WeWork, Uber, Airbnb. So, those people capitalized on that. And there was, uh, I mean, other crises, uh, in the past have always led to innovation. So, I think that with this crisis, the world, uh, will move towards new innovations that we may not necessarily know of now, but there's definitely going to be a rethinking.
>> So, I think you touched upon this question also, but we'll, uh, if this conflict, say, if it just goes beyond, say, 45 days and, um, and it begins to more structurally disrupt the global shipping and energy markets, what kind of repercussions could we expect for the global economy and the ripple effects on Sri Lanka?
>> So, if this goes beyond 45 days, I mean, it could have a really major impact on the global economy. I think if you look at the stats, this decade has the slowest growth since the 1960s. So, the global economy is already coming out of, of course, last year we had the Trump's tariff shock. So, there's a lot of uncertainty in that area as well. And then we are just a few years coming out of the COVID crisis. So, there is a lot of, uh, factors going into the global economy as a whole. So, this is going to be a sort of another hit. So, if inflation goes up, uh, especially due to this in the US and other major markets, for example, the US Federal Reserve could increase interest rates. And in order to respond to that, central banks around the world could also increase interest rates. So, that is definitely one impact. And the other thing is also demand for products could, uh, go down in the West. Things that can also be a slowdown and an impact on China also, because if you see, China is finding it difficult to move into a consumption, uh, based growth. So, they have a, uh, trade surplus of over a trillion dollars. So, they have to find markets elsewhere to buy. And this is at a time when the US is also pushing back. So, if there is less demand around the world, uh, there would be problems. Because one factor would be without growth, I mean, the Chinese economy can also slow down. The other thing is, of course, China with such a surplus could, uh, export products at much cheaper, uh, rates, which would affect industries overall around the world. So, this always means there is going to be repercussions, but we will see it as it comes. But if it goes beyond 45 days, of course, uh, for Sri Lanka, especially, I see the impact on the current account and debt sustainability. Because one of the factors is that though we have, uh, uh, $7 billion in reserves, we have some projections by the IMF, we need to be $8.8 billion by, uh, the end of this year, and by next year, have to cross, uh, $13 billion. So, two factors is that, uh, we have to, we are, though it's not a condition, we are supposed to issue a, uh, bond of, uh, $1.5 billion by next year, and another one in '28, uh, of another $1.5 billion. So, ratings, everything would be considered. Because unlike other crises, like unlike Hurricane Idai, I'm just saying in this scenario, it's not gloomy, just, uh, just playing this out. If this crisis takes very long, it's that we are being hit on multiple fronts, like tourism, remittances, exports coming into effect, the prices of oil, fertilizer going up. So, since this is a hit on multiple fronts, I think there will definitely be a major slowdown in the economy. So, so these are things that, uh, we can, but this will also lead to opportunities, as I mentioned, we can rethink our energy, uh, policy. One thing, one thing I'll mention is that Sri Lanka has an, uh, very good potential when it comes to energy. For example, when we import about $4.5 billion worth of oil, and 20% of our, uh, electricity generation comes from oil.
>> Yeah.
>> So, since, according to a World Bank report, offshore wind energy potential itself exceeds our demands. So, if you do the right investments, one thing definitely, grid connectivity with India, where we can sort of export this. This is in a scenario once we get the investments and everything done. So, this sort of a push can be for the good of Sri Lanka in the long term.
>> Thank you. That was insightful. So, fuel prices have been adjusted in line with the pricing formula, but there's also a view that these adjustments alone may not be sufficient, right? And especially when institutions like the CB is reporting losses, right? So, how do you see this, particularly in the context where Sri Lanka is under an IMF agreement and needing, and also needing to meet critical IMF targets, fiscal targets?
>> Right. So, the question is about the, uh, pricing formulas.
