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Country Report Sri Lanka

Country Report

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Although economic growth in Sri Lanka slowed down last year, elevated inflation remains a concern. While both the budget deficit and the current account deficit declined slightly in 2012, both deficits remain large.

Author: Koen Brinke (intern)

Strengths (+) and weaknesses (-)

(+) Improved economic development after civil war

Since the end of the civil war in 2009, economic growth prospects have significantly improved. Strategic economic development projects are likely to boost the structural growth rate. 

(-) Unhealthy fiscal position

Sri Lanka’s public debt is very high at 78% of GDP. The country recorded a high 6% of GDP budget deficit in 2012.

(-) Weak balance of payments position

The balance of payments position is currently very weak. The current account deficit was almost 7% of GDP in 2012, and the trade deficit was even 13% of GDP. Additionally, Sri Lanka faced notable capital flight. 

(-) Weak external liquidity

Sri Lanka has a low level of foreign exchange reserves, as reserves cover only 3.5 months of imports. This implies a high vulnerability to external shocks. 

Key developments

1. Economic growth slowed down, but is expected to pick up slightly this year

Sri Lanka’s economy grew 6.4% in 2012, after growing 8% in 2011. The slowdown is largely the result of weak external demand, a tightening of fiscal policy and adverse weather conditions. A severe drought in the second and third quarter had a strong negative impact on agricultural production and reduced hydropower generation. Although private consumption growth slowed down, it still accounted for more than half of total growth. For 2013, economic growth is expected to accelerate slightly. Private consumption is  expected to to be the main driver of growth, while exports are likely to fall.

Figure 1: Economic growth slows down
Figure 1: Economic growth slows downSource: EIU
Figure 2: Budget deficit remains large
Figure 2: Budget deficit remains largeSource: EIU

2. Very slow pace of fiscal consolidation

The budget deficit declined to 6.3% of GDP in 2012, down from 6.9% of GDP in 2011, resulting from a small decrease in government consumption. The budget balance is expected to decline slightly further in 2013. Noentheless government expenditure in 2013 is set to increase, as the government is doing large investments in infrastructure to boost Sri Lanka’s structural economic growth. Major infrastructure projects include the construction of new harbors, roads, power plants and irrigation schemes. The public debt stood at 79% of GDP in 2012 and was thus relatively high, particularly when taking into account that Sri Lanka has a small tax basis. Tax revenues as a percentage of GDP have been declining for years and reached a meager 11% of GDP in 2012. Consequently, the government debt to tax revenue ratio is very high (600%).

3. Inflation has risen, but already decelerates

Although economic growth slowed down, inflation rose to 7.5% in 2012, up from 6.7% in 2011. Inflation in the second half of 2012 increased to near double digits. This was due to a large depreciation of the rupee, an increase of  fuel and electricity prices by the government, and a drought which increased food prices. Afterwards, Sri Lanka’s central bank eased its monetary policy stance to spur economic growth, thereby putting additional upward pressure on inflation. The central bank repeatedly cut its policy rates starting from December 2012. The last time was in in May this year, when the central bank cut the repo rate by 50bps to 7%. Despite the easing of monetary policy, inflation fell to 6.1% yoy in July 2013. This deceleration was largely the result of a high base effect in July 2012, when inflation accelerated to 9.9%. A cautious monetary policy stance remains appropriate until inflationary pressures have evaporated.

4. Authoritarian tendencies of the government

Sri Lankan president Rejapakse has been firmly in power since 2010. His rule has become increasingly authoritarian. Although the constitution prescribes an independent court system, the legal system has become increasingly politicized and unreliable. Another critical issue is the poor press freedom. The frequency of attacks on media organisations and journalists in Sri Lanka has increased in recent years. Although the offenders are officially unidentified, opposition media organisations that have been victims of the attacks have accused the military. In June, the Ministry of Mass Media and Information proposed a new code of ethics for all media that prohibites publications that promote “anti-national attitudes” or that may affect Sri Lanka’s foreign relations. The move is seen as an attempt to clamp down on journalist critical about the regime. In addition, the government tends to take a heavy-handed approach to protests. In March, Sri Lanka's security forces blocked hundreds of mostly ethnic Tamils from travelling to Colombo to protest about relatives missing after the war. Inter-communal tensions remain high and could lead to sporadic violent protests. After international pressure to address its poor human rights record, the government has diversified its foreign relations away from Western countries. Both the Sri Lankan army and the Tamil Tigers are accused of committing war crimes during the civil war that ended in 2009. There are fears that the conflict with the Tamil Tigers will return, as political repression of the Tamil community continues. The increasingly authoritarian rule and ethnic tensions could threaten political long-term stability and peace.

Factsheet of Sri Lanka
Factsheet Sri LankaSource: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank.

Background information

Sri Lanka, formerly called Ceylon, was a British colony from 1815 to 1948, when the island gained independence. In 1972 the island was renamed as Sri Lanka and became a republic. Sri Lanka is a parliamentary democracy, with a presidency as the main seat of power. Since 2005, Mahinda Rajapaksa of the Sri Lanka Freedom Party (SLFP) has been president. He has been reelected in 2010. Nearly 70% of the population is Buddhist. There are two main ethnic groups, the Sinhalese and Tamils. The Tamils are a minority group particularly living in the north of Sri Lanka. In 1983 the Tamil Tigers, a separatist militant organisation, started a civil war against the Sinhalese-dominated government to establish an independent state called Tamil Eelam. Almost three decades of civil war ended when the government conclusively defeated the Tamil Tigers in 2009. The civil war greatly hampered the economic development of Sri Lanka. After the civil war, poverty figures have declined significantly. In 2011, roughly 7% of the population lived on less than USD 1.25 per day, compared to 15% in 2007. Nowadays, tourism, the textile and apparel industry, and tea production are Sri Lanka’s most important economic sectors. Textiles and tea are the main export products. These products are mostly exported to the United States and European countries. The openness of the economy is quite low, as exports make up only a quarter of GDP. India is Sri Lanka’s main import partner and Sri Lanka has a bilateral free trade agreement with its big neighbor.Sri Lanka scores moderately on social indicators, except the Press Freedom Index, which ranked Srilanka 162 out of 179 countries.

Economic indicators of Sri Lanka
Data table Sri LankaSource: EIU
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