South Asia moved through May facing a mix of external pressures and domestic adjustments. The global tariff environment continues to be uncertain, with rising trade barriers beginning to affect export performance across parts of the region. While South Asia’s overall trade exposure remains relatively modest compared to other Asian regions, the indirect impact is starting to show, specially in sectors like apparel and electronics that rely on stable access to global markets.

Countries are responding in different ways. India continued to strengthen its trade ties, with the long awaited UK–India free trade agreement marking a key development this month. Bangladesh, though facing near term disruptions in its garment sector, is progressing with structural reforms, including a more flexible exchange rate.

On the other hand, tensions between India and Pakistan have resurfaced. While the direct economic fallout remains contained, Pakistan’s move to close its airspace to Indian flights has led to a decline in overflight revenues, adding further pressure to its already strained external position. Rating agencies have flagged this as a risk, though India’s broader outlook remains steady, supported by lower inflation and growing domestic demand.

Elsewhere in the region, there are signs of gradual progress. Bangladesh’s foreign reserves have improved, helped by rising remittances. Sri Lanka secured a new World Bank support package focused on job creation and private sector growth. The Maldives is pursuing long-term diversification through a new financial hub project, though funding and regulatory concerns remain.

Overall, the region continues to adjust to a more uncertain external environment. Global trade conditions, political developments, and financing constraints are shaping near-term decisions. While South Asia remains on a recovery path, the pace and strength of that recovery will depend on how effectively each country manages its domestic challenges and responds to external shifts.

The report covers further details, including:

1. Tariff impact and government response of each country.

2. Top 3 things you should know about the regional countries.

3. Summary of key economic indicators for the month.

4. Key news articles in detail.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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 full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -

What does the 90-day pause include?

For countries that “have not retaliated” against the US (so far, seems to be almost all countries other than China), the US has announced the following –

1. A 90-day pause on the country-specific tariff rates announced on April 2nd

2. A 10% blanket reciprocal tariff on all applicable countries during the 90-day pause

So far, these have been the only specifics announced on the 90-day pause itself, but there is likely further detail upcoming. Trump has also indicated there might be company based exemptions on some or all tariffs as well.

So far, it also seems that specific sectoral tariffs will still go through at higher rates - such as those on steel, aluminum, vehicles, and recently signaled on pharmaceuticals.

What is the tariff increase on China and is there more to worry about?

Alongside the 90-day pause, the tit-for-tat escalation against China over the last few days has come up to the US putting a 125% tariff on Chinese exports into the US. More worryingly, there is some indication that the US is focusing the global trade war more squarely onto China.

Both Trump and his advisors have used significant language framing China as the “big problem” in global trade, especially as part of the shift towards the 90-day pause. Two key Trump cabinet members have inferred that a broader “coalition” against China might be part of the expected negotiations with other countries -

• Commerce Secretary Howard Lutnick has said that that “The world is ready to work with President Trump to fix global trade, and China has chosen the opposite direction.”

• Treasury Secretary Scott Bessent has said that Trump “goaded China into a bad position” and that “they [China] have shown themselves to the world to be the bad actors”.

This touches on the key imbalance this situation creates – tariffs on China are prohibitively high but the rest of the world has a relatively equal playing field now. Will there be large transshipment of goods from China to the US through other countries? Will the US find ways to avoid that from happening?

What’s next, what should you look out for, and why?

The immediate relief that this measure has given has led to massive recoveries in markets. However, the situation obviously remains highly volatile. There are a few factors we think clients should be watching out for –

1. What does the US hope to get out of the negotiations during this pause?

2. Will 10% tariffs still lead to a global slowdown or a recession?

3. Will other countries end up being pushed to put tariffs onto China?

4. Will China devalue the Yuan in response to this singled-out escalation?

5. How much will oil and global commodities recover?

6. Will global bond markets recover similarly to other assets?

Over the upcoming weeks, we will continue to cover these pain points especially with more specifics on impacts to exporters and other firms directly affected in the current world in transition.

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are open to limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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 full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -

Historically capital has moved to East and Southeast Asia which drove growth in the region.

For decades, money flowed steadily toward East and Southeast Asia, turning the region into a key player in the global economy. The trend began in the late 1970s and early 1980s, continuing through the 2010s. Funds came from the United States, Europe, and Japan, heading to countries like China, Vietnam, Thailand, and Malaysia.

