Lanka records highest economic growth in three decades

The
8 per cent growth of the Sri Lankan economy during
the year 2010, according to the Central Bank of Sri
Lanka (CBSL) is the highest annual rate of growth
reported in the last three decades. This growth far
exceeds the average annual growth of 4.9 per cent
recorded since the liberalisation of the economy in
1977.

“This remarkable performance was supported
by the restoration of permanent peace, which created
an environment conducive for the expansion in
economic activity, the strong macroeconomic
environment, increased domestic demand, the
development of infrastructure facilities, and
improved external demand with the gradual recovery
in the global economy and favourable domestic
weather conditions,” the Central Bank said at the
release of the 2010 Annual Report last week.

According to the CBSL, all key sectors of the
economy demonstrated a commendable performance in
2010, underpinned by the peaceful domestic
environment, improved investor confidence,
favourable macroeconomic conditions and gradual
recovery of the global economy from one of the
deepest recessions in history.
Here is an extract from the Overview Section of the
2010 Annual Report.

Inflation
Inflation continued to remain low at around
mid-single digit levels and the benign outlook for
inflation enabled the Central Bank to ease its
monetary policy stance further in 2010. While
significant demand pressures were absent, improved
domestic supply conditions, downward adjustments of
certain administered prices and the reduction of
import duties on several consumer items had a
favourable impact on prices.
The Central Bank reduced its policy interest rates;
the Repurchase rate and the Reverse Repurchase rate,
with a view to supporting economic activity further.
Market interest rates continued to adjust downwards
in line with the policy rate reductions and the
overall growth of monetary aggregates remained
consistent with the envisaged path. The growth of
broad money was driven by the increase in commercial
banks credit to the private sector reflecting the
broad based demand for credit with the recovery in
domestic economic activity as well as increased
post-conflict capacity expansion.

However, monetary management could be challenging
in the period ahead owing to possible continued high
growth in domestic credit as well as a possible
increase in capital inflows, thus requiring close
monitoring of macroeconomic developments and
formulating appropriate demand management policies
to prevent the build-up of excessive demand
pressures.

Fiscal situation
An encouraging improvement in the overall fiscal
situation was witnessed in 2010 with the recovery in
government revenue supported by the expansion of
economic activity, the addressing of certain
persistent structural issues in the tax system, as
well as the containment of recurrent expenditure.
The overall deficit was reduced to 7.9 per cent of
GDP in 2010 from 9.9 per cent in 2009. The
government has affirmed its ongoing commitment to
fiscal consolidation by reducing the budget deficit
to 6.8 per cent in 2011 and to below 5 per cent in
the medium term.

In line with the recommendations of the
Presidential Commission on Taxation, several vital
revisions were introduced to the tax structure
focusing on the simplification of the tax system,
rationalising exemptions, improving tax compliance
and strengthening tax administration. In addition,
steps were taken to streamline the tax concessions
granted under the Board of Investment (BOI) Act
focusing on larger and strategic investments. The
continued fiscal consolidation efforts would
reinforce the conduct of monetary policy in
achieving economic and price stability.

The external sector, which made a remarkable
turnaround since the second quarter of 2009,
continued to improve in 2010. Both exports and
imports recovered strongly, while increased earnings
from the tourism industry and higher inward
remittances offset the widening trade deficit to a
great extent, reducing the external current account
deficit. Increased capital and financial flows
resulted in the balance of payments (BOP) recording
a surplus in 2010, further strengthening external
reserves of the country.

Agriculture
The improved performance in all key sectors of the
economy contributed towards the high economic growth
in 2010. The Agriculture sector, which contributed
around 11.9 per cent of the GDP in 2010, grew by 7.0
per cent, compared to 3.2 per cent in 2009, mainly
driven by the increased production of paddy, tea,
rubber and minor export crops along with significant
improvements in the fisheries sector output.
Benefiting from favourable weather conditions, the
tea sub sector registered the highest ever annual
production of 329 million kg compared to the
distressed output in 2009, while rubber production
also continued to increase. Export agricultural
crops such as cloves, pepper and cinnamon
contributed positively to the improved performance
in the Agriculture sector.

