Sri Lanka
By - Dr. Yeah Kim Leng (PhD) Chief Economist
2010 April 2010 April February2011 2010 November

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Sri Lanka’s Economic Outlook 2012
ReGLocal Team
Kuala Lumpur Dr. Yeah, Kim Leng (PhD) Group Chief Economist (603) 7628 1010 Kristina Fong Senior Economist (603) 7628 1080 Jason Fong Economist (603) 7628 1703 Barry Ooi Economist (603) 7628 1106 Colombo Adrian Perera Chief Executive Officer (94) 11 259 6099

Strengthening domestic resilience against global headwinds

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Mounting risks economies against recovery momentum of developed

After having rebounded strongly from the global financial crisis with a 5.1% expansion in 2010, the global economy has hit a soft patch this year. Uncertainties arising from the ongoing sovereign debt crises in the Euro zone, together with the anaemic growth of the United states (“US”) and Japan, have raised concerns that the global economy may be heading towards a more pronounced slowdown in 2012, with a higher risk of either ”stall speed” growth or a “double dip”. In particular, the US continues to deal with persistently high rates of unemployment. We thus expect the American economy to only post a sub-par expansion of 1.5%-2.0% this year, despite the Federal Reserve’s efforts to inject liquidity into its system. Moreover, the situation in the Euro zone has become more worrying of late; substantial downside risk remains in the face of a possible intraregional debt-crisis contagion, which may prompt even rasher growthretarding austerity measures. As such, we expect economic growth for the 17-member European Union (“EU”) to stall in the coming year. The softening global economy in 2H 2011 and the elevated risk of a ”double dip” going into 2012 reinforces the importance of developing economies, especially the more export-dependent ones, shifting to domestic demand to sustain their growth momentum. Concurrently, they also have to look at ways to further boost intraand inter-regional trade and investment, to offset the weak and volatile demand from advanced economies that is envisaged to persist through the next several years.

Sri Lanka growing from strength to strength – expected to achieve 7.8% growth in 2011, 7.6% in 2012
Sri Lanka charted resilient growth in 1H 2011, clocking up 8.0% yearon-year (“y-o-y”). We expect this momentum to continue in the second half of the year, on the back of strong levels of industrial and service activities and also bolstered by robust private consumption. This underpins our projection of a 7.8% expansion for 2011, albeit tempered by the downside risk from the uncertain external environment. In 2012, we expect the Sri Lankan economy to post a slightly above-potential growth of 7.6%, on the back of continued capacity-building activities. The services sector remains a key contributor to the economy, accounting for 59.3% of Sri Lanka’s GDP in 2010. Given the resilience of the domestic-driven services industry (against falling prices of


Economic Outlook

communications-related services and the rising importance of the financial sector), the services sector is forecast to achieve a growth of 8.3% in 2011, followed by 8.0% in 2012. Compared to the services sector, the industrial sector has failed to expand significantly in the last couple of years after the end of the country’s ethnic conflict. This is because more extensive infrastructure development is required for any substantial increase in industrial activity. As capacity-building remains among the main themes for post-war liberalisation, we expect the construction sector to sustain its momentum in the foreseeable future. This growth will also keep fuelling demand for minerals and other materials used in construction. We thus expect the industrial sector to record a robust expansion of 8.2% in 2011, with another 8.0% in 2012. The agriculture sector has exhibited the most volatile performance amid output shocks arising from inclement weather. Given the resilience of tea and rubber production, however, we project a growth of 4.5% in 2011 and 4.4% in 2012 for this sector.

More robust domestic-driven growth as post-conflict economy strengthens
The sudden rise in preference for consumer durables, formerly viewed as luxury items, and properties is a welcome boon that indicates revived optimism on political and economic stability. We anticipate a full year’s growth of 12.5% for private consumption in 2011, which is seen to taper to a more sustainable 8.8% in 2012. While public investment had helped sustain the Sri Lankan economy through the erstwhile war era, there had also been increasing foreign interest in the country, largely led by India. Fiscal-consolidation efforts have underscored the government’s commitment to macroeconomic stability while boosting investor confidence. Investment activity is expected to accelerate 11.7% this year, followed by 8.1% in 2012. Gross exports have been recovering from the global recession, with imports outpacing exports, driven by strong domestic demand and nation-building efforts. The country’s main export markets are, however, a concern; with the US and EU still mired in stagnation, demand is envisaged to shrink further next year, although the real effect on growth should be minimal as Sri Lanka is not as exportdriven as some of its peers. We anticipate exports to advance 7.2% this year and 3.7% the next while the trade deficit should widen even further, albeit at a slower pace.


As such. as Sri Lanka remains highly sensitive to movements in the prices of energy-related commodities and products – such as automotive fuel and household energy. However. a 29% y-o-y increase.0% for the coming year.Monetary policy remains supportive of growth against unflattering global backdrop The Central Bank of Sri Lanka (“CBSL”) is likely to hold repo rates at 7. which constituted a third of the total value of the country’s imports in 2010. Key risks and challenges The persistent uncertainties plaguing the global economy remain a key downside risk to developing countries. Sri Lanka’s inflation is projected to range around 6. Currently. gradual normalisation may take place on the back of better economic conditions. inflation is expected to chart a similar pattern as movements in global commodity prices due to Sri Lanka’s substantial import exposure to primary commodities – typically related to food and energy.5%-7. as the global economy is expected to deliver a lacklustre performance in 2012.0% in 2012. Under this scenario. particularly in an environment of rising commodity prices and strengthening domestic demand.e. in the form of volatile commodity prices. there is some room for gradual appreciation in the near term. i. While the CBSL is expected to continue controlling the level of the rupee against the US dollar in 2012. This is largely to give the CBSL additional monetary leeway to manage domestic inflation. Going forward. a shift away from such reliance would help to cushion growth prospects in light of the apparent downside risks. Another externally driven shock lies on the supply side. As at end-2Q 2011. to ensure a more sustainable pace of growth over the longer term. Food security is another issue in terms of the susceptibility of food products to fluctuations amid adverse weather conditions. Although this 4 . loans and advances from commercial banks amounted to 27% of GDP. more than half of Sri Lankan exports are still centered on the US and EU markets. with foreign capital flowing in at a sustainable pace. With 15% of Sri Lanka’s food imports derived from India – which has been experiencing significantly high levels of inflation – there is also a risk of upward price pressure through imported inflation. Our base-case scenario assumes mild fluctuations in commodity prices.

Economic Outlook was mainly driven by lower interest rates in early 2011 and more upbeat consumer sentiments. the increasing leverage in the household sector may become unsustainable if real wage does not rise in tandem with the heightened debt levels. the issue of twin deficits remains. It remains imperative that policies address this to keep the country on a sustainable growth path. From a more structural viewpoint. 5 . with both the budget deficit and current-account deficit still significant. On a more positive note. both these balances are expected to show a declining trend as better economic prospects will shift the burden of growth and employment creation to the private sector. on the assumption that the government keeps to its strategy of fiscal consolidation.

