Regions and Countries

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p. 10 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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B. Risk Factors

55. The Government is committed to building up momentum to achieve a high and sustainable economic growth of 7-8 percent by 2004.⁸ Favorable factors that warrant higher growth than in the 1990s include stable macroeconomic management backed up by an open-economy policy, fiscal consolidation, and monetary policy; and microeconomic policy complying market mechanism such as public sector reform, privatization, financial reform, and price liberalization. Nevertheless, the economy remains at risk.

56. The impact of the ethnic conflict on the economy and poverty is estimated to be substantial. Accordingly, a consensus has emerged that the resolution of the conflict is a prerequisite to improve economic performance including fiscal deficit, capital flows, local currency value, aggregate economic growth, and poverty profiles. The result of ongoing efforts of the Norwegian delegates and other donors’ support for the movement has yet to be seen.

57. Parliamentary elections on 10 October 2000 have added uncertainties to the Sri Lankan economy. Both incumbent and opposition parties were committed to opening and liberalizing the economy.⁹ However, until such legacy of economic policy is verified and until good coordination between the Government and the Parliament is confirmed, impaired economic activities and delayed investment decisions are unavoidable. In the elections, the People's Alliance (PA), the ruling party, won 107 of the 225 seats in Parliament. The PA was short of 6 seats to form a governing majority in Parliament, but obtained the support of two minority parties and an individual group to secure 116 seats. Therefore, solid coordination between the Government and the Parliament needs to be confirmed.

58. The deterioration in terms of trade, which worsened from 114.2 in 1998 to 106.8 in 1999, is another concern. Sri Lanka is not only a small open economy; it also has a rigid trade structure where the promotion of exports requires a simultaneous increase in imported intermediate goods. In particular, in terms of current US dollars, the prices of the first two major agricultural exports of Sri Lanka are projected to either decline or show only a marginal increase.¹⁰ Coconut oil prices that showed a 12.0 percent increase in 1999 are expected to decline by 11.8 percent and 3.8 percent in 2000 and 2001, respectively. Tea prices that declined by 10.1 percent in 1999 will only marginally increase by 1.1 percent and 0.5 percent in 2000 and 2001, respectively. These price movements will reduce exports. Considering that these exports amount to 16.3 percent of total exports, balance of payments and economic growth will be adversely affected.

59. The Sri Lankan rupee depreciated against the dollar by 9.8 percent during 2000. The depreciation is expected to improve the external sector performance. However, since the industry sector relies heavily on imported intermediate goods (50.6 percent of total imports in 1999), depreciation coupled with high crude oil prices will also bring about higher production costs, and eventually high imported inflation. High inflation will lead to higher interest rates, which will in turn depress investment and cause the fiscal burden of the already highly indebted Government to balloon. On the other hand, recently the currencies of other counterparts also depreciated fast.¹¹ On balance, the net effect of depreciation in Sri Lanka is yet to be seen.

60. Development of the labor market is an important indicator in determining the competitiveness of the economy. However, Sri Lanka's relatively rigid labor market, compared with those of other advanced or developing countries in Asia–in particular, crisis-affected countries have achieved remarkable progress in labor market flexibility–has impeded channeling domestic capital and foreign capital into domestic investment. The long-term prospect of economic growth depends heavily on the development of tripartite coordination among the Government, employers, and workers.

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