Country briefing note <download pdf file>
Growth slows due to both external and domestic factors
- The economy of Sri Lanka expanded on average more than 8% annually during 2010 and 2011. The high growth momentum was supported by an improved macroeconomic environment, increased capacity utilization, expansion of economic activity in Northern Province and Eastern Province and enhanced external demand.
- This strong growth momentum continued into the first quarter of 2012, but growth gradually moderated from the second quarter onwards in response to policy tightening and weakening global demand. GDP grew by 6.2% for the year as a whole. The deceleration in growth was mainly due to relatively lower growth of the agricultural and services sectors. On the demand side, the investment-to-GDP ratio has been improving and crossed the 30% mark in 2012.
- GDP growth is expected to improve to 6.5% in 2013 due to easing of both monetary and fiscal policies, and improved performance in all major sectors, particularly the agricultural sector which suffered a setback in 2012 due to adverse weather conditions.
- Inflation which was only 2.7% in February 2012 compared with that in the same month in the previous year rose to 9.9% in July 2012. Inflation for the year as a whole averaged 7.6% as compared with 6.7% in 2011. The upward revision of administered energy prices, rise in food prices due to drought conditions, depreciation of the domestic currency as well as increase in import duties on several food items contributed to upward pressure on prices.
Monetary policy needs to strike a balance between curbing inflationary expectations and reviving growth
- Countries in the subregion are facing serious challenges of slowing down of economic growth and at the same time containing of high inflationary pressures. Therefore, some countries have started to ease monetary policy to support private investment and growth. Policy rates were raised in Sri Lanka in February and April 2012 to curtail trade-related credit in order to reduce trade and current account deficits as well as to contain inflationary pressures. However, the policy rate was lowered by 25 basis points in December 2012 as GDP growth was decelerating sharply.
Budget deficit falling
- The budget deficit in Sri Lanka though still high has been narrowing in recent years. It came down to 7.8% of GDP in 2011 from 8.1% of GDP in 2010. It was expected that the Government's target for budget deficit at 6.2% of GDP in 2012 would be achieved by restraining expenditure and improving revenue collection, particularly through the strengthening of tax administration.
Current account deficit narrows
- In Sri Lanka, the current account deficit has been narrowing, and foreign exchange reserves have stabilized. Both exports and imports contracted in 2012 due to the global slowdown, which helped in containing the trade deficit. Tighter monetary and credit policies slowed credit and import growth. Strong growth in workers' remittances by 16.3% helped in narrowing the current account deficit to about 5% of GDP in 2012 from 7.8% of GDP in 2011.
- In order to realize its development potential, countries in South Asia in general will have to overcome a number of development challenges, including large concentrations of poverty and hunger, rising inequality, poor levels of human development, wide infrastructure gaps, lack of a diversified base for high value added products and exports, widespread food and energy insecurity and high risk of disasters.
- The subregion's economic, social and environmental priorities must be balanced in favour of eradicating extreme poverty and hunger. Today, South Asia remains home to the world's largest concentrations of people living in poverty and hunger, and people without access to basic sanitation and electricity. The subregion is also characterized by having the world's highest levels of child and maternal mortality. Progress on the health, nutrition and sanitation-related Millennium Development Goals and related targets has been stalled because of the large inequalities and disparities within populations that persist in the subregion.
- This subregion faces the dual challenge of raising productivity to ensure that incomes are rising and poverty is falling, and creating enough jobs for a growing working-age population, which is expanding by about 2% per annum. With almost 60% of the population under the age of 30, Governments of countries in South Asia have to take advantage of this demographic bulge. Otherwise, the consequence can be social unrest, conflict and insecurity.
- Countries in the subregion should maximize growth through productive job creation and appropriate structural change to reduce poverty, hunger and inequalities. Countries in the subregion should also provide good-quality education, health, sanitation and other infrastructure to make the most of the youth bulge. In addition, a minimum social protection floor should be established that meets the basic needs of vulnerable populations.
- South Asia faces growing energy demand, and a number of energy challenges — energy poverty, lack of available supplies, poor energy infrastructure and transport facilities and environmental externalities. The subregion's energy deficits are particularly detrimental in terms of growth and poverty alleviation as parts of the subregion faces regular and sustained power outages. Energy security, linked with energy availability, accessibility and affordability, is a paramount policy concern for countries in the subregion.
- Strengthened regional cooperation can help solve a number of the challenges facing South Asia and can be an important development strategy to ensure a sustainable future for the subregion. Greater regional integration not only increases intraregional trade, but also promotes efficiency-seeking investment in the subregion's supply chain and production networks. This, in turn, creates more and better jobs in addition to building productive capacity, particularly in the subregion's least developed countries. Regional cooperation can play a pivotal role in crafting solutions to shared vulnerabilities and helping ensure food and energy security, as well as reducing the subregion's vulnerability to natural disasters.