The high rate of unemployment (September 2011: 9. the effects of such policies had. Jobs still scarce in US US labour market remains weak. Business sentiment has also weakened as the high unemployment rate presents a baffling “catch 22” situation . much of this recovery can be attributed to significant interventions by policymakers. but demand is weak due to lack of employment.1% expansion in 2010. Apart from depressing consumption patterns over the same period. GLOBAL ECONOMIC CONDITIONS AND OUTLOOK A. the ratio of its work force to the entire population has declined to 58% for more than 18 months. These include the massive USD767 billion economic stimulus programme known as the American Recovery and Reinvestment Act and an extended period of easy monetary conditions. By the first half of this year. the global economy has hit a soft patch this year. World economic prospects – Developed economies facing strong headwinds After having rebounded strongly from the global financial crisis with a 5. This is hardly representative of a healthy economy considering the average pre-crisis ratio of around 63%. for the most part. Uncertainties arising from the ongoing sovereign debt crises in the Euro zone. with a higher risk of either ”stall speed” growth or a “double dip”.1%) and decelerating output growth indicate that the American economy has yet to return to its vibrant pre-crisis state. after several quarters of sustained economic recovery since mid-2009. epitomised by the Federal Reserve’s controversial USD600 billion asset-purchase programme – colloquially known as the second Quantitative Easing programme or QE2 – that was initiated late last year. exacerbated by political footdragging The US was able to achieve its pre-crisis level of national output in 2Q 2011. have raised concerns that the global economy may be heading towards a more pronounced slowdown in 2012. With more than 14 million Americans unemployed through most of the post-crisis era. However. together with the anaemic growth of the United states (“US”) and Japan.I. the jobless masses have also exerted tremendous pressure on public finances through diminishing income-tax revenue and heftier unemployment benefits through government entitlement programmes. The prolonged scenario of weak labour-market conditions has kept some 6 million people unemployed for more than 27 weeks – what the US Bureau of Labour Statistics (or BLS) defines as “long-term unemployment”. diminished. 6 .firms are unlikely to hire because of poor consumer demand.

Economic Outlook Figure 1: Labour-market indicators in the US Source: US Federal Reserve Moreover. both the upside and downside risks to this forecast hinge on the ability of the American political machinery to redouble its efforts to restore sustainable economic growth in the coming months. in turn. Jobless individuals are likely to lose their primary wage skills if they remain unemployed for an extended period.0% this year. its track record of deficit financing has already inflated the American public sector’s debt burden. This indicates that the US is unlikely to implement any effective fiscal policies to rejuvenate its ailing labour market in the immediate term. more sizeable deficit funding through debt. However. With its persistently high rates of unemployment. which can turn into a permanent loss for the economy. This has.5%-2. This weakened state of consumer demand in the US will no doubt affect Sri Lanka’s exports to the world’s largest economy. the latest in a string of paralysing political stand-offs – largely due to ideological differences on debt and deficit levels. A valuable USD447 billion job-stimulus plan proposed by President Obama had been jettisoned in Congress. despite the Federal Reserve’s efforts to inject liquidity into its system. Restoring America’s labour market to its pre-crisis state would entail further job-creating policies and. we expect the US economy to only expand at a sub-par pace of 1. become a substantial bargaining chip between the 2 major political parties since the debilitating financial crisis – culminating in a month-long debate before the almostimminent breach of the Congress-set debt ceiling in early August. long periods of high unemployment rates may have a severe structural impact on the economy. That said. 7 . by extension.

as evidenced by the increasing spreads in their sovereign yields against the region’s benchmark German bunds. Undoubtedly. target a higher inflation rate to reduce real repayment costs. such as Spain and Italy. such policies – such as raising taxes and cutting government spending – will have the effect of dampening economic growth.e.e. Figure 2: Fiscal characteristics of selected European economies Source: International Monetary Fund (“IMF”) and RAM Economics Note: Data represents projections for 2011 by the IMF 8 . i. various fiscal-reform pledges have been announced to soothe investors. these countries have the dubious combination of relatively substantial current-account and fiscal deficits as well as spiralling public debts. Portugal and Ireland) have intensified to such an extent that further deficit financing by these countries is just not possible without tapping the €440 billion European Financial Stability Fund. As Greece receives an additional €109 billion bailout to keep it fiscally solvent in the near term. they are unable to unilaterally dictate their exchange rates. However. Furthermore. Larger economies. being part of a monetary union limits the options they may have to counter the run on confidence. investors’ lack of faith in the sovereign debt papers of these economies is not unfounded. Given the limited options available to these debt-laden economies.Europe – falling dominos No end in sight for Europe’s debt woes. have also not been immune. and could even increase their relative debt burdens as national production would be unable to keep up with fiscal financing requirements. contagion fears not unfounded The European sovereign debt crisis has yet to reach its nadir since the beginning of 2010. fears of a run on confidence in other peripheral economies (i. An excess of any of these characteristics can be detrimental to a sovereign’s repayment aptitude. or impose capital controls to limit speculative flows.

0 2. together with a more gradual approach to fiscal discipline.5 -2.1 -0. but possible.2 2.5 0. Lack of growth will be compounded by the tightening of interest rates by the region’s monetary authority – the European Central Bank (“ECB”) – earlier this year. Overall production capacity has been severely reduced amid the loss of lives and physical capital. this may prompt even rasher growth-retarding austerity measures. regardless of the present level of fiscal sustainability.5 1.1 2.9 -4.5 -3. the 9 .4 -3.0 0. The slim. this had immediately disrupted the supply chains of higher-end manufactured goods in the AsiaPacific region – especially in automotives and electronics. Japan – a seismic change Supply chain has recovered but appreciating yen hinders Japanese recovery and growth The Great East Japan Earthquake on 11 March this year has extended Japan’s recession (2Q 2011: 1. If the region’s debt concerns persist.5 0.0 -2.3 2. we expect economic growth for the 17-member euro area to stall in 2011.7% growth) and may ignite further loss of confidence in the other economies within the region.5 -1.6 Source: IMF World Economic Outlook update Consequently. upside to this glum scenario is a coordinated policy effort (such as implementing a politically distasteful region-wide fiscal union) that could restore investor confidence in the region’s sovereign bonds.1 1.8 Output gap (as % of potential GDP) -3.5 2. thereby further suppressing global investment activity.0% contraction). these factors are likely to prolong the region’s current slowdown (2Q 2011: 1. Table 1: IMF projections on output and inflation for selected European economies in 2011 GDP (annual change) France Germany Greece Ireland Italy Netherlands Portugal Spain 1. As Japan is the technological leader in the eastern hemisphere. growth momentum will largely depend on the degree of fiscal austerity implemented by each nation.8 Inflation (annual change) 2.8 -6.Economic Outlook Individual countries’ growth rates are expected to be divergent within Europe itself.4 2. However.0 -0. business sentiment could deteriorate and may heighten risk aversion. There is substantial downside risk as the threat of the intraregion debt-crisis contagion is still highly plausible.6 2. Together.