>> Pricing for. I think the pricing formula definitely has to be, uh, used. That is something that we can't afford to move back on. Because, uh, one thing that has helped us or will help us during these shocks is where the burden is, of course, uh, when it's put on the consumers. I understand it'll be difficult and, uh, difficult for economic growth. But at the same time, you know, one of the things is that when fuel prices around the world go up, and the prices are fixed here and not increased, that means people continue to consume, consume more. It has an effect on the current account. When it's passed on to the consumers, the, of course, uh, the demand will do. I mean, oil is mostly inelastic. So, but it can sort of, uh, bring it down. But at the same time, we have to take care of the vulnerable through cash transfer programs and others. So, that could, uh, help. But, uh, as far as, uh, the reforms go, I think we have to go ahead with some of them. Because even right now, there are, even though we do a price formula, there are some things that, for example, the pricing is delayed due to, uh, approvals from certain institutions, government institutions. So, that, that is this thing, cross-subsidization. So, these are factors that have to be taken into account. But reforms is definitely a.
>> Thank you. So, yeah, every crisis creates an opportunity. So, do you think that this geopolitical shock could push Sri Lanka towards deeper reforms, say, or stockpiling, or whether it's energy expansions or, uh, energy efficiencies?
>> Yes. So, I think, uh, with this crisis, if Sri Lanka can really plan it and the correct reforms and the regulatory frameworks are put in place, we have a good opportunity. For example, one, as I mentioned before, energy.
>> So, energy, we have in abundance, not just offshore wind, solar, hydro. So, these are things we definitely need to move into. And as I mentioned, grid with India would be very valuable. The second point is, of course, logistics, because now, I mean, even if the, the whole Middle East crisis ends today, people are, uh, especially going to be not so confident about ports in the Middle East. So, that is definitely going to shift. So, this is where Sri Lanka can capitalize. But one thing is, of course, we need, uh, international, uh, shipping companies to be allowed. So, that will bring the, uh, confidence and the shipping here. Uh, for overall, it's just not about that, it's also about the amount of investments that come. So, that is definitely one. The second thing is, I think we have an opportunity when it comes to, uh, airlines.
>> So, so if you see about, uh, 25% of flights go through that area. So, Sri Lanka could, but we have, uh, issues when it comes to airport capacity. So, those can be improved. And of course, bringing in major international airlines. Of course, we'll have to restructure our current airline to meet the capacity, uh, for that. So, these are some of the factors where I see opportunity. Uh, overall, uh, other things, I mean, if we do the correct, uh, uh, frameworks would be data centers.
>> I mean, I'm not saying we can go into that area right now, but if the government can put the needed, uh, frameworks, uh, and others, that is definitely an area. Because if you see the latest UN report, the highest amount of investment is going into data centers, about 20%. It's more than any other sector. And what was very interesting is because, uh, uh, Iranian drones hit, uh, data centers in the UAE. AWS centers were hit, and others were targeted. So, data centers are extremely, uh, sensitive to factors. They're always kept in very peaceful areas. So, this is definitely going to be an area where they're going to shift, uh, elsewhere. So, Sri Lanka could look at it as an opportunity, as I mentioned, subject to, uh, proper reforms and others. And also, another factor that plays into this is when we see data centers being based regionally. One advantage Sri Lanka still has is not just close proximity to India, but Sri Lanka is the probably the only country in South Asia which has good relations with almost all other South Asian nations, with India, with Pakistan. We're the only country which has an FTA with India and Pakistan. With Bangladesh, Myanmar, Nepal, so we could be like, uh, the regional headquarters for South Asia. So, that is an opportunity that is definitely, uh, there. And another factor, of course, is, uh, tourism.
>> Of course. Uh, so, I think, uh, with this crisis, of course, there needs to be a proper plan, an action plan put in place. If you really look at this, with a long-term mind, I mean, you look at Dubai. Dubai wasn't built in one or two years. I mean, it took decades of planning. It was very, very phased out. The leaders had a very long-term vision. So, what we need to do is a plan, not just to, we can't make this country, I mean, something like a Singapore or Dubai in five years or four years. We need to have a plan where every phase, we need to have targets. So, if we do that, I think even this crisis, or many crises around the world, they always bring opportunities to Sri Lanka.
>> That's very interesting. Uh, uh, also, the global consumption patterns, they have increasingly shifted towards Asia in recent years, and Asia is being a powerhouse. Now, if instability in the Middle East persists, could this accelerate a broader economic shift towards Asia, and how do you think that Sri Lanka could position itself?