The money that came in then began to transform these economies. China became the world’s top producer, with its ability to produce on a large scale rapidly growing. It built factories for everything from phones to cars, creating jobs and expanding cities. South Korea, Thailand, and Malaysia focused on exports, shipping electronics, food, and palm oil to global markets. Vietnam’s growth stood out after a 2009 crisis, using funds to build industries like textiles.

However, Trump’s relection and global tariffs could now change the story for these economies.

Following Donald Trump’s re-election in November 2024, investors grew increasingly cautious about the future of global trade. Even before any formal policy changes, the threat of tariffs and protectionist rhetoric prompted market reactions. Investors began reallocating capital, anticipating potential disruptions to supply chains and trade relationships that had supported the growth of East and Southeast Asian economies for decades. In the weeks and months after the election, several regional stock markets experienced declines, reflecting this uncertainty. The possibility of rising trade barriers created a sense of risk, especially for economies heavily dependent on exports to the United States.

Further, countries in East and Southeast Asia will likely experience these changes unevenly. Those with deeper reliance on U.S. trade like Vietnam and China may feel the impact more acutely, while others with more diversified export bases could weather the transition better. Nevertheless, the broader message is clear, the global environment that once fueled massive capital flows into the region is now starting to shift.

Could this money eventually end up in South Asia?

The money currently sitting in safer assets is unlikely to stay there permanently. When risk appetite returns, investors will begin looking for regions that offer growth potential with relatively lower exposure to global trade tensions. This is where South Asia might start to stand out.

Compared to East and Southeast Asia, South Asian economies might end up facing fewer risks from tariffs. One of the main reasons is their lower reliance on exports. According to World Bank data from 2023, Vietnam’s exports make up around ~90% of its GDP, and the exports to US is around 30-40% of GDP. Similarly in Thailand and Malaysia, the exports to US as percentage of GDP is closer to 12%.

South Asia, in contrast, has lower export exposure. Countries like India and Sri Lanka record trade related exports in the 10–20% of GDP range, while Bangladesh is even lower. India's exports to the U.S. are only 3.5% of GDP, according to the World Bank. Bangladesh, been growing its manufacturing base in textiles, an industry that could benefit from rising costs or trade complications in Southeast Asia, though recent complications despite internal challenges. So, South Asia’s lower trade dependence, combined with expanding domestic industries, might ironically end up making it a realistic alternative for investors looking to diversify.

In addition to the fact that South Asia as a region might less exposed to this tariff risk, it is also a region that has been growing. It has been the fastest-growing region, with India driving its growth. With a large domestic market, India offers a place to sell goods without depending heavily on exports, potentially attracting funds to build new industries.

While some money moves into the South Asian region, can some of it move to Sri Lanka?

Sri Lanka has surpassed growth targets, growing by 5% in 2024, it has made some progress in its external debt restructuring, continued its fiscal reforms, and stuck to the IMF pathway despite a change in the government. The IMF has also commended Sri Lanka, calling its recovery “remarkable.” In a situation like this, while there is still so much more that has to be done to attract some form of investment, maybe in terms of portfolio or even FDIs, the probability of some money coming in is still higher than ever before.

Where else could the capital go, if not for South Asia?

It’s not just South Asia that could stand to benefit. Some of the capital could flow into smaller, less exposed economies that offer a stable environment. For example, Mexico has been less affected by the recent tariffs and is geographically close to the U.S. With lower labour costs and strong trade ties, it could be a practical choice for investors and manufacturers alike.

Overall, while it's still too early to say exactly how much capital will move, or where exactly it will land, one thing is clear, the flow of global changing is changing, and it does not have to necessarily move in the way it did in the past. And in this new environment, regions like South Asia, less exposed and still growing, might just find themselves with an opportunity to shape a new investment story.

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are open to limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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

While in the near term, the direct impact of the tariff shock might dominate changes in the BOP, as the year proceeds, we are likely to see the second order impacts coming into play and even dominating the overall BOP impacts. This report takes a look at what these varied factors can be and the scenarios we have for the BOP.