Within domestic agriculture, paddy production
recorded an impressive growth in 2010 due to
increased extent of cultivation particularly in the
Northern and Eastern provinces, favourable weather
conditions and the continuation of agriculture
support schemes. Coconut production declined
significantly by 19 per cent in 2010, and sugar
production also recorded a marginal decline. The
significant expansion in fishery activities in the
Northern and Eastern provinces largely contributed
to the increase in fish production by 12 per cent in
2010, while domestic milk production increased
notably with the committed efforts to enhance
domestic milk production.

Industry
The Industry sector grew by 8.4 per cent supported
by increased domestic and external demand with
enhanced investor and consumer confidence. Improved
performance in industries, such as food and
beverages, rubber based products, textiles and
garments coupled with increased performance in the
construction sector and increased hydropower
generation contributed to this growth. The share of
the Industry sector in total GDP increased
marginally to 28.7 per cent in 2010.

Factory industry, which contributed approximately
54.6 per cent to the total industry output, recorded
a 7.5 per cent growth during 2010. The textile,
wearing apparel and leather products category, which
was adversely affected by the global economic
crisis, showed signs of recovery during the last
quarter of the year despite the withdrawal of GSP+
concessions effective from August 2010. The apparel
industry remained competitive through increased
productivity, improved quality, diversification and
gradual recovery in external demand.
The high growth in food, beverages and tobacco
products category, which accounts for nearly 48.0
per cent of the total factory industry output, was
driven by the expansion in domestic demand
particularly from the Northern and Eastern provinces
and increased tourism-related activity during the
year. The major contributors to the increased output
in export market oriented industries were ship
building and repairing and transport equipment and
machinery.

The non metallic mineral products category also
performed well during the year with high demand for
cement and building materials. The substantial
improvement in hydropower generation raised value
addition from the electricity sector, while the
construction sector expanded by 9.3 per cent with
the continuation of major infrastructure development
projects as well as increased construction activity
in the private sector.

Services
The Services sector grew by 8.0 per cent in 2010.
The wholesale and retail sub sector, which accounts
for the largest share in the Services sector, grew
by 7.5 per cent with increased external trade
withthe gradual recovery of the global economy and
domestic trade with the restoration of peace.The
hotels and restaurants sub sector grew sharply by
about 39.8 per cent underpinned by the strong
performance in tourism. Other major sub sectors such
as transport and communications, and banking,
insurance and real estate also recorded
significantly higher growth rates compared to 2009.

The transport and telecommunications sector grew
with the improved performance in transport, cargo
handling, aviation and telecommunications sectors.
The banking, insurance and real estate sub sector
expanded
with increased income from investments and lending
activities, foreign exchange operations and widened
financial services through the expansion of bank
branches and other service outlets.

Reflecting the recovery in economic activity,
consumption expenditure increased by 14.9 per cent
in 2010, while savings and investment of the country
also recovered. As a percentage of GDP, private
consumption increased from 64.4 per cent in 2009 to
65.8 per cent in 2010, while government consumption
declined from a high level of 17.6 per cent to 15.6
per cent. Both domestic savings and national savings
increased, from 17.9 per cent of GDP and 23.7 per
cent of GDP, respectively, in 2009, to 18.7 per cent
and 24.7 per cent, respectively.
Private investment recovered from 17.9 per cent of
GDP in 2009 to 21.6 per cent in 2010, while public
investment declined marginally from 6.6 per cent of
GDP in 2009 to 6.2 per cent in 2010, and as a
result, total investment as a percentage of GDP in
2010 increased to 27.8 per cent. The recovery in
total investment resulted in widening the national
savings and investment gap to 3.1 per cent of GDP,
which was reflected in a higher deficit in the
external current account.