Trade and Industry (Japan) and Ministry of Land. At its peak (on 9 September).3% to its overall GDP performance in 2Q 2011 – making it the key culprit of its economic contraction. if somewhat muted. If historical data is any judge. Additionally. the negative price effects arising from the persistent appreciation of the Japanese yen has not helped. We expect the Japanese economy to record a marginal growth of up to 0. Upside potential hinges upon the success of the planned 800 billion yen debt issuance to fund reconstruction and help companies cope with the strong yen. 10 . The yen is likely to experience further upward pressure. in a bid to weaken its currency. Japan certainly has the capacity to rebuild. the yen had appreciated nearly 8% against the USD since the start of the year. Despite the pressing need for largescale rebuilding efforts and the massive liquidity injections by the Bank of Japan.5% in 2011. Much of Japan’s growth in the second half of this year will depend on the pace of reconstruction and its export sector. recent weaknesses in the other advanced economies have pushed up the Japanese currency. Infrastructure and Transport (Japan) Japan’s net exports provided a negative net contribution of 1. Nonetheless. and a dramatic turnaround in global economic conditions. largely due to the US’s continued easy monetary policy and the worsening of the European sovereign debt crisis. the effects of the shock had been felt by the entire East Asian manufacturing sector throughout 2Q 2011.regional supply chain has since recovered. with manufacturing regaining nearfull capacity. Figure 3: Japan’s construction-related indicators Source: Ministry of Economy. the signs are only slightly encouraging. While this can be attributed to worsening demand conditions in the other advanced economies and the nation’s internal supply shortfall since the earthquake. This had prompted up to 2 policy interventions in as many weeks by Japan’s Ministry of Finance.

imported inflation has likewise eased.a substantial component in the nation’s Consumer Price Index (“CPI”) – which accelerated to a 2-year high in July. coupled with appreciation of the Yuan. divergent global growth prospects. rising inflation (September 2011: 6. China’s rate of inflation is expected to slow down in the coming quarters. inflation has remained relentless. such as reducing access to loans and improving physical supply constraints. Furthermore.1%) has become a concern for the world’s second-largest economy. This is most evident in the prices of food . but inflation fears persist China’s economy expanded 9. with gradually retracing global commodity prices and the appreciating Chinese Yuan. relatively easy liquidity conditions in the advanced economies and intermittent internal supply disruptions. 11 . Figure 4: China’s inflation and wage indicators Source: National Bureau of Statistics (China) and RAM Economics In recent months. its preference for a managed exchange rate. The cooling measures employed by the public sector.a remarkable achievement given its sheer size.Economic Outlook China – growing pains China still expected to drive global economy. However. The latest bout of inflation in China is due to a combination of rising income.5% in 1H 2011 . The effects of these measures are already evident in the country’s decelerating manufacturing pace – as measured by its Purchasing Managers Index (or PMI) – and slower loan growth. While various monetary and capital controls have been frequently employed in the last 2 years since the ostensible end of the global financial crisis. This. has dented China’s export competitiveness. the persistent rise in prices has pushed up nominal wages – particularly for the export-oriented manufacturing sector – despite the inherently vast labour supply within the world’s most populous country. have helped curb price increases. In view of this.

such as the faster-growing economies in Asia. with threat of minor volatility in short term For the better part of 1H 2011. inflation could substantially disrupt growth if price hikes are persistent. Global financial conditions – shaken and stirred Capital flight to quality a distinct possibility. triggered another round of capital flight to safe assets. especially given the continued expansion of its middle-class population. when the US averted an imminent debt default via a literal eleventh-hour deal. in turn. the sovereign debt crises raging on both sides of the Atlantic had frayed the nerves of many participants in the global financial markets. The haphazard nature of the deal had led to a downgrade of its sovereign credit rating by one of the 3 prominent international credit-rating agencies. Nonetheless. China’s growth prospects are expected to remain intact this year (RAM Economics’ forecast: 9. The sustainability of China’s growth is of significant concern to Sri Lanka as the former has become a major exporter to the latter and a driving force behind global growth. for instance. there is a distinct possibility that capital may flow to markets where returns are higher. the price of gold had shot up nearly 30% over the same period. This had been exacerbated by the end of easy liquidity as the Federal Reserve’s QE2 programme came to a close in June and the tightening of the key policy rate by the ECB. The Federal Reserve’s pledge to hold US interest rates at near-zero 12 . which ironically included the very asset that had had its credit rating downgraded earlier.Consequently. In the course of these events. Likewise. Figure 5: Indicators of US financial volatility and gold prices Source: Bloomberg With risk-averse behaviour permeating the capital and financial markets in the advanced economies. sovereign debts and currencies that are not denominated in euro had also appreciated markedly. The downgrade had. there had been a flight to safe-haven assets.0%). This had reached a tipping point by early August. which had in turn dramatically propelled the prices of commodities such as precious metals.

which may affect growth in the short term. capital flows. The failure of the 12-member Organisation of PetroleumExporting Countries (or OPEC) to reach an output quota at its semi-annual meeting had exacerbated the volatility of oil prices.Economic Outlook levels over the next 2 years is likely to encourage further cross-border capital movements. Smaller risk appetites will inevitably dampen prospects for global investment. Commodities –an oily patch Oil prices expected to trend downwards. Under the circumstances. In light of the above. 13 .6 million bpd and check prices. speculative asset prices and heightened inflationary pressures in rapidly expanding economies with rigid exchange-rate regimes.e. to an average of approximately USD90 for the remainder of the year. we expect only a small degree of financial volatility (i. The degree of volatility in these markets will mainly depend on the near-term growth prospects of the advanced economies. This may translate into mild volatility in global exchange rates. but rice may still face upward pressures Energy prices – particularly oil – had risen steadily since the geopolitical crises in the Middle East erupted in late 2010. before peaking in early May 2011. but rumblings in other oil-producing nations such as Algeria may put a dampener on that. on a scale that is much smaller than what occurred in 2008) through the rest of the year. This particular market is highly volatile as traders had speculated on the potential outcome of the raging crises in the oil-rich region for the most part of the year. Recent developments offer mixed indicators on future movements in oil prices: the resolution of the Libyan uprising should see the country’s output resume at 1. we have revised downwards our earlier forecast on the price of oil.

accelerating domestic inflation in Vietnam may drive up production costs. That said. which may also affect world prices. the price of rice may experience some upward pressure this year due to the internal environments in the 2 largest global exporters of this Asian staple – Thailand and Vietnam. The planned enactment of Thailand’s populist policies – particularly with regard to elevating the price of locally produced rice – may price the commodity out of the export market while the recent floods have decimated output.Figure 6: Oil-price indicator Source: Bloomberg Prices of agricultural produce have been moving in different directions this year due to a host of reasons. substitutability and policy actions. Demand and supply levels seem to be reverting to normal amid less inclement weather while physical supply constraints have become the focus of many policymakers. As the year-end macroeconomic conditions in both countries are far from certain. 14 . especially in foodprice-sensitive China. such as variances in weather patterns. Conversely. it is premature to gauge the overall impact they will have on Asian food prices and inflation.

