Lanka to continue on high growth path

by Shirajiv Sirimane

For America, the most developed country in the World, more attacks similar to 9-11 and the Boston Marathon are possible, unlike in Sri Lanka where the world believed it would never be able to end a 30-year terrorism culture where bombs exploded almost every day somewhere in Sri Lanka.

Since this historic defeat of terrorism, Sri Lanka is now moving towards another ambitious task of a $ 4,000+ plus per capita income regime and a $ 100 billion economy.

Presenting the 63rd annual report of the Monetary Board to President and the Minister of Finance and Planning, Mahinda Rajapaksa recently, Governor Central Bank Ajith Nivard Cabraal said that this dream would be made a reality as all the financial targets set in the past seven years are achieved. “Our aim is to surpass this target before 2016,” he said.

Central Bank Governor Ajith Nivard Cabraal presents the 63rd Annual Report of the Monetary Board to President Mahinda Rajapaksa

He however said that when this trap is reached there is a possibility the country falling in to a ‘middle income trap’, stagnating growth. “This happened to some countries and for Sri Lanka the five hub concept (Maritime, Aviation, Energy, Commercial and the Knowledge along with tourism) spelled out in the Mahinda Chintana would help avoid this.”

The Sri Lankan economy grew at a healthy rate of 6.4 percent in 2012 while inflation was maintained at single digits for a fourth consecutive year, despite several global and domestic challenges. Improved business and consumer confidence, which supported a robust economic growth of 8 percent in the preceding two consecutive years, was accompanied by high credit and monetary expansion and a widening trade deficit fuelled by high import demand.

Inflation was maintained within single digit levels in 2012 for the fourth consecutive year. Inflation declined to a low level of 2.7 percent in February 2012.

However, the upward adjustment of energy prices and transport fares in February 2012 to reflect the rise in oil prices in the international market, the pass-through of the depreciation of the rupee, supply disruptions on account of adverse weather conditions that prevailed in major cultivation areas and the impact of past high monetary expansion resulted in inflation edging up to end the year at 9.2 percent.

Nevertheless, within a relatively short period the impact of the policy measures adopted was evident with the trade deficit and credit granted to the private sector decelerating while managing inflation expectations also helped, containing inflation at single digit levels throughout the year. By end 2012, the annual average rate of inflation stood at 7.6 percent.

Reflecting the government’s continued commitment to the fiscal consolidation process, the overall fiscal deficit was contained significantly below the previous year’s level, although it marginally exceeded the target in the budget.

The slowdown in economic activity and the decline in imports had a negative impact on government revenue collection. However, by maintaining a tight rein on recurrent expenditure and scaling back on capital expenditure, the overall fiscal deficit was contained at 6.4 percent of GDP, marginally above the targeted level of 6.2 percent of GDP and significantly below the 6.9 percent of GDP in 2011.

The external sector strengthened during the year benefiting from the policy measures that were adopted in early 2012 to improve macroeconomic stability. Import expenditure declined by 5.4 percent with non-fuel imports declining at a faster rate of 8.6 percent. Despite the decline in exports by 7.4 percent due to weak external demand and the decline in international commodity prices, the trade deficit contracted to 15.8 percent of GDP in 2012. The improvement in the trade account, increased inflows from trade in services including tourism and transportation, and continued high growth in workers’ remittances helped contain the current account deficit to 6.6 percent of GDP in 2012.

The gross official reserves rose to US dollars 6.9 billion by end 2012.

Real sector developments

The economy grew by 6.4 percent in real terms in 2012 amidst the slow recovery in global demand and the multi-pronged policy measures introduced to strengthen macroeconomic stability. All key sectors contributed positively to economic growth in 2012.

Reflecting the expansion in economic activities, the unemployment rate declined to 4 percent in 2012 from 4.2 percent in 2011.

The Agriculture sector grew by 5.8 percent in 2012, recovering from a slow growth of 1.4 percent in 2011, amidst drought conditions in the third quarter of the year and heavy monsoonal rains and floods in the latter part of the year.

Most agricultural commodities benefited from the favourable prices that prevailed in 2012.

The Industry sector grew by 10.3 percent, contributing substantially to the expansion of the economy in 2012.

The continuation of major government funded infrastructure development projects and increased construction activities of the private sector, including tourism related new construction and renovation activities, contributed to this growth.

External Sector Developments

Overcoming the challenges encountered towards the latter part of 2011, the external sector performed well during 2012 benefiting from the comprehensive policy package implemented by the Central Bank and the government during early 2012. These policy measures mainly aimed at reducing the widening trade deficit in 2011 and early 2012, by curtailing non-essential imports and improving export competitiveness.

Long term inflows to the financial account, including the proceeds from the fifth international sovereign bond, FDI inflows, and other inflows to the banks and private sector, helped strengthen the BOP to record a surplus of US dollars 151 million by end 2012.

Also, the continuing US sanctions against Iran curtailed Sri Lanka’s import of crude oil for its refineries, resulting in higher imports of refined petroleum products at a relatively high cost partly contributing to the increased expenditure on petroleum products during the year.

The services account recorded a significant improvement in 2012 mainly due to increased earnings from transportation, information technology services, travel and tourism.

Remittances by migrant workers increased by 16.3 percent to US dollars 6 billion during the year, continuing to be the largest single source of foreign exchange inflows to Sri Lanka.

The improvement in the trade balance and increased inflows from trade in services and current transfers helped restrain the current account deficit of the BOP.

Accordingly, the current account deficit was contained at US dollars 3.9 billion (6.6 percent of GDP) in 2012 from US dollars 4.6 billion (7.8 percent of GDP) in 2011.

Gross official reserves (excluding ACU balances) increased to US dollars 6.9 billion by end 2012 from US dollars 6.0 billion in 2011.

The total international reserves of the country increased to US dollars 8.4 billion from US dollars 7.2 billion in 2011.

The increase in official reserves reduced the country’s vulnerability to external shocks as reflected in the measures of reserve adequacy.

The import coverage of gross official reserves (excluding ACU balances) was 4.3 months in 2012, compared to the internationally accepted norm of 3 months of imports.

Reserve adequacy, as measured by the ratio of gross official reserves to short term external debt (with remaining maturity of one year or less) improved to 63 percent by end 2012 Fiscal Sector Developments

The government succeeded in reducing the budget deficit to 6.4 percent of GDP in 2012 from 6.9 percent of GDP in 2011, further consolidating the achievements made in the recent past to lower the fiscal deficit.

The funds of the Employees’ Provident Fund (EPF), which accounts for about 79 percent of the superannuation sector assets, reached Rs. 1,144 billion by end 2012.

High growth path to continue

The Sri Lankan economy is expected to continue on a high growth path benefiting from improved infrastructure facilities and favourable macroeconomic fundamentals.

Encouraging the private sector to reap the benefits of the government’s investments in infrastructure and facilitating them to expand productive capacity would be vital to achieving the envisaged medium term growth targets. Maintaining consistent policies and a conducive business environment will attract higher foreign direct investment (FDI) helping to bridge the gap between the current level of domestic savings and investment required to sustain the projected high growth momentum. Sri Lanka received a major boost when the global ‘Doing Business Index’ upgraded Sri Lanka from the 89th position to 81 position in 2013.

Sri Lanka is the highest ranking country in South Asia and is the only country in the region to improve this ranking. Sri Lanka is now aiming at the 30th position for 2016 taking the country even closer to be the ‘Wonder of Asia.’