Countries and Regions

	Table of Contents
p. 2 of 20 BACK | NEXT I. Country Performance Assessment A. Economic Performance Assessment B. Poverty Assessment C. Assessment of Socio-Environmental Performance D. Governance: Sound Development Management E. Implementation Assessment II. Country Operational Strategy III. Sector Strategies IV. Regional Cooperation V. Donor Activities and Aid Coordination VI. Cofinancing and Catalyzing External Resources VII. ADB’s Operational Program VIII. Economic and Sector Work Program IX. Local Cost Financing

Country Assistance Plans - Sri Lanka : I. Country Performance Assessment

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A. Economic Performance Assessment¹

1. In recent years, the macroeconomic performance in Sri Lanka has improved, in spite of the impacts of civil conflict in the north and east of the country. The economy has grown at an annual average of 5.2 percent during the 1990s. In 1999, Sri Lanka registered a lower economic growth of 4.3 percent compared to 4.7 percent in 1998, mainly the result of declining industrial production and exports that suffered from the slackening world economy. After recording 3.8 percent growth in the first half of 1999, the performance of the industrial sector improved in the second half of the year reflecting a gradual improvement in exports. During 1999, the agriculture sector performed well, reflecting higher output levels of plantation crops. Although gross domestic product (GDP) growth in 1999 is below the average trend in the 1990s, it is heartening if the increased political instability during the period is considered.

2. Domestic investment increased to 27.1 percent of GDP in 1999 compared to 25.1 percent in 1998, mainly due to the re-fleeting of the Sri Lankan Airlines, the privatized national airline, and the expansion of telecommunication services. Infrastructure development projects, together with housing and small-scale construction projects in the rural area also contributed to the increase in investment expenditure in 1999. The ratio of national savings to GDP increased slightly from 23.4 percent in 1998 to 23.9 percent in 1999 owing to higher private savings and the reduction of fiscal deficit.

3. Total government revenue increased by 12 percent from 17.2 percent of GDP in 1998 to 17.6 percent in 1999. Revenue collections from income taxes, excise taxes, national security levy and non-tax revenue showed a substantial improvement. In contrast, revenues from customs duties and goods and services tax (GST) were less than expected largely on account of the low value of imports and high refunds under GST during the first half of 1999. However, due to improvements effected in the refund system, as well as in the enforcement mechanisms, the revenue from GST improved in the second half of 1999.

4. On the expenditure side, the cost of salaries, including those of provincial councils and security forces increased by 8.7 percent. Despite the reduction in interest rates, the cost of public debt increased in 1999 due to increased borrowings. Defense expenditure in 1999 was marginally lower than 1998. All in all, total government expenditure was 25.1 percent of GDP in 1999 compared to 26.3 percent of GDP in 1998. The 1999 budget deficit reached 7.5 percent of GDP, an improvement on the 9.2 percent of GDP in 1998, although it still remains at a high level.

5. Monetary policy in 1999 aimed at maintaining financial market stability, while helping to strengthen the declining trends in inflation. The consolidated broad money supply (M2b), which includes the operations of the foreign currency banking units, increased by 13.4 percent as of end 1999. Inflation showed a declining trend in 1999, averaging 4.7 percent compared to 9.4 percent in 1998, due to improved domestic supply of food items and lower import prices. The unemployment rate declined to 8.9 percent in 1999 compared to 9.5 percent in 1998, due to the growth of employment in tourism sector, a strong growth of small businesses, and increased recruitment to the public sector.

6. External sector developments in 1999 reflected the lagged effects of depressed global demand and the continued decline in commodity prices. Exports registered a negative growth of 4.1 percent in 1999, mainly because of lower prices for tea, rubber, textile and garment products. Imports marginally increased by 0.2 percent in 1999 as import prices went down across the board with the exception of oil. Accordingly, the trade deficit widened to $1.3 billion in 1999 compared to $1.1 billion in 1998. The services account showed a marginal improvement, registering an estimated surplus of $147 million in 1999 compared to $145 million in 1998 despite a rapid recovery in the tourism sector. During 1999, tourist arrivals totaled 436,400 persons, a 14.5 percent increase compared to 1998.

7. The current account deficit widened to 3.1 percent of GDP in 1999 and the overall balance of payments registered a deficit of $263 million in contrast to a surplus of $37 million recorded in 1998. Gross official reserves, which were $2 billion at the end of 1998, declined to $1.6 billion at the end of 1999. This level of reserves was sufficient to finance 3.3 months of imports of goods. External debt to GDP ratio increased in 1999 to 57.4 percent from 55.5 percent in 1998, and debt service ratio also increased from 13.3 percent in 1998 to 15.2 percent in 1999.

8. Despite the escalating conflict in the north, the economy grew by 7.0 percent in the first half of 2000. The agricultural sector grew by 2.9 percent, lower than the previous year. However, the manufacturing sector recorded a higher growth of 11.9 percent. In particular, the expansion of textiles and wearing apparels, and rubber and plastic products was noticeable due to increased world market demand. Meanwhile, the progress in domestic economic activities also created a demand for petroleum, basic metal products, wood and wood products and processed food. The telecommunication sector continued to grow due to the expansion in the communication network and infrastructure following large private sector investment during the past few years.