The softening of the global economy in the second half of this year and the elevated risk of a ”double dip” going into 2012 reinforces the importance of developing economies.Economic Outlook B. with the net effect being a reduction in trade and loss of economic efficiency. At the same time. Volatile financials and commodity prices Depending on the direction. Sharper swings in capital flows As evidenced by the EU’s sovereign-debt contagion effects. not to mention to explore new initiatives with exporting countries to bolster supply. which is envisaged to persist through the next several years. Of particular concern to low-to-middleincome developing economies is that there is a need to increase investment in agricultural production to boost food security. Governments also need greater fiscal flexibility to mitigate sizeable price shocks through the short-term provision of food and energy subsidies. shifting to domestic demand to sustain their growth momentum. magnitude and duration of the swings in commodity prices. especially the more export-dependent ones. emerging financial and capital markets have been roiled by the ”flight to safety” behaviour of global investors seeking the safe haven of USD-denominated assets. Emerging economies have been affected in varying degrees. 15 . they have to look at ways to further boost intra. especially amid disrupted supply caused by natural calamities. depending on the magnitude of the pull-out of foreign capital and the impact on market prices. and also increased global liquidity flows to commodity markets and emerging economies. Implications for developing economies Increased dependence on large emerging economies The Outlook published in 2010 had highlighted the impact of the 2008/09 global crisis on the rebalancing of global demand from the crisis-hit advanced economies to the large emerging economies. A clear lesson from this latest episode of rising global-market volatility is the need to strengthen domestic financing and banking systems.and inter-regional trade and investment to offset the weak and volatile demand from advanced economies. including local currencies. as a safeguard against sharp swings in short-term capital flows. the volatile commodity markets have detrimental effects on producer and consumer countries alike.

1% 7.0% Following on from the robust trend in 2010.4% 7. The establishment of better-quality visitor services and tourist infrastructure.9% 5. forestry and fishing sector charted the poorest growth performance on the back of adverse weather conditions at the beginning of the year. the agriculture.9% 8. Given official estimates of 8. There has also been increased interest in post-war Sri Lanka as a holiday destination in the last 2 years.1% 7.1% -1. experienced a surge in activity.1% GDP 1. The tourism sub-sector.1% for the first half of 2011. with tourist arrivals rising 34.2% 2.0% in 2010. in particular.1% 5.8% this year. Forestry & Fishing 4. Notably.AND MEDIUM-TERM OUTLOOK C. driven by resurgent tourism industry Growth momentum to continue.II.3% y-o-y in the first 9 months of this year. slightly above its potential output level.6% 8.8% 8. We expect the Sri Lankan economy to expand 7. We project a marginally lower growth of 7. SRI LANKA’S SHORT. which had destroyed large tracts of agricultural land and the corresponding produce.4% 5. 16 . with the majority of tourists from Western Europe. given the downside risks of persistent uncertainties in the external environment.8% 6. the services sector maintained its expansionary momentum at 9. has also fuelled the interest in Sri Lanka. such as hotels and dining venues. Services to propel economy.4% 9. Table 2: Economic performance in the first half of the year 1H 2009 2H 2009 1H 2010 2H 2010 1H 2011 Agriculture.0% 8. but tempered by external uncertainties After a robust growth of 8.8% Industry 2.8% 10.6% in 2012. bolstered by healthy private consumption. clocking up an 8.3% growth this year. the Sri Lankan economy maintained its growth momentum in 1H 2011.3% Services 1. we expect its momentum to continue in the second half on the back of its robust industrial and services sectors. i.e.0% y-o-y growth.3% 8. on the back of continued capacity-building activities.

the services sector is forecast to achieve a growth of 8. Needless to say.7 million) in tourism receipts for the first 8 months of this year. followed by another 8.3% in 2011. the tourism industry as a whole is an important driver of services growth and remains one of the chief areas of focus for the country’s development plans. which has proven immensely lucrative given its high-growth stage of development.Economic Outlook Figure 7: Broad view of economic performance Source: Department of Census and Statistics. The latest estimates from the CBSL cite a 49% jump (or USD 521. Moreover. given the continued resilience of domestic-driven services (on the back of falling prices for communications-related services and the rising importance of the financial sector). Sri Lanka Popularity as tourist destination drives services sector The requirement for these services has driven the growth of this sub-sector. with additional allocations to this sector in Sri Lanka’s latest 5-year economic plan.0% in 2012. 17 .

3% in the first half against 8.4% in 1H 2010.7% in 2010.0% and 59.Figure 8: Tourism sector leading the way in services growth Source: Department of Census and Statistics. Sri Lanka Construction subsector propelled industry to record growth The industrial sector has been exhibiting a convincing uptick since the global recession. The industry and services sectors’ shares of GDP are expected to edge up to a respective 29. from 28. this has been driven by mining and quarrying activities. The government aims to lift the industrial sector’s share of GDP to 35% by 2015.7% by 2012. In particular. 18 . more robust demand from the construction sub-sector has been propelling the production of building inputs and materials. expanding 10.

6 3.5 28.5 2.6 11.0 11. Contribution to GDP growth (% points) 2007 2008 2009f 2010f 2011f 2012f C.2 8.0 11.8 Notably.4 2.9 4.9 12.4 Industry 7.5 4.8 6.4 0.4 1.9 11.0 7.5 3.8 6.0 4.8 28.9 0.3 59.3 4. However.0 3.8 0. as more extensive infrastructure development is required for the prominent expansion of industrial activities.0 100.1 5.2 7.5 59.0 100. Share of GDP (%) 2007 2008 2009f 2010f 2011f 2012f Development focused on postwar infrastructure reconstruction 6. Capacity-building remains the government’s focus.0 100.9 59.9 4.5 8.5 0. the industrial sector has failed to chart any significant growth in the last couple of years relative to the services sector.0 7.6 28.6 59. with multilateral grants and loans centred on the building of much-required infrastructure.8 100.6 59.2 28.7 28.3 8. Annual change % 2007 2008 2009 2010f 2011f 2012f 6.0 B. 19 . the latest Global Competitiveness Report by the World Economic Forum shows that Sri Lanka fares quite well in terms of infrastructure development compared to its peers.2 2.1 12.3 8.8 4.4 8.2 3.6 5.8 7.0 100.2 8.0 8.0 Services 7.3 59.8 7.4 2.4 0.4 28.1 1.6 0.Economic Outlook Table 3: Contributions and shares of industries within Sri Lanka’s economy GDP A.5 8.4 7.0 100.0 3.7 1.9 4.6 Agriculture 3.