The full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -

The direct first order impact from Trump’s tariffs

On the surface, the massive 44% tariff hike should imply that Sri Lankan exports to the US should see a contraction. However, the reality could be affected by factors such as which party in the supply chain takes on the cost of the tariffs and the actual change in volume of exports. This leads to a few scenarios -

• If Sri Lankan manufacturers absorb the full tariff cost

• If the tariff costs are fully covered by foreign entities

The second order impacts from Trump’s tariffs

However, we cannot just pencil in a reduction in export earnings into the pre-tariff BOP outlook. There are a few key factors that can affect this situation, especially since the tariffs are not just on Sri Lanka but on the world.

• Falling raw material and intermediate imports – As exports fall, the requirement to import raw materials and intermediate imports will fall as well.

• A global slowdown in demand will affect all exports – While the 44% tariffs will affect exports to the US, a global slowdown will mean all of Sri Lanka’s exports, and even tourism and remittances, can get affected

• Global price changes can go both ways – Varied price changes, in global commodities and currencies, can affect the import and export numbers for varied imports and exports for Sri Lanka

Outside of these more obvious changes, a world going through lower trade and a complete transition, can see other unexpected changes that can impact the BOP, in both direct and indirect ways.

Two broad pathways for the global economy from here

As we highlighted in Frontier Global Watch – The Global Economy in Transition the current global economy is structured between the consumer demand generated by US deficits and the manufacturing capacity of China that keeps it in surplus. If we understand the current moment as one where this system is fundamentally changing, that will inevitably mean big changes.

Outside of a scenario where things return to normal, we think that there are two broad contexts that can be applied.

• Scenario of falling global prices - This scenario maps closely to our overall scenario where “US deficits shrink, but Chinese surpluses stay strong". If this scenario tips into recession, this is what we called a “deflationary recession”.

• Scenario of rising global prices – This scenario maps closely to our overall scenario where “Both US deficits and Chinese surpluses shrink". If this scenario tips into recession, this is what we called an “inflationary recession”.

Outside of these, it’s also possible for some parts of the world to see rising prices and other parts to see falling prices. Understanding broadly what these pathways mean can in turn help us understand the potential impacts on the BOP outlook for Sri Lanka, even in the context of such divergent pathways.

What would a scenario of falling global prices mean for Sri Lanka?

The main benefit of such a scenario is the falling price of oil imports. Right now, we are seeing a significant reduction in crude oil prices as the market factors in the potential for significantly lower global demand conditions. Certain producers with lower marginal costs have also increased output to increase their market share during a volatile period. If lower demand conditions dominate the market, then other commodity prices would also continue to fall lower in the near term, cotton, copper, iron, chemicals, fertilizer, etc.

• Falling fuel costs are a big potential FX saver

• Global currency depreciation can push input prices lower

These two points could combine together as well. Even in other intermediate imported inputs like cotton yarn, plastics, chemicals, the reduction in commodity prices can help contain import costs. As a result of the import cost reduction, the actual net export loss would be less.

What would a scenario of rising global prices directly mean for Sri Lanka?

While the ongoing market moves indicate falling commodity prices, the eventual outcome could be different if the policy responses by major economies is to respond to Trump’s tariffs in varied inflationary ways. This could be through significant currency movements, retaliatory export controls, specific regional trading arrangements, to name a few. Cutbacks in supply as a result of firms rapidly cutting back on output to deal with the ongoing volatility and curtail losses can also contribute to this scenario.

What would an outright global recession mean for Sri Lanka?

A global recession would support the downward movement in commodity prices, since it would mean lower demand conditions for a longer period of time. Lower import costs could be an immediate gain, provided policy reactions don’t cause inflationary impacts.

But the impact won’t be limited to exports. Tourism and remittance earnings could be lower than was earlier anticipated for 2025. Of course, Sri Lankans could also reduce their travel abroad, so that could mean a lower net impact.

What does all this mean for the current account?

All of this implies that Sri Lanka’s current account balance for 2025 could remain within the baseline scenario we have assumed so far. This is because the foreign earnings contraction can be largely offset by the reduction in import costs, especially in the next few months.

Beyond this baseline, depending on actual developments the surplus or deficit could be higher – for example crude oil prices could fall more than expected or tourism could end up being weaker than expected.

Can Sri Lanka count on financial flows in a volatile global environment?

Typically, in a global recession, countries like Sri Lanka can see capital outflows especially as investors flee to safe haven assets, including US Treasuries. The rate cuts that follow recessions tend to create financial conditions that enable developing countries to then attract capital subsequently. But the scale of global transitions underway can complicate decisions in terms of what assets count as safe havens. As we have noted earlier, there has been an accumulation of savings parked in financial center such as Singapore and Hong Kong.