>> Um, I think, uh, anyway, even without the crisis, the global economic shift is anyway moving towards, uh, Asia. So, here you find the most amount of contribution to growth. For example, if, if you're talking about, uh, Sri Lanka in particular, we have India next to us, which is the fastest-growing G20 economy. And, uh, even most of the trade, everything, manufacturing power is coming from Asia. So, I think, uh, uh, this will definitely, you know, uh, accelerate, uh, things towards the East. There may be more, I mean, even before this whole crisis, the world was moving towards regionalism. So, more than a broader thing, because I think the US is more interested in the Western Hemisphere. Every country settles towards, uh, regional trade. So,
>> I think, uh, this would just, uh, accelerate that. I mean, trade and others might go through, because the Middle East is also a sort of a hub connecting three continents. So, now that there is turmoil there,
>> I mean, but it's too early to predict. But anyway, I mean, even without the Middle East crisis, I definitely think that, uh, the shift is towards Asia.
>> We have some of the largest economies, I mean, China, India, in this part.
>> Okay. So, now that you touched on India.
>> Yeah.
>> So, how can the country, or rather Sri Lanka, better leverage that relationship?
>> So, uh, so talking about that, I mean, if you ask me, what is Sri Lanka's, uh, future? How do we, uh, uh, rise up as a nation? I think in one word, it's the answer is India.
>> India.
>> India has the greatest opportunity for us in every way. One thing is, they are interested in us. They want to invest with us. They want to have greater trade. Because, I mean, of course, getting a bit into the political economy, there are talks that, you know, India wants to take advantage of. But, I mean, it's not true. If you look at the past FTA we have with India, about 60% of Sri Lanka's exports use the FTA. Only about 5% of India's, uh, exports to Sri Lanka use the FTA. So, India doesn't need the FTA. We need it. And India, I mean, even the ETCA, I mean, it's not something that is a priority for India. I mean, it's a $4 trillion economy, soon to become the third largest economy in the world. I mean, we are just around a hundred billion dollar economy, and they have agreements with the EU and other major economies. So, I mean, we have to look at this as an opportunity. Because one thing, I, I say this at all forums, is that that is where our opportunities lie. For example, even if you take the southern states of India, that's comes to over a trillion dollars. And the closest state there, Tamil Nadu, that itself, according to a Deloitte report, uh, would be a $1 trillion economy by 2034. So, one thing is, when the economy of India grows so fast, uh, the factor to be noted is they would need a lot of energy. So, when we invest into renewable energy, we could, uh, export it if there is a grid.
>> So, that is a major benefit. And this is not something new. Because if you look at countries like Nepal, India, and Bangladesh have an agreement for trade. I mean, you know, Nepal's energy goes to Bangladesh via India.
>> So, that is the way countries are developing. I mean, this is three countries working together. Why can't two countries go?
>> I mean, uh, so this always gives us, uh, an edge in that. The other thing is also the market is booming. I mean, there are hundreds of millions of people getting into the middle class in India. So, that's another major opportunity. And I also feel, uh, opportunities when it comes to supply chains. We can integrate more with the, etc., and other trade barriers are brought down. That is an opportunity. Because we always talk one thing, I mean, mention, uh, Sri Lanka is in a critical stage where we have debt payments to be made. So, two ways we can do this is, one, increase our exports, or bring in more investments. But to increase exports, we have to look at trade. And about 70% of global trade is supplying value chains. So, this is the area we can go into. I mean, if you look at especially southern India, that's where most of the industrial base is. You know, even Apple is coming there, manufacturing there in a big way. So, these, if we can sort of integrate it, this will be a, uh, big, uh, boom for us. Because that is where, as I mentioned before, great opportunities lie. Because we don't have, uh, that much of other options as well. Because, you know, when we talk about, uh, trade, we talk about, uh, getting a manufacturing sector here entirely on our own. These are not, uh, feasible. Because they were at different stages, you know, many others, you, some experts give the example of Korea or China, Vietnam, but those were different eras.