Sri Lanka Output from the manufacturing sector has been steadily trending upwards since late 2009.such as chemicals. we expect the construction sub-sector to be able to sustain its expansion in the foreseeable future. which has led to a jump in the sales of 20 . In turn. petroleum and rubber products . The principal drivers of this output growth also include the strong uptrend in private consumption. Figure 10: Gradual build-up of the industrial sector Source: Department of Census and Statistics. 2011. with a surge in industrial-based output .Figure 9: Infrastructure status of lower-middle-income countries in South Asia Source: Global Competitiveness Report. this growth will keep fuelling demand for minerals and other materials used in construction.underlining the largest consistent expansion in production. World Economic Forum As capacity-building remains one of the main themes to leverage on for postwar liberalisation.

The devastating floods at the start of this year had destroyed major agricultural areas in the northern and eastern regions of the country while the widespread damage has led to the need for more funds to be allocated for rebuilding purposes.2% in 2011 and 8.0% in 2012. the agriculture sector has exhibited the most volatile growth due to output shocks arising from inclement weather. the industrial sector is still expected to post robust growth rates of 8.Economic Outlook Rising domestic consumption powers manufacturing sector cars and other durable goods. Sri Lanka Agricultural output remains volatile amid inclement weather On the whole. Nonetheless. 21 . Even so. textiles and apparel – which account for over 40% of Sri Lanka’s exports by value – may record less robust growth in the coming year amid softening global demand. Figure 11: Industrial output trends reflective of export-oriented growth Source: Department of Census and Statistics. Such healthy consumption indicates heightened consumer confidence and more employment as well as brighter prospects for the country.

4% in 2011 and 2012 for the agriculture sector. albeit marginally. 22 . has been rising steadily. Notably. however. Figure 13: Agriculture-based production affected by supply shocks Coefficient of Variation Tea: 16% Rubber: 17% Coconut: 21% Source: Department of Census and Statistics. Given the resilience of tea and rubber production. Sri Lanka The agriculture sector is also perceived to carry the highest level of downside risk overall.Figure 12: Performance of the agriculture sector Source: Department of Census and Statistics. Rubber output. Sri Lanka In particular. the sector’s contribution to GDP growth is declining. benefiting from the global shortage of natural rubber that has kept prices lofty while turning it into an attractive agricultural activity.5% and 4. we project respective growth rates of 4. on the other hand. coconut production is perceived as the most volatile when measured by the coefficient of variation. in particular.

Forestry & Fishing Industry Services GDP 7.2% 4.9% 5.5% 5.8% 2012f 4.3% 3.0% 8.0% 7.6% 6.3% 7.5% 8.2% 8.0% 8.2% 3.5% 2010 7.6% Source: Department of Census and Statistics.0% 2009 3.4% 8.0% 2011f 4.Economic Outlook Table 4: Summary of GDP growth by industry 2008 Agriculture. Sri Lanka and RAM Economic Research 23 .0% 8.4% 8.

D.8% in 2012. driven by credit The newfound peace has allowed the country to focus on rebuilding and advancing the domestic economy. the increase in public spending and investment has not crowded out consumer demand and private investment appetite. Consumers have responded favourably to the accommodative interest rates by increasing their appetite for debt (refer to Figure 15). Figure 14: Private consumption provides growth impetus Source: Department of Census and Statistics & RAM Economics Domestic consumption to underpin growth. We thus expect private consumption to advance 12. this pattern should continue in 2012. formerly viewed as luxury items. the economy has rapidly shifted to more sustainable private-sector-led growth. While the quick recovery is not unexpected on the back of the cessation of hostilities. before tapering to a more sustainable 8. Notably. are largely responsible for the change in preferences 24 . Resurgent consumer and investor confidence to further drive domestic demand Sri Lanka’s first full fiscal year untainted by ethnic conflict features a considerable upswing in private consumption and investment. Passenger car sales swelled 155% in 1H 2011. continuing the strong trend of over 100% over the past two half-years. The sudden rise in preference for consumer durables.5% in 2011. Several liberalisation and rationalisation policies by the government. such as significant reductions in import tariffs on vehicles and consumer durables. With interest rates expected to be held fairly steady through the rest of this year and the next. and properties is a welcome boon that indicates revitalised optimism in the country’s political and economic stability.

The industry employs over 30% of Sri Lanka’s work force. the downside risk to private consumption is depressed wages since the start of the year. may also lead to unsustainable private consumption. as more workers return to the labour force and businesses ramp up their hiring to meet the rise in demand. However. public servants and other affected groups through cost-of-living allowances and various subsidies should lead to a sizable increase in public spending.Economic Outlook and demand. as severe flooding at the start of the year had badly affected the country’s rice crop. Depressed wages. combined with the upward trend in credit growth. twice that of the manufacturing and commerce industry. the government’s equally commendable efforts to reduce the cost of living for pensioners. we expect a 11% rise in government expenditure this year. the temporary effects of the shock combined with the government’s efforts on rural aid as well as its land and plantation development agenda should minimise the negative impact on demand. i. However.3%. followed by another 7. Figure 15: Consumer debt propels sales of consumer durables Source: Central Bank of Sri Lanka & RAM Economics Lower real wages may dampen demand Unemployment has eased to an all-time low of 4. In such a scenario.e. Meanwhile. particularly in the agriculture industry.3% the next. 25 .

