Rupee to strengthen from year-end, deflation seen by mid-2027

Frontier Research expects the rupee to begin a fresh appreciation cycle closer to the end of the year, with inflation turning negative by mid-2027 and rates easing further.

Frontier Research Head of Macroeconomic Advisory Chayu Damsinghe told a recent investor forum organised by the firm that the rupee could strengthen to around Rs. 325 per dollar by the end of 2026 and Rs. 315 by end-2027, and further if Brent crude falls to $ 85 a barrel by October or November. Frontier had previously expected appreciation across most of the second half of 2026. Renewed escalation in the Iran conflict has pushed the start closer to year-end, and the move is now expected to extend into early 2027.

“The natural path of the economy is not one of depreciation. You need negative events,” he said, cautioning businesses against building depreciation into their budgets.

Sri Lanka last received two consecutive rating upgrades in 2010. Frontier expects the other agencies to follow the recent upgrade within six to 12 months, potentially unlocking large inflows. “Don’t get caught off guard if that round of appreciation happens,” Damsinghe said.

Point-to-point inflation is expected to stay volatile around 8% before turning down in November and December. The rise from about 2% was supply-driven rather than demand-driven, Frontier said, and should reverse as oil eases. Given the high base, negative inflation by mid-2027 is “very much something you should expect”, Damsinghe said. Longer term, Frontier sees inflation at 2% to 3%, below the Central Bank’s 5% target. Excluding the oil shock, inflation would have averaged close to 1% across 2023 to 2026.

Frontier expects the 12-month Treasury Bill yield, now near 10%, to fall 50 to 100 basis points this year and about 100 basis points more in 2027, with a similar path for five-year and 10-year Bonds. The forecast decline is smaller than Frontier projected a few months ago because a less supportive global rates environment limits how far local rates can fall. Deeper cuts would need large inflows, Damsinghe said.

Brent averaged about $ 95 a barrel in the first phase of the Iran war, eased to around $ 80 in June and July, and is now back above $ 95. Frontier now sees conditions normalising in early or mid-2027 rather than by end-2026.