As a result, we think that the overall external BOP balance situation can remain within our broad previous expectations. But a higher-than-expected current account deficit, for instance, might erode the surplus or even require more foreign asset drawdowns either by the commercial banks or CBSL.

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are open to limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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

While there is some possibility that the current tariff regimes could reverse to some extent with negotiations, we’re of the view that fundamentally the world is in a higher tariff regime. The big risk for us here, is that this is a scenario of global recession. Such a global recession is likely to be far more impactful on global assets than tariffs on individual countries alone. We think the recent fall in global assets, and especially in oil, which has crashed 15% since April 2nd, is reflecting increasing market worries of such a scenario.

In such a context, preparing for the tail risk scenario of a global crisis becomes critical. For an investor, what would that look like?

This note is under the “Trader’s Edge” product line by Frontier, which is aimed at providing perspective to those interested in short-term trading opportunities in financial markets. The full note sent to clients includes a more detailed and applied exploration of these questions. A few limited extracts of these are given below in the context of the global environment -

What would a global crisis look like in the current environment?

In our recent report “Frontier Global Watch | The Global Economy in Transition”, we spoke about how there are varied ways we see the global economy moving from this point onwards. We gave 4 main scenarios –

1 - Both US deficits and Chinese surpluses shrink

2 - Both US deficits and Chinese surpluses stay the same

3 - US deficits shrink, but Chinese surpluses stay strong

4 - US deficits stay strong, but Chinese surpluses shrink

These are big fundamental shifts we talked about, and whatever way the global economy goes, such shifts will be groundbreaking in the short-term. While we have more details on how we think about the economy in our detailed report linked above, we think the investment impacts of a full-blown “global crisis” can be summarized into two scenarios.

1 - Deflationary recession – Where global demand falls, commodity prices fall, and the world sees a period of low prices alongside recession

2 - Inflationary recession – Where global demand falls, but a sharp contraction in global production and supply alongside direct tariff impacts push prices higher across the world.

What should an investor do for a deflationary recession?

If the world is to see a deflationary recession, then the immediate consequences will likely be a contraction of global equities, global commodities, and falling inflation. Recent episodes of similar nature have been met with strong and coordinated global action by central banks. Interest rates have been lowered, liquidity has flooded markets, and asset prices have eventually roared up after a crash.

What should an investor do for an inflationary recession?

If the world is to see an inflationary recession, then the immediate consequences are likely to include a fall in global equities, but where global commodities and prices shoot up. The most recent global context where a similar was seen was in the 1970s, where global central banks ended up hiking rates instead to deal with inflation. Even stretching back a hundred years, such contexts have meant falling equity returns, falling fixed income returns, and commodities in particular massively overperforming.

What should an investor do if they don’t know what’s going to happen?

In reality, whether the world sees a deflationary recession, an inflationary recession, or no recession at all is not something visible right now. It seems inaccurate to claim that the world is “certain” at this point in time. Most of the prior “patterns” in the world have shifted drastically, and the way the future is moving is more uncertain than at many points in the past.

What if we tie this to Sri Lanka specifically?

For an investor in the Sri Lankan economy, they’re also dealing with the changing Sri Lankan context right at the same time the global economy changes. While the Sri Lankan BOP is a big one that everyone is keeping an eye on, one particular thing we’re looking out for is whether Sri Lanka’s fiscal recovery slows down.

Given the uncertainties present, we will leave with our usual mantra when considering an uncertain situation. While we can’t predict the future, when things move fast, we can move to prepare for it.

“You can’t predict. You can prepare”

- Howard Marks

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are open to limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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

For Frontier, the idea that the global economy is transitioning from one system to another is hugely impactful. Even if the probabilities are not 100%, the consequences it would bring are incredibly high. This note we’re sending is to lay out our understanding of this concept in more detail, so that our clients can remain ahead of the curve.

The full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -

How did the global economy work before the tariffs changed it?

Frontier’s framework for understanding the world economy is straightforward. We see the world as one where China produces, the US consumes, and the rest of the world intermediates between these two pillars. This is a world where the US runs large deficits, China runs large surpluses, and the rest of the world runs smaller surpluses and deficits in between.

• The US deficits – The fundamental driver of the global system since 1971 in our view, is the external deficits run by the US. This has helped the US become the world’s consumer, buying from varied producing nations of the world.