Proposed developments such as the recently implemented East Reawakening programme should also enable these regions to catch up with the rest of the provinces and help narrow the income disparity within the country. i. the Northern and Eastern regions (refer to Figure 17). Dept. & RAM Economics Public investments centre on developing and reintegrating Northern and Eastern provinces Despite the country’s generally stellar performance throughout 2010-2011. only 2 provinces charted growth last year that surpassed that during 20042008 amid the ongoing civil war then.Figure 16: Trends in labour force and real wages Source: Central Bank of Sri Lanka.e. of Census and Statistics. thereby creating positive spillover effects on employment. These areas ravaged by war have enjoyed significant improvements in their infrastructure following reconciliation. but should taper off slightly for the country as a whole as private investment picks up the slack. Public investment should remain strong in these regions in the near term. availability of credit and the revival of the agriculture industry. 26 .

indicative of a country that is still in the process of rebuilding.Economic Outlook Figure 17: War-torn regions focus of development Source: Central Bank of Sri Lanka & RAM Economics FDI inflows slowed down this year. Investment growth has primarily manifested itself in the construction of non-residential buildings and transport equipment. Even though the number of investment approvals has been lower than anticipated.1% in 2012. largely led by India. it is still expected to fuel the growth of realised investments this year to 11. 27 . with another 8. but domestic private investors expected to step up While public investment had helped sustain the Sri Lankan economy through the erstwhile war era. Fiscal-consolidation efforts have underscored the government’s commitment to macroeconomic stability while boosting investor confidence. Although total realised foreign investments has slowed down over the past year. the lower ratio of FDI to total private investment in 2010 is an encouraging sign that domestic investors are stepping up. there had also been increasing foreign interest in the country.7%.

with the US and Europe still mired in stagnation. Dept. Nonetheless. World Bank & RAM Economics Trade deficit to widen as poor external conditions weaken foreign demand Gross exports have continued recovering from the global recession. However. The country’s main export markets are a concern. demand should shrink further next year. the real effect on growth should be minimal.Figure 18: Investment growth slower but still robust Source: Central Bank of Sri Lanka. of Census and Statistics. We anticipate exports to rise 7. imports still outpace exports. 28 .2% this year and 3. but at a slower pace. driven by strong domestic demand and nation-building efforts.7% the next while the trade deficit should widen even further. with annual growth rates of over 30% nearly every month in 1H 2011. considering Sri Lanka is not as export-driven as some of its peers.

8 2008 7. International Monetary Fund.4 9.Economic Outlook Figure 19: Trade deficit still widening as exports remain focused on developed economies Source: Central Bank of Sri Lanka.2 11.0 1.8 2012f 8. & RAM Economics Table 5: Summary of GDP growth by expenditure component Private consumption Public consumption Investment Exports Imports GDP 2007 3.7 6.4 4.0 6.3 8.2 5.0 8.5 11.5 2010 9.3 -12.3 -9.8 13.8 5.7 7.1 3.6 3.0 7.3 7.0 3.3 0.5 9.5 16.6 29 .8 7.0 11.3 3.0 2009 1.0 2011f 12.1 7.5 9.9 7.7 7.

Additional analysis suggests that the projected growth rate of 7.0% due to growth and inflation concerns The CBSL had reduced its key policy rate – the repurchase or “repo” rate – by 25 basis points (“bps”) to 7. Figure 20: Sri Lanka’s key interest rates As the global economy is expected to deliver a lacklustre performance in 2012.E. This had been aimed at mitigating the economic impact of the floods that had taken place in late 2010. 30 .1% and 9. the prime lending rate for Sri Lanka’s financial institutions had remained relatively stable through this year. implying that industries may face some capacity constraints in the near future. only fluctuating between 9. Accordingly.6% . Monetary policy focused on growth as inflation takes backseat Interest rate likely to be held at 7.00% at its first monetary policy meeting this year. the CBSL is likely to keep interest rates unchanged in the coming year. pre-crisis level.4% following the steady decline since 2009.despite the uncertain global conditions – in 2012 will result in a mild positive output gap for the economy. The deteriorating external conditions – particularly in the US and Europe – and the geopolitical crises in the Middle East in the first half of this year had dimmed domestic growth prospects and subsequently stayed the monetary authority’s hand in normalising interest rates to a higher.

The rupee. which had then triggered a sudden and sharp appreciation for the greenback. being a heavily managed currency against the US dollar. the subsequent downgrading of the US’s credit rating a few days later had caused a flight to quality to – ironically. almost culminating in a default for the world’s largest economy. Furthermore.Economic Outlook Figure 21: Sri Lanka’s GDP growth and estimated output gap Consequently. the CBSL may begin a gradual normalisation of interest rates to ensure a more sustainable pace of growth over the longer term. has only appreciated mildly so far this year. the very asset whose rating had been lowered – more US debt. Although the debt ceiling was eventually raised at the 11th hour in early August. as persistent price hikes may result in significant structural inefficiencies within the economy. The tumultuous year for the advanced economies has caused significant volatility in currency markets. 31 . there has been tremendous pressure for the Sri Lankan currency to appreciate as the US continued its USD 600 billion liquidity programme initiated late last year. However. the mid-year debate on the US’s public-debt ceiling had frayed many investors’ nerves.

the rupee has experienced large and frequent swings in its valuation throughout the year. Meanwhile. Investors’ pessimism on several European economies reached a tipping point in late August. This anticipated appreciation is also supported by the CBSL’s decision to relax its foreign-exchange regulations in June and August. 32 . the inflow of foreign capital into Sri Lanka had also supported its strength against the euro. which implicitly and gradually reduces the country’s reliance on the US dollar in international trade.Figure 22: Movement of the Sri Lanka rupee against the US dollar and the euro Rupee to be allowed some room for gradual appreciation to manage domestic inflation Against the euro. particularly in an environment of rising commodity prices and strengthening domestic demand. the Colombo Consumer Price Index (“CCPI”) grew by 7. finally leading to a dramatic tumble for the euro. there is some room for a gradual appreciation in the near term. particularly after 2 major credit-rating agencies had upgraded its sovereign rating in July. accelerating costs associated with transport as well as housing and utilities became a prominent feature of escalating prices in Sri Lanka this year. While rising food prices remained the primary contributor to inflation. In the first 3 quarters of 2011. This volatility has been largely due to the deteriorating fiscal conditions in Greece and the ensuing inconsistent policy measures announced by various European governments in a bid to prevent a continent-wide run on confidence.3% y-o-y. This is largely to give the CBSL additional monetary space to manage domestic inflation. While the CBSL is expected to continue controlling the level of the rupee against the US dollar in 2012.

the imposition of more stringent capital controls or a renewed pessimism among global investors may reduce the likelihood of this occurring. While global economic growth is expected to stay fragile due to the structural adjustments in the advanced economies. domestic prices had also been affected by other commodity price shocks. such as accelerating food prices in India (which supplies approximately 15% of Sri Lanka’s food imports) throughout the year. While investors’ risk appetite may be tempered by recent events in the advanced economies. stronger consumption and foreign capital inflows Going forward. the combination of relatively low interest rates. transport vehicles – in recent months. This had caused the prices of energy-related commodities or products – such as automotive fuel and household energy – to accelerate substantially in Sri Lanka. a significant amount of global capital has been flowing into higher-yielding emerging economies through most of the year. 33 . which had pushed up energy prices. Another risk factor in Sri Lanka’s inflation is a possible surge in foreign capital flows into the country. These sizeable flows can exert upward pressure on the prices of Sri Lanka’s asset markets. Inflationary pressures persist. with further upside risk from rising commodity prices. world commodity prices will chiefly be determined by the demand from large emerging nations and also supply conditions. rising household wealth and upbeat consumer sentiment may elevate prices. Furthermore. This is evident in the aforementioned increases in the purchases of durable goods – particularly. inflation is expected to chart a similar trend as global commodity price movements due to Sri Lanka’s large exposure to imported primary commodities – typically food and energy commodities that accounted for a third of the total value of the nation’s imports in 2010. That said. On the domestic front. thus accelerating the pace of inflation.Economic Outlook Figure 23: Contributors to Sri Lanka’s inflation This sudden increase had been largely due to the geopolitical crises in the oilrich Middle East and North African region.