External Sector Developments
External trade rebounded strongly in 2010, reversing
the sharp contraction observed during the global
recession of 2009. Earnings from exports increased
by 17.3 per cent, reflecting higher earnings from
the industrial and agricultural sectors. Expenditure
on imports grew by 32.8 per cent, led by
intermediate goods imports. As a result, the trade
deficit expanded to US dollars 5,205 million in
2010.
Although export earnings were volatile in the early
part of the year amidst uncertainties regarding the
global recovery, they improved towards the latter
part of the year, indicating a new growth path,
despite the withdrawal of GSP+ concessions. This
reflected the peace dividend and the dynamism of
local exporters. Meanwhile, international commodity
prices rose due to the global economic recovery,
higher demand for commodities from emerging
economies, and global supply constraints.
Consequently, agricultural exports continued to
fetch high prices in the international market.

Higher commodity prices, particularly crude oil
prices, caused expenditure on imports to increase in
2010. Imports of consumer durables, such as personal
motor vehicles and electronic goods also increased
following the tariff reductions and the increase in
domestic economic activity. Similarly, imports of
investment goods also increased in 2010, led by
higher expenditure on imports of machinery and
transport equipment.
External trade in services improved significantly
generating a higher surplus during 2010, while the
income account continued to record a deficit. All
sub sectors of the services account, mainly
transportation, travel, computer and information,
construction and insurance services, performed well
during the year.

Workers’ remittances
A substantial increase in inward workers’
remittances to US dollars 4.1 billion helped offset
the trade deficit to a great extent in 2010. As a
result, the external current account recorded a
deficit of US dollars 1,498 million or 2.9 per cent
of GDP in 2010. The current account deficit widened
due to a large trade deficit, as a result of an
increase in import demand supported by the recovery
of domestic demand and expansion of economic
activity. Inflows to the capital and financial
account exceeded the current account deficit.

Balance of payments
In 2010, the BOP recorded a surplus of US dollars
921 million, following a significantly higher
surplus of US dollars 2,725 million in 2009. Higher
inflows to the capital and financial account, which
exceeded the current account deficit generated the
surplus in the overall balance of the BOP.
The financial inflows to the government as well as
to the private sector for long term investment
contributed to the surplus in the BOP.

External reserves
The external reserves of the country further
improved to record its highest level in 2010.By end
2010, gross official reserves (excluding ACU
receipts) increased to a record high level of US
dollars 6,610 million (equivalent to 5.9 months of
imports) compared to US dollars 5,097 million at end
2009. Higher disbursements of project financing,
continuation of the IMF-SBA facility, the proceeds
from the third international sovereign bond issue,
and the absorption of foreign exchange from the
domestic foreign exchange market contributed to the
buildup of reserves.

Meanwhile, total external assets (excluding ACU
receipts) increased by 19 per cent to US dollars
8,035 million by end 2010 (equivalent to 7.1 months
of imports), compared to US dollars 6,770 million at
end 2009.
Fiscal Sector Developments
Government expenditure was maintained within the
original budgetary targets for 2010 with the strict
monitoring of recurrent expenditure, while
maintaining capital expenditure for the accelerated
implementation of planned infrastructure projects.
Total expenditure and net lending declined from 24.9
per cent of GDP in 2009 to 22.9 per cent of GDP in
2010. The reduction of total expenditure and net
lending by 2 percentage points was the combined
outcome of a reduction in recurrent expenditure by
1.5 percentage points and capital and net lending by
0.5 percentage points.

Concerted efforts taken to rationalise recurrent
expenditure enabled government expenditure to be
contained within the original budgetary allocations,
while the public investment programme was carried
out largely unhindered.
Total net domestic financing in 2010 amounted to 3.6
per cent of GDP, while net foreign financing was 4.4
per cent of GDP, which consisted of foreign loans
(3.5 per cent of GDP) and foreign investments in
government securities (0.9 per cent of GDP).
Meanwhile, the outstanding government debt to GDP
ratio declined from 86.2 per cent in 2009 to 81.9
per cent in 2010 mainly due to a lower budget
deficit and higher growth in nominal GDP.