• The Chinese surpluses – Starting from the mid-1990s, but clearly from the mid-2000s, China has become the single largest producer nation that sells to the US. Over time, Chinese surpluses have essentially ended up balancing US deficits.

• The rest of the world – For the rest of the world, they have ended up working as intermediaries between these two countries. Especially from 2005 onwards, this meant a lot of trade and capital flowed through the developing world, creating a big growth period.

The change in the global economy can be hugely impactful

The tariffs put on by the US administration end up fundamentally challenging this structure of the global economy in our view. Even if the tariffs are reversed to some extent, we think the costs that have already come to the global economy incentivizes the world to move away from this system.

• For the US – If the US wants to fundamentally change a core part of their relationship with the world, that suggests that the world should be ready for smaller US deficits in the future.

• For China – If the US runs smaller deficits in the future, that means China either has to reduce their surpluses or find new markets to sell to. Both of these will mean big changes to the rest of the world.

• For the rest of the world – Outside of the direct impacts of US tariffs on their exports, the context of either a massive global trade slowdown or a complete reordering of which countries consume can be massively consequential.

What are the ways the global economy can move in the future?

From Frontier’s viewpoint, there are 4 broad ways that we think the current global system can move.

1. Both US deficits and Chinese surpluses shrink – This is a scenario where the US reduces consuming from China and the rest of the world and China reduces selling to the US and the rest of the world.

2. Both US deficits and Chinese surpluses stay the same – This is a scenario where most of the measures taken right now end up largely reversing, and the world returns to one that is fundamentally of US deficits and Chinese surpluses.

3. US deficits shrink, but Chinese surpluses stay strong – This is a scenario where the US reduces the consumption it does from the rest of the world, but China still pushes out more and more production of goods.

4. US deficits stay strong, but Chinese surpluses shrink – This is a scenario where the costs and shock of the immediate moment pushes China into taking a decision to restructure its economy, and going through the pain that’s necessary. However, in this scenario, the US ends up reversing enough of the tariffs or returns back into running deficits and running the usual consumption economy.

Both scenarios 3 and 4 are ones where you have significant imbalances across the world, with some areas growing faster, and some seeing long-term declines. Across all 4 scenarios, one particular measure we see is the potential for regional integration.

How does this affect an actual player in Sri Lanka?

The direct and indirect impacts of the current tariffs changing have been extensively covered, including in our recent reports. However, the cost of a changing global economy can be far larger and far more impactful.

• Prepare for volatile costs in the short-term

• Don’t put all your cards in on negotiations

• Retaliation and response of other countries can determine the short-term

• Watch out for what China does

• Watch out for what is going on in Europe

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are open to limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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

On top of this, it’s increasingly clear that the economic rules of the past are no longer working in the same way. This creates a lot of uncertainty and a lot of impacts that can whiplash back onto the Sri Lankan economy as well.

In this context, what does a Sri Lankan firm do? How do you act to protect yourself, to take advantage, and to stay ahead of the curve? In this report, we’re setting out a few key points we think will help clients. We have structured these where the first few questions look at the background, and the latter questions look at specific action points.

The full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -

1. What are the immediate impacts a Sri Lankan firm has to prepare for?

We see two immediate impacts a Sri Lankan firm in particular should be looking at

• The direct decisions of US and other buyers of Sri Lankan exports

Uncertainty about whether the specific tariffs will continue will also affect the market at this stage, but we are of the view that even if the specifics of these reciprocal tariffs change, it seems increasingly likely that most exporters will face higher US tariffs going forward than what has been the norm over the previous decades.

• The cost of volatile markets affecting financial costs

Rapidly moving markets across the world have been another visible impact of the tariffs. Particularly for hedged instruments, currency forwards, and any short-term finance requirements, this then can become a critical point to watch out for. We are of the view that these volatilities, punctuated by moments of hope and calm, will be a feature of at least the next few months

2. What are the less immediate impacts a Sri Lankan firm has to prepare for?

Outside of the immediate impacts, we think other secondary impacts can be there on the global economy that can directly affect the Sri Lankan economy.

• Rising likelihood of global slowdown and even recession

Compared to Sri Lanka’s exports to the US being affected, a general global recession can mean that all of Sri Lanka’s exports can be affected negatively. This would affect any exporter regardless of their current exposure to the US and could be much larger of an impact than the direct impact of tariffs alone.