5% and 7.6 trillion.3 billion of initial public offerings1. the industry’s loans-to-deposits ratio has reverted back to a more sustainable pace of approximately 75% throughout the year. This represents a significant 29% y-o-y increase that can be attributed to the reduction in interest rates early this year. Figure 24: Commercial banks’ loan indicators Although the rapid loan growth is worrying. 1 Source: Colombo Stock Exchange 34 . Indeed. loans and advances from commercial banks summed up to LKR1. as well as better consumer sentiment. Further evidence of investors’ confidence in Sri Lanka can be seen from its sovereign bond yields. or roughly 27% of Sri Lanka’s GDP. Sri Lanka’s debt market charted its largest-ever annual issuance of LKR15 billion. as investor confidence picked up in line with post-conflict optimism. Last year. the base-case scenario – which assumes relatively mild movements in commodity prices and foreign capital inflows at a sustainable pace – estimates that Sri Lanka’s inflation (as measured by the CCPI) will range between 6. This is likely to dip further as rising risk aversion may slow any immediate or near-term investment decisions. Loans and deposits registered healthy growth As at the end of 2H 2011.Consequently. the amount of deposits has kept pace for the most part. The capital markets experienced a flurry of activity in 2010. the equity market recorded a respectable LKR3.0% in 2012.

Going forward. the yields of longer-tenured Sri Lankan sovereign bonds have fallen. it is still an attractive destination for investors. The underlying potential for growth would imply higher returns and long-term growth for less risk-adverse investors. Sri Lanka’s post-war growth prospects remain relatively robust.Economic Outlook Figure 25: Yield indicators for Sri Lankan government bonds The risk premium – as shown by the yield spread between Sri Lankan and US government bonds – on Sri Lankan government bonds has remained relatively flat this year. implying stronger demand for this particular debt tenure. Flattening yield curve and flat yield spread indicate investors’ improving longterm outlook The shorter end of the sovereign yield curve has risen – relative to the previous year – as unanticipated inflation has caused investors to shift to higher-yielding asset classes. 35 . However. While additional funds are needed for the development of Sri Lanka’s post-war economy. The current premium is significantly lower than that during the height of the civil war in 2009. it also reflects an uptick in long-term investor sentiment in Sri Lanka. prudent use of capital controls may be warranted to ensure that excessive demand does not cause a significant deviation in asset prices from their true fundamental values. Mispricing of assets may cause structural defects in the economy and jeopardise the longer-term growth prospects of the country. and may encourage further capital inflows into the economy. with a small uptick to denote global risk aversion amid the unfolding of world events.

POST-CONFLICT ENVIRONMENT ECONOMIC AND BUSINESS Sustaining growth and macroeconomic stability over the medium term Sri Lanka is expected to record a slightly stronger average growth momentum of 6. The projection compares favourably against those for other similarly rated countries (Figure 26). Both are expected to show a declining trend as brighter economic prospects will shift the burden of growth and employment creation to the private sector.III. foreign-currency ratings by S&P Sri Lanka is expected to show strong improvement in its management of price stability. all of which are expected to also show healthy expansion. its average consumer price inflation is expected to be halved over the next 5 years (Figure 27). 2 key macro challenges remain: the nation’s twin government and current-account deficits.6% throughout 2011-2015. Figure 26: Selected countries’ projected average annual GDP growth through 2011-2015 and per capita GDP in 2011 Source: IMF World Economic Outlook September 2011 and RAM Economics. The higher expected growth will boost Sri Lanka’s standing in terms of GDP per capita among its peers that are rated the same or even a notch or 2 higher. 36 . In this regard. on the assumption that the government maintains its fiscal consolidation. Nevertheless.

Economic Outlook Figure 27: Consumer price trends and projections for Sri Lanka and selected countries Figure 28: Managing twin deficits Source: IMF World Economic Outlook September 2011 and RAM Economics. foreign-currency ratings by S&P 37 .

the widespread practice of modern medicine – which can only be obtained from more developed economies – has been proven to have lowered mortality rates for infants under 5 years of age while helping to prevent deaths associated with treatable diseases. Despite the vast social improvements. Preventing the spread of communicable or easily transmittable maladies as well as the provision of potable water has also extended the average life expectancy of many emerging economies’ populations in the last 2 decades. The Green Revolution – the era when agricultural production had effectively doubled in a short span as a result of better technology from richer nations – is an oft-quoted example of growth-oriented external aid. is the support given to alleviate poverty over the longer term. the sustainability – of ODA in Sri Lanka’s future economic growth. Positive side of foreign aid Proponents of ODA suggest that certain development goals – not just outright wealth generation – cannot be attained without external aid. External assistance is also a prerequisite for more robust production. For instance.Significant reliance on foreign aid . According to the World Bank. advanced economies – to support a country’s growth. There have been some cases where recipients of ODA have used these funds to develop the nation’s primary industries (usually to improve crop yields) or to spur sufficient structural changes to attain longer-term economic goals. such as polio and tuberculosis. This may bring into question the role – or rather. This generally refers to the provision of emergency supplies of food and medicines in a war-torn or disaster-struck country. The first form of foreign aid is classified as humanitarian aid. ODA comes in the form of financial or technical support that develops a country’s physical infrastructure.usually multilateral organisations and large. where relief supplies and personnel are provided to cater for the immediate needs of a nation’s citizenry. Better yields for various crops and more sophisticated farming techniques have improved food security.2 billion of net ODA since 1960. The second form of foreign aid. Furthermore. thus making income inequality even more pronounced. also known as official development assistance (or ODA).need to focus on domesticdriven growth Foreign aid refers to assistance from external parties . especially with regard to health and education. Sri Lanka has received a total of USD18. Typically. there are pockets where poverty has become increasingly entrenched. and would later become a catalyst for some nations to facilitate their economic structural changes – to higher value-added production. such as 38 . education or health systems. Sri Lanka’s economic development still lags behind that of many of its East Asian neighbours.

