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Regions and Countries Country Economic Reviews Document
Executive SummaryThe Sri Lankan economy started to recover in the second half of 1999, and the recovery accelerated in 2000. Both internal factors such as weather conditions and political uncertainties, and external factors such as overall economic fluctuation in the wake of Asian financial crisis and high oil prices were key elements in determining the movement of the economy. However, another key factor that constrained the economy was the civil conflict that started in 1983 and intensified since April 2000. In 1999, unfavorable external conditions slowed Sri Lanka’s economic growth to 4.3 percent, lower than the 4.7 percent achieved in 1998; however, the economy started to recover in the second half of the year. The agriculture sector showed its highest growth since 1993. The annual growth rate of the industry sector was not high but, reflecting the recovery of industrial exports, performance in most industrial categories improved during the second half of the year. Output in the services sector grew even more slowly because of the continued slump in the wholesale and retail trade. In the production structure, the share of the services sector in gross domestic product (GDP) continued to increase. An increase in corporate and household savings and a reduction in Government dis-savings contributed to the higher domestic savings. While public investment remained at about the same level as in the previous year, the higher private investment led to higher domestic investment. The gap between domestic investment and domestic savings widened. Fiscal performance improved significantly despite the ongoing conflict in the north and the east. The overall deficit declined to 7.5 percent of GDP from 9.2 percent in 1998. This partially reflects the Government effort to reestablish the fiscal consolidation path achieved during 1995-1997. On the revenue side, the declining trend observed in the total revenue-GDP ratio in the recent past was arrested in 1999 with higher mobilization of tax revenue. On the expenditure side, noninterest current expenditure was maintained at about the same level as in 1998, growth of the wage bill was contained at a lower rate, and expenditure on purchases of goods and services declined. In particular, defense expenditure continued to decline at 4.4 percent of GDP, compared with 5.0 percent in 1998. Capital expenditure did not reach the originally expected level owing to significant shortfalls in expenditures in several major projects in ports, agriculture, railways, and energy. The stock of Government debt as a percentage of GDP increased to 95 percent from 91 percent in the previous year. The monetary policy continued to focus on maintaining stability in the financial market, and further efforts were made to enhance the market orientation of the instruments of monetary policy. Except for a temporary instability in the financial market in April as a result of elections and labor unrest, both the call market and the exchange market exhibited considerable stability. A slight decline in short-term market interest rates reflected a low inflation rate and flexible monetary policy. Although there were some reductions in interest rates, they were much less than the fall in inflation, resulting in an increase in real interest rates. Faster growth in domestic assets was partly offset by a decline in net foreign assets, reflecting the deficit in the balance of payments. Monetary growth was higher than in 1999. The inflation rate of 4.7 percent was the lowest since 1985. It was the outcome of improved monetary controls and fiscal discipline, rationalized tax and tariff structures, greater agricultural production, and improved domestic marketing network and dissemination of price information systems using modern communication media. In addition, the drop in the world market prices of major imported consumer items compensated for the upward pressure on prices through the currency depreciation. External sector developments were dominated by the lagged effects of the depressed global demand and the resultant decline in commodity prices. Exports decreased by 3.9 percent, but imports increased by 1.5 percent because of the import of three aircraft by SriLankan Airlines. Consequently, the trade deficit widened. The current account deficit increased from 1.4 percent of GDP in 1998 to 3.6 percent. Coupled with a declining surplus in the capital and financial accounts, the overall balance of payments registered a deficit of 1.7 percent of GDP from a surplus of 0.2 percent in 1998. Exchange markets remained stable during the year in contrast to the high volatility in 1998. The Sri Lanka rupee depreciated by 8.2 percent against the dollar during 1999. Total external assets at the end of the year were equivalent to 4.6 months of imports of goods and services, while total official reserves were equivalent to 2.9 months of imports. The external debt stock increased and 94.8 percent of the total was medium- and long-term debts consisting mainly of concessional assistance. The total external debt-GDP ratio increased from 55.5 percent in 1998 to 57.4 percent. The debt service payments as a percentage of receipts from exports and services also increased. 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 1999. While the high growth was broad-based, the industry sector outperformed the agriculture sector and the services sector. The inflation rate was higher than expected at 6.8 percent due to a high increase in food and energy prices. Exports continued to grow by 19.7 percent maintaining the growth momentum achieved in late 1999. The high export growth was accounted for by the strong economic growth in the United States (US) and European countries, and the recovery of the East Asian countries including Japan and the Republic of Korea. Reflecting the export-dependent import structure of Sri Lanka, imports also increased by 38.1 percent. Trade deficit was $1,139 million compared with $549 million in the same period in 1999. In the second half of 2000, the economic trend of the first half is expected to continue. The real GDP growth rate is projected at 6.0 percent in 2000 and 4.5 percent in 2001. Exports are expected to increase by 19.8 percent, and imports by a higher rate, 22.4 percent due to higher oil prices. The ratio of the current account deficit to GDP is expected to be 6.0 percent in 2000 and 3.8 percent in 2001. High foreign direct investment, private capital flows and Government short-term capital flows will partially offset large current account deficit. The deficit in the overall balance of payments is projected to widen from 1.7 percent of GDP in 1999 to 3.4 percent in 2000. Despite continuing fiscal consolidation efforts, an increase in defense expenditure will reverse the downward budget deficit ratio to GDP. The ratio is expected to reach 8.7 percent in 2000, and only a small improvement is expected in 2001. Inflation will return to a higher level of 6-8 percent. For sustainable and high economic growth, the Government needs to take the initiative in various areas. A consensus has emerged that a solution to the civil conflict which is estimated to lower GDP by 6 percentage points is a prerequisite to improve economic growth and poverty profiles. Mitigating the high fiscal deficit and public debt is imperative for flexible implementation of both fiscal and monetary policies. The Government must promote the private sector to meet the economy’s expanding resource requirements while developing the appropriate market environment to promote efficiency. More efforts for generating demand should be made in the agriculture sector, an important foreign exchange-earning sector. To link highly developed human capital to high economic welfare, a more flexible labor market and narrowing down the gap between skills demanded and skills supplied are required.
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