• Rapidly changing global import prices and shifting supply chains

Some countries have higher tariffs than Sri Lanka as a percentage, but even countries with lower tariffs have a much higher proportion of trade with the US than Sri Lanka does. Depending on how those countries react, there could be volatilities in import costs at varied points across the supply chain but also critical bottlenecks that can affect availability of supply.

• Changes in global commodity prices

• Shifting capital flows that can affect financing flows

3. What does this mean for exchange rates?

The overall impact on Sri Lanka’s exchange rate across 2025 is unlikely to be very dramatic in our expectation, with the depreciation pressures which we had spoken of earlier increasing only moderately. For this, our main reason is that falling FX inflows will be largely countered by falling FX outflows (lower oil prices, lower textile imports etc.). However, sentiment shifts can result in volatile movements across those points that can affect FX forwards.

4. What does this mean for interest rates?

We think Sri Lankan interest rates can be a bit volatile, but fundamentally not move too much from current levels by end-2025. Any movement in interest rates in Sri Lanka are far more likely to be driven by sentiment shifts in local government securities markets in our view, especially on future inflation and depreciation expectations, than directly as a result of global factors. Since there is not a lot of immediate influence of global capital in Sri Lanka’s interest rate markets right now, direct impacts are unlikely.

5. What should an exporter do in the short-term?

In the short-term, we think the obvious decision for exporters is that they should act defensively in the face of potential tariffs directly, but arguably more importantly against the increasing likelihood of a significant global slowdown.

Part of this could be looking out for specific input costs that can fall for them across the supply chain, identifying specific bottlenecks that can occur due to the different ways individual countries are affected by tariffs directly and indirectly, and keeping an eye out for specific policy measures that input sources might be taking.

6. What should an importer do in the short-term?

In the short-term, we think importers should be looking at the policy measures their source markets are taking in response to the global tariff increases. Importers might have the advantage of benefitting from falling import prices amidst lower global demand conditions in the coming months.

However, the costs for importers can also be specific from sector to sector. This can be in terms of how volatile specific supply chains can be, how financing costs can rise for hedging needs, how volume reductions can affect margin decisions, and specific purchasing windows.

7. What should an investor do in the short-term?

For a Sri Lanka based investor, we think the current context is one that calls for conservative diversification on one end, and the ability to move rapidly into aggressive bold investments as those opportunities become available.

However, the high-risk nature of this moment is one that we would still caution investors about. While we think high-reward is possible, it is very much down to specific risk-sentiment that an investor would hold. Even high-reward options, can include significant losses in the interim, so the ability to hold onto such losses until you see the medium- to long-term benefit is then part of the requirement.

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are open to limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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

While the future with the tariffs is likely to be chaotic and uncertain, we’re setting out a few key thoughts on this to start with.

The full note sent to clients includes a more detailed exploration of these questions. A few limited extracts of these are given below -

1. Why did Sri Lanka get a 44% tariff on its exports?

Sri Lanka doesn’t have a very large trade surplus with the US but has been tariffed at a higher rate than most others with higher trade surpluses. Why is this the case?

How the US government has calculated this is by taking Sri Lanka’s goods trade surplus with the US, which is about USD 2.6 billion, and dividing that by Sri Lanka’s goods exports to the US, which is around US 3 billion. This gives a value of 88%, which the US claims is Sri Lanka’s “tariff” on the US through direct tariffs, non-tariffs barriers, and currency manipulation. The reciprocal tariff is 88% divided by 2, which is 44%.

2. What is the 44% tariff on?

The 44% tariffs appear to apply to all goods exports to the US. There appears to be a list of exempted items, but these don’t cover any of Sri Lanka’s main exports to the US such apparels and rubber products.

“Some goods will not be subject to the Reciprocal Tariff. These include: (1) articles subject to 50 USC 1702(b); (2) steel/aluminum articles and autos/auto parts already subject to Section 232 tariffs; (3) copper, pharmaceuticals, semiconductors, and lumber articles; (4) all articles that may become subject to future Section 232 tariffs; (5) bullion; and (6) energy and other certain minerals that are not available in the United States.”

3. What did other countries get taxed at?

Many countries got the minimum 10% reciprocal tariff, while a list of other countries also got taxed through “reciprocal tariffs” through the same calculation. This calculation also has excluded trade in services. This method has been heavily criticized as not reflective of actual trade dynamics.

