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Backgrounds: Sri Lanka Economy
With an economy of $18.4 billion (est.), and a per capita GDP of about $950 , Sri Lanka has mostly enjoyed strong growth rates in recent years. Sri Lanka began to shift away from a socialist orientation in 1977. Since then, the government has been deregulating, privatizing, and opening the economy to international competition. The ethnic disputes of 1983 precipitated a slowdown in economic diversification and liberalization. The JVP uprising in the late 1980s caused extensive upheavals and economic uncertainty.
Following the quelling of the JVP, increased privatization, reform, and a stress on export-oriented growth helped revive the economy's performance, taking GDP growth to 7% in 1993. Economic growth has been uneven in the ensuing years as the economy faced a multitude of global and domestic economic and political challenges. Overall, average annual GDP growth was 5.2% over 1991-2000. In 2001, however, GDP growth was negative 1.4%--the first contraction since independence. The economy was hit by a series of global and domestic economic problems and affected by terrorist attacks in Sri Lanka and the United States. The crises exposed the fundamental policy failures and structural imbalances in the economy and the need for bold reforms. The year ended in parliamentary elections in December, which saw the election of a more pro-business government.
The government of Prime Minister Ranil Wickremasinghe of the United National Party (which also ruled the country from 1977 to 1994) has indicated a strong commitment to economic and social sector reforms, deregulation, and private sector development. In 2002, Sri Lanka commenced a gradual recovery. Early signs of a peace dividend were visible throughout the economy--Sri Lanka has been able to reduce defense expenditures and begin to focus on getting its large public sector debt under control. In addition, the economy has benefited from lower interest rates, a recovery in domestic demand, increased tourist arrivals, a revival of the stock exchange, and increased foreign direct investment (FDI). In 2002, economic growth bounced up to 4%, helped by strong service sector growth. Agriculture staged a partial recovery. Industrial sector growth, however, faltered for the second consecutive year due to weak demand and lower prices for Sri Lanka's exports. The government was able to exert fiscal control, and inflation trended down. Total FDI inflows during 2002 were about $246 million and were expected to exceed $300 million in 2003. The largest share of FDI has been in the services sector. Good progress was made under the Stand By Arrangement, which was resumed by the International Monetary Fund (IMF). These measures, together with peaceful conditions in the country, have helped restore investor confidence and created conditions for the government to embark on extensive economic and fiscal reforms and seek donor support for a poverty reduction and growth strategy.
Foreign exchange reserves, which fell by 11% in 1999, decreased further in 2000. In response, the government floated the rupee on January 23, 2001. This led to a significant nominal depreciation in 2001, but the rupee has since stabilized and reserves have been replenished.
Economic recovery consolidated during 2003, which was another eventful year for Sri Lanka. Continued peace allowed further progress on macroeconomic stabilization during the first half of the year. Some progress was reversed, however, during the political uncertainty in November and December 2003. Economic growth is estimated at 5.5% for the year. This growth was largely driven by the services sector (particularly telecom, tourism and trade.) Both exports and imports rose over 9% in the first 10 months. Interest rates declined. The inflation rate fell under 9%. External reserves were sufficient to cover 5.6 months of imports. The Colombo Stock Exchange (CSE) rebounded to become one of the better performers in the area. The CSE rose 45% in 2002 and hit a record high in June 2003, but performance declined at the end of the year. Fortunately, the Severe Acute Respiratory Syndrome (SARS) epidemic did not spread to Sri Lanka, and tourism was not severely affected. Sri Lanka's garment exporters reported a surge in orders, shifted from China due to SARS. On the negative side, in mid-2003 Sri Lanka experienced its worst floods in 50 years, which caused extensive damage in south and southwestern parts of the country. The government is relying on donor funding to reconstruct the flood-damaged areas, avoiding recourse to government finances. The adverse impact from floods on overall growth for 2003 is estimated to be marginal.
