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p. 9 of 11 BACK | NEXT Executive Summary I. Recent Economic Developments II. Short- and Medium-Term Economic Prospects and Policy Issues A. Short- and Medium-Term Economic Outlook B. Risk Factors C. Major Policy Issues

Country Economic Review: Sri Lanka : II. Short- and Medium-Term Economic Prospects and Policy Issues

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A. Short- and Medium-Term Economic Outlook

53. During the first half of 2000, GDP grew by 7.0 percent, helped by a favorable external trade environment that continued from the second half of the previous year. The high growth was broad-based, but the industry sector grew fastest by 10.4 percent, outperforming the 2.9 percent of the agriculture sector and 7.1 percent of the services sector. Consequently, the unemployment rate also declined to 8.0 percent. The high economic growth was partly due to the poor performance in the first half of 1999, the basis of comparison. Total tourist arrivals were slightly lower than last year’s level, reflecting concerns over safety. M2b grew by only 11.4 percent as of end-June 2000 year-on-year; however, the annual inflation rate was lower than expected at 3.3 percent as of June 2000 due to improved agricultural production, lower international prices of imported food items, and containment of money supply.

54. Exports continued to grow by 19.7 percent during the first half of 2000 maintaining the growth momentum achieved in late 1999. The high export growth was attributed to the strong economic growth of the US and European countries, and the recovery of the East Asian countries including Japan. The main contributor to export growth was textiles and garments that increased by 24.0 percent. Imports increased at a much faster rate of 38.1 percent than exports. Reflecting the export-dependent import structure of Sri Lanka, imports of intermediate goods such as crude oil and textiles increased by 34.0 percent. However imports of investment goods such as transport equipment—excluding three aircraft—and machinery and equipment showed a lower growth rate of 19.6 percent.

52. The economic trend of the first half of 2000 continued in the second half. Reflecting better performance in the second half of 1999, however, the growth rate was lower than in the first half. Overall, real GDP growth is projected at 6.0 percent in 2000. Light consumer goods, building materials, and agrobased industries maintained high growth rates. The services sector grew by 5-6 percent, with higher growth reflected in the electricity and communications sectors. In 2001 and 2002, economic growth is expected to be lower than in 2000, reflecting mainly a worsening external demand (Table 8).

53. Exports increased by 19.9 percent in the second half of 2000, and imports, excluding aircraft, by a higher rate, 20.9 percent due to higher oil prices, and imports of machinery, equipment and building materials. As a result, the trade deficit reached 10.9 percent of GDP in 2000, compared with 8.7 percent in 1999. The ratio of the current account deficit to GDP is expected to be 6.0 percent–3.4 percent, excluding aircraft–in 2000. High foreign direct investment, private capital flows, and government short-term capital flows will partially offset high current account deficit. The deficit in the overall balance of payments consisting of $1.8 billion in trade account deficit, and $1.0 billion in current account deficit, is projected to widen from 1.7 percent in 1999 to 3.4 percent in 2000. Subsequently gross official reserves are expected to decline from 2.9 months of imports of goods and services in 1999 to 1.5 months in 2000. Debt service payments as a ratio of exports of good and services are projected to decline from 15.2 percent in 1999 to 13.8 percent in 2000.

54. Despite continuing fiscal consolidation efforts, an increase in defense expenditure will reverse the downward budget deficit ratio to GDP. In the initial budget for 2000, the ratio of defense expenditure to GDP was expected to be as low as 3.9 percent compared with 4.4 percent in 1999. However, the intensification of the conflict in April reversed the trend and the ratio rose to 5.1 percent. As parallel measures, the Government has raised the national security levy and excise taxes on alcohol and tobacco, and reduced nonessential capital expenditure by about 10 percent. However, the rigid budget structure could not help but allow the fiscal deficit to increase to 8.7 percent of GDP from 7.6 percent in the initial budget for 2000, although the fiscal condition is expected to improve slightly in 2001. In deficit financing, the delay in privatizing Sri Lanka Telecom to 2001 made the Government resort to financial sector resources. This resulted in a crowding-out effect in the financial market and a pressure on the monetary policy. Under these economic conditions, the consolidated broad money (M2b) grew at 12.9 percent in 2000 and is expected to increase slightly higher in 2001. The inflation rate returned to a higher level of 6.2 percent by December, mainly due to administered price revisions following the increase in world prices of essential imports including oils. The prices of essential commodities such as food, water, electricity, and transport have risen. The impact of currency depreciation since June 2000 will factor in the high inflation in 2001.

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