4. When will these impact us?

These tariffs are meant to come online on the 9th of April. This gives some time for countries to “negotiate” the tariffs and come up with deals with the US. However, this also is meant to give time for the US to increase the actual tariffs, if countries react in “adversarial” manner to these tariffs – for example by raising tariffs of their own.

5. Could Sri Lanka have avoided this?

Countries like India and Vietnam have done varied trade and non-trade actions in recent weeks and months to try and hold off any tariffs but they have been tariffed on the same basis, nevertheless. Countries like Australia which actually have an overall goods and services trade deficit with the US have also been tariffed, because the US has excluded purchases of services when calculating. Even Israel, got a 17% tariff imposed despite the political closeness between the two countries.

6. Will this continue or will the tariffs change?

So far, the tariff policy of the Trump administration has been directionally consistent – more tariffs – but operationally inconsistent – tariffs coming on and off haphazardly. Overall, the specifics of these tariffs might not be what continues but the overall direction is likely to be a world of higher tariffs.

6. What is the impact onto Sri Lanka as a result of this?

The direct impact would be that the ability of the Sri Lankan exporter to export to the US at the same price is much lower. On a one-to-one basis, this should mean lower exports to the US and a hit on the external account of Sri Lanka, and a general increase in the price of “risk and uncertainty” across global trade – so higher forward costs, higher hedging costs, etc.

However, this is still not a straightforward impact in our view. There are still countries with higher tariffs than we have received, including competitors such as Vietnam. In this context, the actual impact on our exports might not be so direct. Whether Sri Lankan exporters end up having countries they can move operations to, whether changes in the cost of raw material will affect the supply chain, and how other countries respond with their own measures will all come into play.

7. What second order impacts can come into play?

A higher-than-expected US tariff increase is going to lead to reduced growth and demand forecasts across countries and sectors. This can lead to downward pressure on global commodity prices and aspects such as freight charges. These can help offset part of the cost of tariffs, as exporters benefit from lower input costs.

For Sri Lanka in particular, lower oil prices and lower cotton yarn prices (and lower imports) can significantly contain overall imports in a year that was expected to see an increase in non-fuel, non-textile imports. As a result, the impact of lower exports to the US (especially in apparel and rubber products) might not mean a one-to-one impact on the current account balance.

8. What should a business and an investor do?

In our view, this extent of tariffs, especially in the form they are calculated, was a surprise. However, with the Trump administration, as we explored in our “Other Hand” report a few weeks ago, such “surprises” are almost to be expected.

“Further dramatic changes that are taken to their extreme are unlikely to be the base case expectation that one can engage with. Yet the very fact that there have already been dramatic policies actually implemented tells us that further similar moves are not out of the picture at all. Across varied contexts in history, when large changes are undertaken, they tend to be self-reinforcing. This could be due to the institutional changes that occur alongside massive policy changes, it could be due to the norm-defying nature of such changes, or it could simply be the fact that dramatic changes are, by definition, dramatic and not slow, hedged, or guarded. Big bangs tend to be big bangs because they “break” things a lot.”

Fundamentally, this is a period of rapid change and big underlying costs. In such a context, our usual advice to a client is to take a conservative and cautious position that allows you to stay afloat and not be “knocked out of the game”. From business to business, investment to investment, this will be a different decision that a client will need to make – but the basic premise is to be defensive. Identify the areas that will be least hit, that will be most resilient, that will last the storm and heavily move behind those walls.

Frontier usually restricts sharing of their research and advisory notes. In exceptional situations, such as the currently volatile global environment, we are okay with limited sharing of our work. We just ask that you inform us ahead of time of such a limited sharing.

For limited time access to the full note, please reach out to us on research@frontiergroup.info. Clients who have access to Frontier Athena can visit athena.frontiergroup.info

(Frontier Research is a Colombo-based firm that engages in macroeconomic research and advisory for corporate and investment clients on Sri Lanka, South Asia, and South East Asia.)

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 recipient of this report 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. Frontier Research has taken every reasonable precaution to minimize the risk of viruses but is not liable for any damage you may sustain as a result of any virus or other malware in this email. For operational, business and security reasons, Frontier Research reserve the right to monitor all email communications including system generated technical and analytical information that is transmitted through our network. 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