>> You know. Of course, Korea did it while they put barriers up, made a thing called import substitution. That means for an industry to come up, they closed the barriers for like 5 years. Then once the Samsungs and the high-end became a bit big, they opened it up for free trade. So, that was in the '50s, '60s. Then China and Vietnam was the 1980s. So, where there was rapid globalization, they just, uh, let the western companies come here, manufacture, and reexport. But today, after Trump, there is no, I think globalization is coming to an end. So, we have to look at other factors. And the critical factor when it comes to the other factor, I mean, just moving away from India, or even it'll be useful when it comes to increasing trade with India, is we have to look at multinational companies as well. Because if you look at exports, few people know this, but about 82% of global exports are done by multinational companies. And 64% of knowledge-intensive exports are done by multinational companies. So, this is where I think we have to move into. Like an example I give is Thailand. Thailand produces a lot of cars, but nobody knows of any Thai car brands.
>> It's always Japanese.
>> It's also very concentrated how economies function. The other notion, I think, if we want to improve, is we can't, uh, always say that we can produce everything. That's not how we function. You look at global trade, about 40% of global trade is concentrated trade. Like Taiwan concentrates on semiconductors. Cars are mostly Japan, Germany. Now China is also becoming a big player. Other things, like, for example, when it comes to beef or others, it's the US and Brazil. So, so Sri Lanka needs to find out where its strategic priorities are. And just one example I'll give is, uh, Japan,
>> in the 1950s. So, Japan, when they wanted to rebuild, their strategy was, they did not put a plan to find out which sectors would go up.
>> They did the opposite. They said, let's find out which are unproductive, and let's close them down. Because when you shut down unproductive sectors, that means that resource, that human labor goes into productive sectors. And the best way we can do this is trade liberalization. Open up trade. Automatically, the market will take care of the unproductive sector. We'll become a much stronger economy.
>> That would be a good one to debate later.
>> Yes, sure.
>> So, before we wrap up, uh, what would be your key closing thoughts for Sri Lanka as we navigate this period of uncertainty?
>> So, I think, uh, I mean, uh, if you ask me, the impact is definitely going to be there. So, my concern would be on the, the current account, the debt sustainability. That will be a factor. But it largely depends on how long this crisis is going to take. Because it's, we are going to get it on multiple fronts for this, exports, especially if, uh, freight, insurance, uh, charges all go up, and, uh, cost of doing business goes up, remittances, tourism, and oil prices go up, fertilizer prices go up. So, this will have an impact. But on the positive side, I think it's also a chance for Sri Lanka to relook at this. So, there, uh, as people fear, there definitely won't be an era of like no fuel or anything. Because just about 85% of, uh, world's oil is produced elsewhere. So, even if the Strait of Hormuz is closed for months, uh, eventually, after some time, the world will reconfigure, of course. But the one factor is, of course, oil prices will be much higher.
>> Definitely very high. But, of course, uh, it's not the end of the world. And, uh, like every crisis, I think this will also bring opportunities. And opportunities, I think, energy, renewable energy, definitely one thing. And if Sri Lanka can put a proper plan, especially opening, open, opening many sectors to international companies. We have a chance to shipping, yin hub, data centers is definitely another factor. And lastly, tourism can take off, uh, uh, with this, mean, with the right, uh, policies.
>> So, so I would always, uh, end this in a positive. I think every crisis is always a thing for. If I may end with one point, 1991, India came close to bankruptcy because of the same Middle East crisis because Saddam Hussein invaded Kuwait. And if it wasn't for that crisis, India would have been a slow, closed economy like how it was in the '80s. So, that Middle East crisis changed India, and now it's the fast-growing G20 economy. So, I think, like the '91 Middle East crisis changed India, maybe this 2026 crisis can change Sri Lanka.
>> So, uh, that was a very insightful and fruitful discussion. Uh, my sincere thanks to Mr. Sal Rafi for joining us today and sharing your, uh, perspective. Thank you so much. So, and, uh, thank you for being with us today, and we'll hope to see you with another insightful discussion with Softlogic Stockbrokers. Till then, have a good day.