Early projections for 6.5% growth in 2004 did not account for political instability, which will negatively impact performance. The future of Sri Lanka's economic health is uncertain but is primarily dependent on resolution of the political cohabitation crisis, as well as the continuation of the peace process, political stability, and continued policy reforms--particularly in the area of fiscal discipline and direct management. Implementation of major reforms in the civil service and education sectors and more disciplined spending and improved revenue collection would help generate stronger economic growth. If privatization continues and export orientation strengthens, weaknesses in government will have less impact on growth. Real growth is expected to continue in the 4%-6% range beyond 2003 but may remain below the 8%-9% growth needed to move quickly into the status of a middle-income or newly developed country.
All major sectors of the economy are expected to expand. Recovery in the global economy also is important as well as effective aid utilization. According to the Finance Minister, the fiscal deficit was forecast to decline to 7.5% of GDP in 2003, with the government instituting more controls on fiscal management. Given Sri Lanka's high debt burden (101% of GDP), fiscal consolidation is central to budget planning and macroeconomic programming. Stagnant government revenue, however, remains a big worry in 2004.
Other challenges include diversification from Sri Lanka's key exports--tea and garments. Garment exports will face increased competition in a quota-free era when the Multi Fiber Arrangement expires in 2005. The future of the tea industry is threatened by a shortage of plantation labor and growing competition. There are new efforts to diversify exports, explore tourism potential, and improve competitiveness. The government has an ambitious information and communications technology strategy to connect and service every corner of the country. This project, if implemented successfully, could change Sri Lanka's economy and social fabric and would take it into the information age. The government hopes to take advantage of Sri Lanka's strategic location on shipping routes, make use of the Indo-Lanka Free Trade Agreement, and sign free trade agreements with other countries to achieve regional trading hub status. If peace returns and all these efforts bear fruit, real growth could be in the 6%-7% range beyond 2004, and will help realize the government's intention of making Sri Lanka the gateway to South Asia.
The service sector is the largest component of GDP (54%). In 2003, the service sector continued its strong expansion, fueled primarily by strong growth in telecom, tourism, and financial services. Public administration and defense expenditures have remained steady. Repatriated earnings of Sri Lankans working abroad continued to be strong. There also is a small but growing information technology sector, especially information technology training and software development and exports.
Manufacturing accounts for about 16% of GDP. The textile, apparel, and leather products sector is the largest, accounting for 44% of total industrial output. The second largest industrial sector, at 24% of total manufacturing output, is food, beverages, and tobacco . The third-largest industrial sector is chemical, petroleum, rubber, and plastic products.
Agriculture has lost its relative importance to the Sri Lankan economy in recent decades. It accounts for 20.1% of GDP and provides employment to 33% of the working population. Rice, the staple cereal, is cultivated extensively. The plantation sector consists of tea, rubber, and coconut; in recent years, the tea crop has made significant contributions to export earnings and saw production slightly decrease in 2003. Tea prices have remained stable. The construction sector accounts for 7.4% of GDP and mining and quarrying 1.8%. In recent years, the government has eliminated many price controls and quotas, reduced tariff levels, eliminated most foreign exchange controls, and sold more than 55 state-owned companies and 20 estate-holding companies. Colombo boasts one of the most modern stock exchanges in the region, and the Sri Lankan Government offers a range of tax and other incentives to attract potential investors.
Trade and Foreign Assistance
Sri Lanka is highly dependent on foreign assistance, and several high-profile assistance projects were launched in 2003. The most significant of these resulted from an aid conference in Tokyo in June 2003; pledges at the summit--which included representatives from the IMF, World Bank, Asian Development Bank, Japan, the European Union, and the United States--totaled $4.5 billion. This funding was in response to a poverty reduction strategy program laid out in "Regaining Sri Lanka," an action paper authored by the Sri Lankan Government, and a number of studies commissioned by the donor community that, together, provide a basic framework for economic revival. While implementation of previous aid projects has been spotty, the government believes it can improve this record by streamlining tender processes and improving project management skills.
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