Sri Lanka

Briefing Notes for the Launch in Colombo, March 2009

Growth moderates but remains robust

The global slowdown that has come in the aftermath of the financial crisis is having an adverse impact on the real economies of South Asia. However, the adverse impact is not as strong as in some other, more open, economies of the Asia-Pacific region. An estimated 2008 GDP growth of 6% in Sri Lanka is encouraging, given the global recession, high and volatile oil prices, sharp increases in food prices and a tight anti-inflationary monetary policy. A significant improvement in the performance of the agriculture sector helped to check an even sharper deceleration in growth from 6.8% in 2007 and a 28-year high of 7.7% in 2006. Government took measures to improve the liquidity of the financial sector and also introduced fiscal stimulus package which should soften the economic downturn, and further strengthen domestic demand. Supported by these measures, the economy is expected to grow around 5.5% in 2009.

Rapid increase in inflation

Inflation has been driven up in all the countries of South Asia, partly by unrelenting pressures from higher international commodity prices, particularly the prices of oil, basic metals and selected food items. Inflation in Sri Lanka continued to rise. In 2007 it was 15.8%, and is estimated at 22.6% for 2008. The surging global prices for fuel oil and staple foods, such as milk and wheat flour, drove the high inflation. Expansionary fiscal policy also exerted upward pressure. Inflation began to subside in the middle of 2008 with improvements in domestic supply factors, moderation of international commodity prices and reduced demand due to tight monetary policy.

Fiscal situation deteriorated

The Sri Lankan Government took measures to enhance its revenues, mainly by broadening the tax base, changing the tax rates to provide some exemptions to encourage development in specific sectors, and improving tax administration. On the expenditure side, the retail prices of petroleum products continued to adjust to reflect the cost, while administered electricity tariffs were revised upwards in line with increased input costs. The budget deficit was estimated at 7% of GDP in 2008, down from 7.7% of GDP in 2007.

External balances under pressure

The surge in prices of fuel oil, food and other commodities created severe problems for the external balances of most countries in South Asia. In 2007 Sri Lanka registered a growth of 12.2% in exports and 10.2% in imports. However, growth in exports decelerated to 6.5% in 2008. While growth in exports of agricultural commodities, particularly tea and rubber, remained strong, growth in exports of industrial products, particularly textiles and garments, was slow. At the same time imports, largely of petroleum products and consumer goods, grew at the high rate of 24.0%. In 2008 the deficit in the trade balance amounted to $5.9 billion, compared to $3.7 billion a year earlier. But private remittances, which amounted to $2.9 billion, helped to narrow the current account deficit, which was estimated at 7% of GDP in 2008. The country’s gross official reserves were $2.6 billion by the end of December 2008, down from $3.1 billion in December 2007, and were sufficient to finance more than two months of imports.

Poverty and widespread inequalities remain major challenge

Among long-term challenges, poverty remains a major problem for most countries in South Asia. Also, economic and social inequalities remain widespread. The main challenge for countries in the subregion, therefore, is not only to improve growth rates on a sustained basis but also to make them more inclusive for a rapid reduction in poverty and inequality. The composition of sectoral growth has important implications for pro-poor growth. Agriculture, construction and small and medium-sized enterprises (SMEs) generate pro-poor growth through employment generation, and should be supported.

To benefit from employment opportunities, the development of human resources is essential. In turn, education and health services are key to the development of human resources. Public provision of these services is crucial to the poor, as they can not afford to pay the prices charged by private providers. Print and public media should be vigorously used to change people’s attitude towards girls’ education and other forms of social exclusions and to ensure that the poorest of the poor have access to information on available opportunities.

Social safety nets are also essential for the poor and vulnerable who are unable to benefit from economic growth directly or indirectly. This support should be strengthened to provide a coping mechanism for the poor, especially in the event of macroeconomic shocks such as current global economic crisis. Without such interventions to address the problem of poverty and inequality, rapid economic growth cannot be sustained over the long term, for there are clear links between inequality and social unrest and violence.

Lack of physical infrastructure is a major impediment to business growth in South Asia, most notably shortcomings in electricity service. Huge gaps between supply and demand of electricity exist in several countries in the subregion, and these gaps will widen unless new electricity capacity is added. Involvement of the private sector through private public partnerships is the only way to meet the growing needs for energy. Along with generating more electricity, it is important to efficiently utilize existing capacity. Transmission and distribution losses are massive, partly due to theft. Rehabilitation and proper maintenance of the distribution system should be a priority to minimize transmission and distribution losses.