9. In the second half of 2000, the economic trend of the first half of 2000 is expected to continue. Reflecting better performance in the second half of the previous year, however, the growth rate will be lower than the first half. Overall, real GDP growth rate is projected at 6.0 percent in 2000. Light consumer goods, building materials and agro-based industries are expected to maintain high growth rates. The services sector would grow by 6 percent with higher growth rates reflected in the communications sectors. Private investment will increase steadily owing to the efforts of Government to strengthen private sector confidence. The ratio of current account deficit to GDP is expected to be 7.9 percent in 2000. Exports are expected to increase by 13.1 percent, while imports by a higher rate, 23.1 percent, due to aircraft import and higher oil prices. Privatization proceeds and higher private capital flows will aid the improvement of the overall balance of payments. Debt service payments as a ratio of exports of good and services and current private transfers are projected to decline to 14.3 percent in 2000 from 15.2 percent in 1999.

10. The Government's defense expenditure averaged 3.4 percent of GDP annually during the first half of 1990s. Following a breakdown in negotiations on settlement of the civil conflict in 1995, the defense expenditure increased to 6.5 percent of GDP in 1995, but it continued to decline to 4.4 percent in 1999. In 2000, it is projected to amount to about 5.1 percent of GDP due to the intensification of conflict in the north since April 2000. To finance the additional expenditure on war efforts, the Government has raised the national security levy and excise taxes on alcohol and tobacco, and reduced nonessential capital expenditure by about 10 percent. Having recognized the negative impact of the long-lasting civil conflict on the economy and society, the Government has undertaken to intensify efforts to reach a political and peaceful solution to the conflict in addition to the devolution of more power to the provinces especially the north and east.

11. The 2000 budget estimates expenditure at 26.9 percent of GDP (current expenditure: 19.8 percent, and capital expenditure: 7.2 percent of GDP). Revenue is estimated to increase to 18.5 percent of GDP in 2000. Accordingly, budget deficit is expected to be over 8.0 percent of GDP compared to the original budget of 7.6 percent. Nonetheless, the Government aims to reduce the budget deficit to 5 percent of GDP by 2002 supported by a number of structural reforms following the completion of the general elections in October 2000. The 2000 budget deficit is planned to be financed by foreign grant (7 percent) and foreign borrowing (10 percent), divestiture proceeds (18 percent), and domestic borrowing (66 percent). The Government aimed at reducing domestic borrowing from 6.7 percent of GDP in 1999 to 5.5 percent of GDP in 2000. This target may not be achieved given the increased spending on security and the delayed divestiture of telecom shares. The 2000 budget also contains various reform measures that will be taken during 2000 including relaxation of restrictions on foreign holdings of banking and insurance companies and tax reforms.

12. The Government was also faced with a deterioration of gross official reserves and shortage of liquidity in the market. In June 2000, the Central Bank of Sri Lanka depreciated the rupee by 4 percent against the dollar in order to increase the competitiveness of exports and encourage repatriation of foreign exchange. Prices of basic goods and services including electricity, gas, bus fare and some food items increased during the first half of 2000 resulting from high oil prices and increased import prices of consumer goods. Inflation is expected to average at about 7.5 percent in 2000. The key economic indicators are given in Appendix 1.

13. Although a gradual recovery of the economy is expected, there still exist areas of concern for sustainable growth in the short to medium term. Civil conflict in the north and east had a long negative impact on the country’s economic growth. Other factors constraining growth include sluggish progress in productivity improvements, particularly in agriculture and industry, a substantial budget deficit, inefficiencies in the financial sector, bureaucratic delays in the delivery of public services, and unemployment among educated youth. The recent sharp rise in oil prices could be an additional burden on the economy in 2000.

14. To overcome these obstacles and revive the economy, various structural reforms would need to be implemented in the short to medium term. Major policy initiatives needed to achieve sustainable growth and macroeconomic stability include public administration reform, pension reform, financial sector reform, and public enterprise reform. Public administration reform, including civil service pension reform, has become more important because of the increasing need for a better-equipped public service to perform its role in promoting private sector growth and reduce fiscal deficit. Several donors have made external assistance available for public administration and pension reforms, but only limited progress has been achieved to date.

15. The Government is actively pursuing financial sector reforms with external assistance, aiming to develop a sector that is large enough to mobilize the required capital, both domestic and foreign, and to allocate it efficiently to productive uses. Recent achievements include progress in the development of a long-term debt market by increasing treasury bond issues and mobilizing private resources in the international debt market through the issuing of a 10-year floating rate note. Despite these achievements, the domestic capital market remains small. Traditional fund sources, i.e., the development finance institutions, continue to be the major sources of long-term finance. Limited access to financing, particularly long-term financing, and the high cost of funds in the country hinder private sector activities. The development of market-based financial institutions and instruments through financial market reforms is important to facilitate private sector expansion.

16. Despite the successful implementation of the privatization program, public enterprises still maintain a strong presence in financial services, agriculture, manufacturing, and infrastructure. Public enterprise reforms through private sector participation warrant stronger support in the future. Public enterprise reforms need to be accompanied by vigorous labor market reforms. These should include the determination of labor compensation, the creation of labor retraining and reemployment programs aimed at helping workers displaced during public enterprise reform and the restructuring process, and the establishment of a safety net to make the labor market more flexible. As both the presidential and the general elections have now been completed, the Government is focusing its efforts on major reforms, evidenced from its firm commitments to key policy and institutional reforms under the private sector development program assisted by ADB and other major external agencies.

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