Monetary Sector Developments
With the reduction in both the Repurchase rate and
the Reverse Repurchase rate by 25 basis points in
July, and a further reduction of the latter by 50
basis points in August, the policy rate corridor was
narrowed, and by end 2010, the Repurchase rate was
7.25 per cent, while the Reverse Repurchase rate was
9.0 per cent. Policy rates were reduced again in
January 2011, narrowing the corridor further, which
has since remained bounded by the Repurchase rate of
7.0 per cent and the Reverse Repurchase rate of 8.50
per cent.

Excess liquidity
Following the turnaround in rupee liquidity in the
domestic money market from mid 2009, the money
market liquidity continued to be in excess in 2010.
The build-up of excess liquidity was largely due to
the absorption of foreign exchange inflows to the
country by the Central Bank with a view to
preventing an undue appreciation of the rupee. The
issue of the sovereign bond in October to
international investors, net foreign investments in
Treasury bonds and Treasury bills, and other inflows
of foreign funds to both the government and the
private sector, resulted in the excess of foreign
exchange in the domestic foreign exchange market
during the first three quarters of the year.

Financial Sector
The banking network further expanded with the
establishment of 85 branches, 97 extension offices
and 130 automated teller machines (ATMs).With regard
to non bank financial institutions, the registered
finance companies (RFC) sector gradually recovered
in 2010 after experiencing liquidity problems in
2009. Timely measures implemented by the Central
Bank restored depositor confidence in RFCs.
Specialised leasing companies (SLCs) continued to
grow in 2010 with an improvement in credit quality
and favourable provisioning for bad and doubtful
accommodations. Key financial indicators of the
primary dealers in government securities improved
during 2010, while risk management indicators were
maintained within prudent levels.
The insurance sector also reported improved
performance in 2010. The Central Bank further
strengthened its supervisory and regulatory
framework to improve the soundness and risk
management systems of banks. The new regulatory
measures introduced included the increase in the
minimum capital that is required to be maintained by
licensed commercial banks (LCBs) and licensed
specialised banks (LSBs), on an annually staggered
basis from 2010 to 2015; the implementation of a
mandatory deposit insurance scheme, the reduction of
the required level of general loan loss provisions;
the application of the assessment of the fitness and
propriety to officers performing executive
functions; the requirement for unlisted locally
incorporated private banks to obtain a listing on
the Colombo Stock Exchange (CSE) by 31 December
2011; and the issuing of Directions on outsourcing
of activities.

Outlook
In 2010, the first full year of operation subsequent
to the ending of the three-decade long conflict, the
economy of Sri Lanka has displayed its true
potential, with impressive macroeconomic
achievements. The challenge for policymakers today
is to sustain these achievements with macroeconomic
stability in the face of more frequent internal and
external shocks. While appropriate demand management
policies are required to maintain low and stable
inflation, effective addressing of supply-side
impediments is also needed.
The continuous advancement of productivity, the
adoption of new technology and human capital
development would reduce the pressure on the labour
market, while improvements to physical
infrastructure and appropriate changes to the
regulatory framework need to be pursued to
facilitate greater labour mobility as well as
greater labour availability to maintain the expected
high growth. The diversification of exports, in
terms of products and markets, is needed to increase
the resilience of the economy to external
disturbances, and to this end, the effective
utilisation of existing bilateral and multilateral
treaties and actively pursuing the establishment of
further trade relations with emerging regional
markets as well as promoting private sector
investment and strengthening the “Doing Business”
environment are necessary.

The impact of disturbances arising from adverse
external developments including price movements of
commodities such as crude oil, could also be
lessened through the implementation of necessary
reforms to the institutional framework of key public
enterprises to operate them more efficiently and in
a commercially sustainable way to reflect market
conditions. These changes will support the ongoing
fiscal consolidation process, which would in turn
strengthen demand management policies.

Compiled by Azhar
Razak

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