Benefits of reducing the need for foreign aid Foreign aid is vital for further development of emerging economies. which can result in less-than-effective use of any technical support provided by advanced economies. However. again.deteriorated a country’s long-term growth prospects. left to their own devices. poor technological diffusion – the ability of a country to absorb and learn new technologies – is also cited as a failure of foreign aid vis-a-vis development. While critics of this argument may claim that constant aid flows may be the panacea for this problem. education level and standards of living of a country’s citizens – for developing nations over the past few decades. the main argument against ODA is the inefficiencies in its use. Meanwhile. Besides blunting the effectiveness of these funds within the economy. especially.g. Financial resources. Ineffective use of ODA can also manifest itself in the overprovision of public services e.g. unproductive use of ODA can give investors a dim view of the management of the public sector and may raise the cost of deficit financing in the future. Although there have been success stories among some ODA recipients. which is then stripped to its individual components for resale when repairs are required for the original equipment. Aid in practice The different growth drivers and constraints for each country render it very difficult to estimate the effectiveness of ODA. lopsided trade agreements) in the future. it can propagate economic dependency that can in turn have growth implications (e. as it may promote social instability in the long run. can prove highly inefficient as there is always the possibility of diverting funds from their intended use – whether intentionally (corruption or fraud) or unintentionally (regulatory burden or the cost of bureaucracy). This will. an oversupply of hospitals in a sparsely populated area. literacy. It is especially pertinent when conventional economic thinking half a century ago suggest that economies. inefficiencies can also widen the income-inequality gap and may hamper confidence. Lower-income nations tend to have relatively lower education levels. are able to independently break out of the poverty trap through sufficient savings. retard the country’s growth. but success largely depends on its effectiveness and efficiency On the other hand.Economic Outlook manufacturing – as the demand for agricultural labour become significantly reduced. A common example of this is higher-end agricultural equipment that has been imported into an agrarian-based economy. Besides. there has been an equal number of disheartening episodes where foreign aid has failed or – worse . there have been some general indicators that the overall standard of living for the developing world has improved through decades of foreign aid. The 39 . This is evidenced by the rising Human Development Index – a composite index measuring the life expectancy.

1% are attributable to multilateral donors.4% in 2010. attempts to reign in the budget deficit as a percentage of GDP remains high on the authorities’ agenda. Sri Lanka The value of grants to GDP has been rationalised at a moderate pace over the past few years. In tandem with the country’s heightened budget deficit (expected to reach 6. The heavier reliance on foreign debt financing has also pushed up repayments as a percentage of GDP. 67. The rapid build-up of basic infrastructure requirements in recent years.8% of GDP in 2011) and hefty expenditure requirements. and construction of the requisite infrastructure for clean water. by 2010. subsidised fertilisers and high-yield crop seeds. As the government tries to consolidate its spending and increase revenue to finance its expenditure. this only accounted for 0.3% of Sri Lanka’s GDP. which were apparent in 2011. Sri Lanka and foreign aid Reliance on foreign aid replaced by foreign debt financing. from about 41% in 2007 to 54. Sri Lanka’s external exposure and foreign claims have noticeably increased in terms of net foreign financing as a proportion of total financing sources. putting pressure on widening budget deficit Grants have been on a declining trend with foreign grant receipts declining by 34. has brought about increased multilateral financial support for the island nation. As the value of foreign aid tapers off. such as for flood relief and rebuilding efforts. after the official cessation of the civil war. to 1. of this. 40 .8% in 2010.8% in 2010. Figure 29: Sources of deficit financing Source: Department of Census and Statistics.decades-long ODA debate in both academic and political circles has yet to be resolved and remains inconclusive. There have been some areas where general agreement is required on the extent of aid – such as the provision of basic medicines and the introduction of modern medical practices. Sri Lanka tends to receive ad hoc foreign grants and transfers under specific circumstances.

e. this trend is expected to be maintained. Sri Lanka Robust domestic private consumption should expand income from indirect taxes Part of the strategy for long-term sustainability of government spending is the continued strengthening of viable revenue sources. supported by healthy private consumption. net income and profits). As evident from Figure 31 below. This has been a relatively steady pattern over the past 5 years. 41 . this comes on the back of the country’s robust growth. the value of indirect taxation consistently far exceeds that of direct taxation. although there has been a slight shift to increased contributions from tax revenue derived from income generation (i. reaching 88. Tax revenue forms the bulk of government revenue.7% in 2010.Economic Outlook Figure 30: Level of foreign aid and deficit financing Source: Department of Census and Statistics.

Sri Lanka Improved overall business environment should draw more FDI.Figure 31: Sources of tax revenue Source: Department of Census and Statistics. raise output. The establishment of a more conducive environment to further stimulate domestic sources of growth will be imperative to such efforts. less reliance on foreign monetary assistance and the private sector’s better capacity-building aptitude are seen as positives that propel the economy forward while putting government fiscal balances on a more sustainable footing. The reduction of corporate tax rates and other business taxes may diminish collections of direct taxes in the immediate term but nonetheless. 42 . these structural economic reforms are expected to spur FDI and bolster business activities of the private sector. The improvements have pushed Sri Lanka up 9 notches to 89th position in the latest World Bank Ease of Doing Business Survey. As such. and widen tax base The government’s commitment to reducing the impediments against doing business is evidenced by a number of fiscal and administrative reforms in the past year.

more than half the nation’s exports are still centered on the US and EU markets.while attracting more foreign investment . On a more positive note. Despite these global headwinds.6% on average throughout 2011-2015. the country is anticipated to show strong improvement in its management of price stability while its average consumer price inflation is expected to be halved over the next 5 years. strengthen Sri Lanka’s financing ability . This would boost the country’s standing in terms of GDP per capita among its peers rated the same or even a notch or 2 higher and in turn. Currently. they are expected to moderate next year. Given this. unexpected supply shocks remain of utmost concern to policy makers and industry players.Economic Outlook IV. on the assumption that the government maintains its fiscal consolidation. a shift away from its present dependence will help cushion growth in light of the apparent downside risks. From the domestic viewpoint. SUMMARY AND CONCLUDING OBSERVATIONS The persistent uncertainties plaguing the global economy remain a key downside risk for developing economies.thereby boosting the progress of its economic development. Sri Lanka is expected to sustain a slightly stronger growth momentum of 6. 43 . further policy initiatives are needed to rationalise the government’s moderately high budget deficit. Sri Lanka is highly susceptible to volatile commodity prices (for energy and food). However. Although inflationary pressures have increased this year. Moving forward. both the current account and fiscal deficits are expected to be reduced as brighter economic prospects will shift the burden of growth and employment creation to the private sector. to maintain sustainable growth and achieve the medium-term growth estimates for continued economic development.

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