BMI View: We believe that the recent weakness in the Sri Lanka rupee is both a blessing and a curse for Sri Lanka's booming tourism industry. With the rupee now at the cheapest it has ever been against the euro, it should help to entice additional arrivals from the bloc which remains the island's top tourist market. That said, the downside of having to deal with a much weaker rupee is that the cost of major tourism-related infrastructure developments is likely to face some upside pressure.
The recent weakness in the Sri Lankan rupee, which touched a record low of LKR134.52/US$ on August 28, is both a blessing and a curse for the island's booming tourism industry. Tourist arrivals have gone from strength to strength ever since the end of the country's long-running civil war in May 2009, with the industry having registered a record 1,005,605 arrivals last year (up 17.5% from 2011), taking in US$1.0bn (up 20.8% from 2011) in related earnings. According to the latest data, the sector's robust performance has continued in full force this year despite the ongoing sluggishness of the broader economy, as total arrivals are up 12.5% year-on-year (y-o-y) to 611,225 in the period from January to July, while earnings have risen by 22.9% y-o-y to US$565.4mn in H113 ( see chart).
|Strong Growth Continues|
|Sri Lanka - Tourist Arrivals and Earnings, US$mn|
Blessing: Weak Rupee To Entice Key European Market
The rupee's latest collapse should provide some added support to the country's tourism industry as the weakness in the local currency boosts the sector's international price competitiveness. In particular, we highlight that the rupee is now at the cheapest it has ever been against the euro ( see chart), which is critical given that tourists from the eurozone continue to be the island's top market. Indeed, through the first seven months of the year, arrivals from the bloc came in at 132,608 (up 13.1% y-o-y), constituting roughly 22% of the total. The bloc's slowly improving economic prospects - the composite purchasing managers' index (PMI) came in at a 26-month high of 51.7 for August - is similarly encouraging on this front.
|A Boost For Competitiveness|
|Sri Lanka - Tourist Arrivals, January-July (LHS) & Exchange Rate, Normalised as of January 2, 2003 (RHS)|
We do, however, note that the more pronounced weakness in the neighbouring Indian rupee counteracts the recent gains in competitiveness of Sri Lanka's currency relative to each other. This is noteworthy because Indian tourists are the island's second largest market, with 99,013 total arrivals registered from India from January to July this year (up 2.1% y-o-y). Due to the larger collapse in the Indian rupee, the Sri Lanka rupee is presently at decade-plus highs against it ( see aforementioned currency chart).
|Cost Pressures Mounting|
|Sri Lanka - Cost of Construction Indices|
Curse: Weak Rupee To Stymie Tourism-Related Developments
The downside of having to deal with a much weaker rupee from the industry's perspective is that the cost of major tourism-related infrastructure developments is likely to face some upside pressure. The government granted Australian gaming tycoon James Packer approval to build a US$350mn lakeside resort in June and to the John Keells Group for a US$850mn mixed development in July. Projects such as these are likely to face exchange rate pressures as building materials constitute roughly a third of Sri Lanka's total investment goods imports. Crucially, we highlight that overall construction cost inflation has already been hardening in recent years, with the rate having risen from its low of zero inflation in Q309 to 11.1% as of Q113 based on the latest data. As such, while the weak rupee may prove to be a short-term blessing for the industry in terms of boosting arrivals, it is likely to prove more harmful over the longer run as project costs head north.