Country Report Sri Lanka
On the economic front, Sri Lanka is performing relatively well. Growth is holding up strongly and the balance of payments is improving. The increasingly authoritarian style of the Rajapaksa government is, however, less positive news.
Strengths (+) and weaknesses (-)
(+) Improving economic prospects
Since the end of the civil war (2009), economic prospects have continued to improve – along with the growth rate - and strategic economic development projects will support future growth.
(-) Unhealthy fiscal position
Sri Lanka’s public debt is very high at 78% of GDP, while the government is running a budget deficit of around 6% of GDP.
(-) Weak current account external liquidity
The current account and trade balances are persistently in deficit. Foreign exchange reserves are relatively low, covering some 4 months of imports and about 140% of annual debt servicing costs.
(-) Increasingly authoritarian government
The Sri Lankan government, led by president Rajapaksa, is becoming more and more authoritarian, which is leading to increased social tensions.
1. Relatively strong and stable economic growth
GDP growth has been relatively strong and stable since 2010, ranging between roughly 6% and 8% a year. In 2014 and 2015, real GDP growth is estimated at slightly above 7% (figure 1). Private consumption growth, which is supported by increasing incomes as well as stable remittances inflows, is one of the main growth drivers. In addition, investment growth has also been strong and stable, partly on the back of infrastructure investments that are needed to make up the investment backlog incurred during the civil war. Investment growth is, however, expected to slow gradually in the years ahead. Point of concern is Sri Lanka’s weak public finances. Public debt amounts to 78% of GDP and the government runs persistent budget deficits of around 6% of GDP. The deficit is expected to narrow slightly in 2014 and 2015, mainly as taxes on specific sectors, such as the financial and telecommunications sectors, have been raised. Government spending, however, continues to grow and to structurally improve the government’s financial situation, food and fuel subsidies will have to be reduced or eliminated. This would be a politically sensitive reform that would also increase inflationary pressures. Fiscal consolidation and public debt reduction is becoming more and more urgent, as the government is slowly shifting from relying on financing on concessional terms to financing on commercial terms. Inflation, meanwhile, has been relatively low this year, which has increased pressure on the central bank to loosen monetary conditions. The current monetary stance is supportive of growth and has led to a reduction of lending rates. However, concerns about price stability are emerging. The Sri Lanka rupee continues to depreciate, which increases imported inflation, while a drought will push up food prices in the coming months. Average inflation may therefore exceed the currently estimated 4.1% in 2014.
2. Current account
The current account has improved in recent years, narrowing from 6.8% of GDP in 2012 to 4% in 2013 mainly on the back of a decreased trade deficit. In 2014 and 2015, a current account deficit of around 2.5% of GDP is expected (figure 2). Government intervention, such as increased tariffs and the taxation of gold imports with a 10% charge have been part of the reason for the improvement. FDI inflows are also picking up gradually. This year, FDI inflows are expected to amount to 1.7% of GDP, up from 1.4% in 2013Moreover, portfolio and debt inflows have also increased, which has, in turn, led to an increase of the level of FX reserves. As a result, the country’s external liquidity position improved. Even so, Sri Lanka’s external (liquidity) position remains rather fragile. Total FX reserves amount to roughly 27% of total external debt and cover about 140% of annual external debt servicing costs, while the liquidity ratio is only just above 100% at 106% in 2013 and an estimated 109% this year.
3. Increasing authoritarian tendencies are likely to lead to increasing social tensions
The government, led by President Rajapaksa, is becoming more and more authoritarian. In 2010, the UPFA government used its majority in parliament to increase the power of the president, to reduce checks and balances and to scrap the maximum terms a president can be in office. Supreme Court judges have been impeached on dubious grounds and the media, particularly media that is critical of the government, is repressed. Social differences are exploited by the government. The minister of defence, the president’s brother, is for instance linked to extremist Buddhist groups, which have stepped up their attacks on Muslim minorities. Meanwhile, the military is becoming more and more invested in the economy, especially in the tourism sector, thereby crowding out the private sector. Nevertheless, the president and the government remain very popular with the majority of Sri Lankans and the opposition is weak and fragmented. It is therefore likely that President Rajapaksa will easily win the 2016 presidential elections and that his family’s hold on power will increase further in the years ahead. However, this will also imply that social tensions, which are starting to come to the surface, are likely to increase in the coming years.
Sri Lanka, formerly called Ceylon, was a British colony from 1815 to 1948, when the island gained independence. In 1972, the island was renamed Sri Lanka and became a republic. Sri Lanka is a parliamentary democracy, with the presidency as the main seat of power. Since 2005, Mahinda Rajapaksa of the Sri Lanka Freedom Party (SLFP) has been president. The president and his government enjoy strong support of the population, partly due to the fact that his government ended the three decade long civil war in 2009. The next parliamentary and presidential elections are scheduled in 2016. There are two main ethnic groups in Sri Lanka; 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. The civil war ended when the government conclusively defeated the Tamil Tigers in 2009. The civil war greatly hampered the economic development of Sri Lanka. Since the end of the civil war, poverty figures have declined significantly. In 2013, roughly 4% of the population lived on less than USD 1.25 per day, compared to 15% in 2007. Sri Lanka scores moderately on social indicators, except the Press Freedom Index, which ranked Sri Lanka 165 out of 179 countries due to suppression of the media, especially media that is critical of the government. Tourism, the textile and apparel industry, and tea production are Sri Lanka’s most important economic sectors. India is Sri Lanka’s main import partner and Sri Lanka has a bilateral free trade agreement with its big neighbour.